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Where do we go from here?

The first Tuesday of November is best known for the race that stops the nation… the Melbourne Cup. This year, however, it should have been known for the rate that stunned the nation.

Because, as horses thundered around the turns at Flemington, something far more significant had just taken place. The RBA had slashed the official cash rate from 0.25% to 0.1%.

The Reserve Bank decided the economy needed more propping up. This on top of all the government stimulus packages still hanging around as the country emerges from the pandemic lockdown. So what does this mean for interest rates? Where to next? And how will it affect you?

Why the unusual reduction amount?

In the past, the RBA has generally moved in increments of 0.25%, or 25 basis points, whether raising or reducing rates. On this occasion they chose to move by 0.15%, or 15 basis points.

The reason? They have nowhere else to go before hitting 0% and, on current trends, proceeding into the unchartered territory of negative interest rates. And it seems they don’t want this to happen just yet.

But why? First, the psychological aspect. Once you hit zero, people will want to know why, what it means and how it’s even possible. The impact on confidence would be significant.

A second reason is more technical. Simply that their computer systems and algorithms aren’t able to cope with that number, or the next step into negative.

The current systems might see people being automatically approved for loans once a zero interest rate is input into the computers. Kind of like a monetary Y2K bug sort of scenario. Once they are ready to go, we may see negative interest rates come into play. This could happen early next year.

Ground zero

So what happens when we get to 0% official cash rates and then into the negatives? Well, people with assets that they are paying off will benefit because loans will become cheaper and cheaper. People who have been saving money in an account will be the big losers as they will get no help whatsoever from the banks that are holding their money.

Of course, the official cash rate is always lower than the rates on actual mortgages being offered to customers; right now, rates on most variable loans are still 2% or higher, but if the official rate keeps going down and gets to negative 2 or 3%, we may then see home loans with negative interest rates. Essentially, this will mean that the bank is paying you to borrow money. On the flip side, you will start paying the bank to store your savings with them. If rates hit negative 1% for example, you might find your $100,000 worth of savings ends up being $99,000 by the end of the year. The more you save, the more you’ll have to pay.

Debt for success

The above scenarios would mean you were better off having debt than savings, which would blow the minds of many older Australians who spent their lives diligently paying down their debt and saving money wherever they could. And you can understand where they’re coming from; growing up paying 10% plus home loan rates and getting high returns on term deposits, savings in the bank, shares and dividends. But a negative interest rate scenario would essentially be the direct opposite of the situation they were in.

Be like Noah and build yourself an ark

At some point, inflation will bounce back and potentially speed right up. If you build yourself an ark by carrying as much debt through the next period of uncertainty as you can, you will find that inflation will push up the costs of living and costs of renting. Your assets will be worth much more and their returns will be higher. The only thing that won’t increase will be the amount you owe on them. Inflation will take care of the debt you carry much faster and it will also damage you if you have savings instead of debt. The superannuation you have, the money you have stashed away for your retirement, will suddenly be worth much less.

 

 

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