Why are interest rates so low and what does it mean for you?

The Reserve Bank has so far this year kept interest rates at their historic lows. With the near-zero cash rate looking like it’s here to stay long-term, here’s what you need to know.

Interest rates in Australia remain at record lows in 2021, with the Reserve Bank so far this year keeping the cash rate at its historic level of 0.1 per cent. Interest rates are a hot topic right now as they’re a big factor why Australia’s property sector is back booming again as borrowers flood the market and prices skyrocket. But it hasn’t always been this way. Indeed, for much of the 2010s, interest rates hovered at around 5 per cent, before dramatically going lower in recent times.

So, what’s going on exactly?

To explain, it helps to understand why the RBA decides to cut rates in the first place. In simple terms, a big reason the RBA acts this way is to help stimulate the economy.

So, given the financial upheaval caused in recent times by COVID-19, it’s little surprise that the RBA lowered the official cash rate — the interest that banks pay on the money they borrow — three times in 2020 in a bid to kickstart the economy.

The idea behind this is that when the cash rate falls, it prompts banks to reduce the rates they charge on loans to borrowers. When these rates are lower, borrowers pay less interest on debts, freeing up money for them to spend elsewhere, boosting the economy.

At the same time, lower interest rates mean consumers are more likely to borrow money as it’s less costly to do so. The RBA’s hope is that this increased consumer activity also has a ripple effect on the economy, jumpstarting things like jobs growth and business investment.

There are also more complex structural factors at play driving today’s super low rates. These include persistent and sluggish wage growth as well as the international monetary policy context, which sees very low interest rates at present in many countries around the world.

Are low interest rates a good or bad thing?

Whether you consider today’s low interest rate environment good or bad really depends on your particular financial situation and goals.

For savers, a low-rate environment is usually considered unfavourable as it means less interest accrues on cash in the bank. If you’re in this category then it may be worth thinking about investing instead in low-risk alternatives to cash like blue chip stocks or ETFs.

By contrast, if you’re trying to get on the property ladder, it’s a very different story. For you, lower rates will beneficially impact the amount you can borrow, how much you have to repay, and how fast you will be able to pay off your loan.

For homeowners and property investors, low rates also have upside. If you have a variable rate loan, it can be a big plus so long as your bank or non-bank lender passes on the cut.  Variable rate borrowers can also look to switch to a fixed rate loan in order to take advantage of the current lower rate. Meanwhile, if you have a fixed-rate loan, a low rate setting can be a good time to consider refinancing.

How long will the low-rate environment last?

The RBA has signalled that it intends to keep rates at a very low level until at least 2024. That’s because, as the RBA sees it, there is no prospect of wage growth reaching more than 3 per cent before that time.

The reason RBA watches wages closely is because when wages rise consumers tend to spend more, which can lead to rising inflation and prompt the RBA to hike rates to reduce it.

There are reasons why today’s historic low interest rates may not be sustainable forever, especially if property prices continue to surge this year. There are signs that banks, too, expect 2024 to be the tipping point on rates, with CBA recently hiking its four-year fixed rate, while slashing its one- and two-year rates. Still, it’s very unlikely that the RBA will hike rates anytime soon, which should give you some confidence that overall things will stay this way for some time to come.

Information provided in this article is of a general nature only and we have not taken your personal financial objectives, situation or needs into account. We recommend you consider if you need to seek professional financial advice before making any financial decisions.