Take care with lower interest rates
As the old saying goes, “be careful what you wish for”. In October, in response to a rapid worsening of the already severe global financial crisis, the Reserve Bank of Australia (RBA) unexpectedly cut interest rates by a full 1%. This was even before IMF head, Dominique Strauss-Kahn, warned that the world financial system was on the brink of “systemic meltdown”. People desperate for an easing in interest rates had their wish granted, but not for reasons we can cheer about.
Borrowers will certainly welcome the cut in interest rates. On the other side of the coin, many people will see a fall in their income. With investors cashing up in the face of share market turmoil, money has been flooding into deposit accounts and bonds. Investors who can obtain the RBA’s target cash rate of 6% will see a drop of nearly 15% in the amount of interest they’ll receive compared with the previous month.
The action by the RBA and the further announcement that the Australian government will guarantee all bank, building society and credit union deposits are both aimed at restoring confidence and stimulating spending.
So is now a good time to borrow?
Any real estate agent will tell you this is a great time to buy property, but let’s look at the reasons for these rapid moves to shore-up the financial sector. All this action is taking place because world financial markets are in a precarious state and gripped by panic. Australia may be partially shielded from the worst of what’s going on, but we have been warned that mineral exports will decline and unemployment will increase. Globally, we are in uncharted economic waters and it has become impossible to predict if current international attempts to stabilise financial markets will work. As a result, many people will keep their wallets closed, delay decisions on major spending, and this may well prolong the recession.
It’s also worth remembering that Australia still has a housing bubble. Steven Keen, Associate Professor of Economics at the University of Western Sydney, points out that, at seven times median income, Australian housing is grossly over-valued. To be affordable, homes should cost around three times median income. His prediction - Australian house prices are set for a fall.
It was the pricking of the US housing bubble that triggered the current crisis, so we might not be quite as immune from the global contagion as we would like to believe. The US housing bubble was inflated by the steep decline in interest rates after 9/11. With interest rates in Australia expected to fall further in coming months, let’s hope we don’t compound an existing problem. Tempting as they may be, now might be the time for caution, and to wait and see what new regulatory regimes will be devised to restore stability to world markets.
Source:
Reserve Bank of Australia
The Age Business Day, 13 October 2008
Steven Keen interviewed on ABC 7.30 Report 8 October 2008