ABA CEO warns low interest rates could be 'dampening' the economy

by AB26 Feb 2013

Next Tuesday, the RBA will gather for its monthly meeting and once more consider what should be done with Australia’s official cash rate, but the Australian Bankers Association (ABA) CEO, Steven Münchenberg, says interest rates could be holding back the nation’s economy.

“The run-up to an RBA meeting is a time of much speculation and debate. Will the RBA cut interest rates to stimulate the economy? When will it raise rates to fend off inflation? What does it mean if it just sits on its hands, content that it has the balance right for now?”

A range of business organisations add their voices to the debate, calling upon the RBA Board, or the retail banks acting alone, to cut interest rates further and Münchenberg says their argument is that households are paying too much for credit, which is stifling business and consumer confidence.

However, he says interest rates could actually be ‘dampening’ confidence as households are potentially spending less due to the rates they pay on their loans.

“We all know that the cash rate is at an historic low of 3.00% - a level last seen at the height of the global financial crisis. But as many have pointed out, the banks and other lenders have not passed on rate cuts in full. If we want to test the true impact of interest rates, we must look at actual market rates today compared with other periods in our recent past. In particular, it is worth looking at mortgage rates, which can have a significant effect on the one-in-three Australian households that has a mortgage.”

Today, Münchenberg says, the average advertised rate for a standard variable home loan for consumers is 6.45%. There’ve been only two other periods in the past 23 years when the average standard variable rate has fallen below 6.50%. The first was in 2001, after the dot.com bubble burst and the growth of the Australian economy slowed to 1.6%.

The other was in 2009, when the economy was experiencing the full force of the GFC and growth slowed to 1.0%.

“In contrast, over the three years prior to the onset of the global financial crisis (up to August 2007), the average advertised standard variable rate was 7.50%, or 105 basis points higher than now. By mid-2008, when the cash rate stood at 7.25%, mortgage rates averaged 9.60%, or 315 basis points higher than today.”

He says mortgage rates have therefore fallen significantly in the past five years.

“In his opening statement to the House of Representatives Standing Committee on Economics last week, the RBA Governor confirmed that ‘lending rates...have fallen to be not far from their historic lows. The share of household income devoted to interest payments has likewise declined considerably’.”

Superficially, having interest rates at near historic lows should be good news for consumer and business confidence, says Münchenberg. But argues the reality is ‘mixed’.

“On the plus side, low rates are taking financial pressure off households with mortgages, yet most mortgage holders prefer to keep their repayments high and pay down their mortgages faster, rather than spend the additional money. On the down side, low interest rates tend to occur at times of low economic growth.”

Münchenberg says low growth can undermine the prosperity and financial security of many households and businesses.

“Ever lower interest rates can therefore be seen as a warning that times are uncertain and belt tightening is the smart thing to do. Whatever the Reserve Bank Board decides to do next week, we are already enjoying a rare period of interest rates that are close to historic lows.”