Reserve Bank of Australia Governor Philip Lowe gave some serious hints about another rate cut tomorrow, bringing the interest rate to another historic low at 0.75% — how will this impact Australian borrowers?
Rising unemployment and sluggish wage growth indicate that Australia's economy is not as stellar as it should be. The RBA's monetary policy decision is expected to stimulate the economy by encouraging borrowers to spend, economist Jason Murphy said in a think piece in News Mail.
"The theory is, when the interest rate on borrowing and saving is low, businesses and people should borrow more and spend more, while saving less. That should get the money flowing out of our pockets and through businesses, which in turn hire more people, creating a virtuous cycle," he said.
This works by reducing mortgage repayments, therefore saving money for borrowers and giving them extra cash that they can spend.
A rate cut also affects the exchange rate, benefitting businesses and exporters.
"The big risk with lower interest rates is if they blow up the housing market again. In the past five years, the RBA was reluctant to cut interest rates because it was very worried about house prices being in a bubble," Murphy said.
It took the RBA over two years to finally move the interest rate again. It did so in June and July, when it slashed the cash rate for two consecutive months, bringing it to 1%.
Now that the housing downturn appears to be slowing as the auction market gets lively again, it is easy for people to attribute the green shoots to the back-to-back rate cuts. However, Murphy said a sudden turnaround in house prices should not be blamed entirely on rate cuts.
He cited a study by the Grattan Institute, which said showed that the uptick in house prices over the past months did not line up with the recent rate cuts.
"Instead, it lines up with changes that happened in July, where Australia's banking regulator relaxed rules about who banks would lend to, and how much they would lend," Murphy said.
This is a double-edged sword, he said. While this means that lower rates will help keep the economy stay afloat, controlling lending restrictions will be a challenge – especially if house prices start jumping to great heights again.
"If house prices do keep rising and start to get out of hand, we can use lending rules to control them. We just need to hope the politicians in charge of those lending rules have the courage to use them," Murphy said.
The good thing is that the RBA does not think prices would inflate anytime soon. Lowe said that house-price growth appears to be less of a concern for future monetary policy decisions.
"It seems to me quite possible that we could have a period now of rising housing prices, because construction activity is slowing while the population is still rising quite quickly in the world. So there are some underlying drivers of housing prices," he said.
Lowe, however, said that an extended period of low interest rates will be required to help Australia hit its unemployment, spending, and inflation targets.