Why are interest rates rising?

 

The Reserve Bank of Australia has raised the official cash rate for the first time in nearly 12 years, making life even more expensive for many Australians who own a home. On 02/05/2022  RBA announcement took the official cash rate 25 basis points higher to 0.35%, the first interest rate rise since November 2010.

With surging inflation already putting pressure on households through higher costs at the checkout, many are wondering why the RBA would also move to increase mortgage repayments with a higher cash rate.

 

Why are interest rates rising?

The RBA has three major goals: price stability, full employment, and the economic prosperity and welfare of the Australian people. To achieve this, the RBA  has an inflation target of between 2% to 3% on average, over time, and the cash rate is the main tool used to manage inflation.

Last month, inflation data by the Australian Bureau of Statistics confirmed the Consumer Price Index (also known as headline inflation) – the change in the cost of items households usually buy – has shot up 5.1% in the past year.  The trimmed mean, the RBA’s preferred indicator of underlying inflation, also reached 3.7% – well above the RBA’s 2% to 3% target range.

What happens when interest rates rise?

The goal of a cash rate rise is to dampen inflation by cooling spending activity.

When the cash rate is increased the cost of borrowing for lenders is higher, and that cost is passed on to borrowers in the form of interest rates. And when costs go up, households tend to tighten the purse strings a bit more. It means borrowers will have less money for non-essential items because more of their money is going towards keeping a roof over their head.

It comes as many Australians also spend more on non-discretionary items like food and petrol.

How will a higher interest rate impact me?

For homebuyers, increased interest rates mean their borrowing capacity is now less than it was before interest rates started to increase. So if house prices stay where they are (or increase) they’ll need to aim for something a bit cheaper or save for longer. Lenders will have to factor in the higher interest rate plus any likely subsequent rate rises (more on that later) before determining how much they’re willing to lend.

For homeowners, including those with personal loans to pay for renovations, it means they’ll pay more interest on the loan (or loans) they currently have. And for anyone who purchased their home after November 2010 that might come as a shock because that’s the last time the RBA increased the cash rate, so their interest rates have only gone south since.

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