The RBA Cash Rate
On the first Tuesday of every month the Reserve Bank of Australia (RBA) announces the official cash interest rate. With the current Cash rate at 1.00% and the economy failing to gain strength the, today the RBA dropped the Cash rate to 0.75%
The question is why?
The main purpose of a rate drop is to stimulate the economy. The logic is relatively simple. Low rates on loans mean lower repayments and hence more incentive and serviceability to borrow money now.
However the reality is not so clear cut. Just because the RBA cuts the cash rate, does not necessarily mean that the cut will be passed on to you.
However even saying that isn’t quite accurate because a rate cut can impact you from two different sides.
Loans, Mortgages and Savings
Just because a rate cut happens does not mean you get the benefit of it. Although the RBA can drop the rate, the banks that you loan money from maintain their own interest rates, both for loans and also for savings accounts.
To explain very briefly, even with the RBA cash rate at 1% most bank loans will still be in the territory of 3 – 3.5%.
The interest rates for term deposits and savings accounts will be in the order of 1.25 – 2.25%.
This difference in interest rates is where banks make a fair chunk of their money.
If the interest rate drops further, the place where the impact is seen first is in personal bank accounts where monthly interest will drop and interest on savings drop further. If you’re the person who relies on the savings rate, then a rate drop is the last thing you need.
If the banks decide to hold the interest rates steady on their loans then their margin increases and so does their income. If the rate is passed on to loans, then the chances are you will only see lower repayments if you have the opportunity to refinance or borrow at the ‘new lower’ rate.
But even a lower rate is no guarantee of being able to refinance or get a loan in the first place. After all the banks calculate your serviceability and their risk at a higher rate (6-7%) not at 3.5%. If you don’t qualify then the cuts don’t matter.
Your cash flow matters!
With steady drops in the RBA cash rate, the economy has failed to fire, and the RBA’s one circus trick doesn’t seem to be doing the business, and this only suggests that there are more factors in play.
Irrespective of whether or not mortgages are a factor, Personal debts (bad debts) are a major issue that the public are trying to take care of. It’s no secret that Credit card debts are astronomical and the interest charged for repayments is (by comparison) extremely high, in the order of 20% in some cases.
With the general public trying to get a hold of personal debt, and when the main effort is to pay the banks back the money that is owed to them, it’s no wonder that ‘spending’ is on the decline. When spending falls, everyone suffers. When people try to correct their debts … everyone suffers.
In fact economic stimulation is so important right now, that the government is going to act as guarantor for first time home buyers with only a 5% deposit. Make no mistake. These are big decisions that are being made and come with risks.
When geopolitical factors are taken into account which impact on business models and business operations every day of the week, a simple rate cut looks very short sighted.
How much ammunition is left?
With the decline in interest rates and the economic stimulation failing to roar into life it’s clear there are many other factors that dominate the economic land scape, but each of these impacts on your future.
Personally I don’t find it surprising that people aren’t flocking to go and buy things. The public is concerned about the environment and the bigger issue of getting consumables they don’t need. This hurts (physical/hard) business!
Are people waiting for the bottom? People are very good at waiting and when the interest rates have been declining for such a long period of time, the trend is strong and the public will sit and wait for another few months until the rates drop another step to sure up their cash flow into the future particularly where mortgages are concerned.
Especially if interests drop down to 0.5% or even 0.25% the argument to refinance will be stronger than ever but at this point it has to be noted that when it comes to cutting rates, the RBA only has limited ammunition left.
There is the real possibility that other more powerful options will need to be used such as cuts in Tax rates, but these too come with other effects, and the government wants to reduce its income and leave the economic destiny of the country in the hands of the public as much as it wants to sell its soul to the devil.
The ammunition is starting to run out and there is no resupply coming!
The end goal
Simplistically … the RBA and the government wants you to spend. Keep money circulating in the economy so that businesses remain viable, staff get paid, loans are serviced, etc.
When money circulates with a high speed and frequency of transactions coupled with larger financial transactions taking place, then the economy itself gains power. However like any power equation when the speed and or force behind the power start to decline the economy in this case will begin to lose power and hence strength.
The evidence can indirectly be seen today. With loans being harder to get, more money is starting to accumulate within the banks. With the public trying to service personal debts, money is accumulating in the banks. With the public desperately trying to save, the public is starting to hoard its precious cash, and the first victims are business, the employees and once these heavy dominos fall they become hard to stop.
Low interest rates perform extremely poorly from a saving point of view and the end goal is to have the public understand this following mentality.
“There is no point trying to save, so let’s spend instead”
But if the money is failing to be spent the problem seems to impact everyone.
So after a very long explanation we come to the conclusion. Protecting one self and taking steps for your financial security have never been more vitally important, particularly when the casualties may be so numerous.
With spending seemingly on the decline and the dreaded ‘recession’ word being prepped and loaded into media headlines everywhere ready for final publishing coupled with people’s reactions to bad news, the probability is good that things will get worse before they get better.
Of course I hope I’m wrong!
The need to be in charge of your cash flow has never been greater and with your job potentially at risk, the need to stop relying on a bank and get yourself into position to invest has never ever been more vital.
Your skill is your most valuable asset.
Time is your most precious resource.
Use both wisely!