Why interest rates won’t increase, much - June 2017

Red shoes, walking up stairs

I love throwaway comments about interest rates. We even get them from Government Ministers. Too easily do we allow comments on higher interest rates to stay open ended. What does higher rates really mean, and should we be concerned?

You’re going to continue to hear Australian banks talking up interest rates. That shouldn’t be a surprise. It is getting more expensive for them to write loans but they still need to increase profits. In the past three months, bank share prices have begun falling as the market better understands the headwinds they are facing into.

Recently, there has been noise about the cost of a proposed bank levy (“bank tax”). In the short term these higher costs will push rates up. It will be small incremental increases and nothing startling. When planning your mortgage, I’d assume mortgage rates will increase from rates in the high fours to rates in the high fives. That’s another one percent increase, which is an extra $294 per month on a $500,000 mortgage repaid over twenty-five years.

It’s not the end of the world and not the start of the next great recession – despite all the naysayers out there.

Counterbalancing increasing rates will be more competition. Higher margins will bring new entrants into the market. Competition will put a cap on just how far our banks can increase mortgage rates. Over the next decade “fin-tech” is going to bring a level of competition to banking that we have never seen before.

Global interest rates are still low and the NZ dollar is stubbornly high. The Federal Reserve in the US has bucked the trend and increased interest rates by 0.25% for the second time this year, but that’s in the face of weakening economic data with inflation dropping to 1.9% in the year to May. Yes, these are interest rate increases, but let’s keep in context that they are off extremely low levels.

The main argument for higher interest rates is the return of inflation. Inflation is becoming almost mythical. There is no wage inflation and it’s hard to find inflation anywhere beyond explainable factors like weather or build costs. In my mind, economists are stuck in two-dimensional thinking that is underestimating the accelerating deflationary force of technology.

We also too easily ignore the chokehold that debt has on the global economy. Growth has been funded by debt. So not only are we having to reduce the fuel, but we’re also throwing more of our income at paying it back. We have over consumed now at the cost of future growth. Putting interest rates up will simply starve what little economic growth Western economies have.

Although our reported GDP growth looks strong, it’s not. When you look at it per capita, our growth has simply come from immigration. That’s why wages are going nowhere and will continue to go nowhere.