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WITH interest rates moving for the first time in 18 months, many households across Australia are celebrating.

Those with mortgages are cheering at the thought of extra money in their pockets every month. Someone with a $500,000 mortgage can expect to save $73 a month from the 25 basis points cut announced by the Reserve Bank this week.

Commonwealth Bank, Westpac and a number of other lenders including ING Direct, ME Bank and Bank of Queensland have passed on the cut in full (and more, in Westpac’s case).

The rate cut is also expected to give the Australian economy a boost, with businesses encouraged to hire more staff and with consumers encouraged to spend more money.

But before you go popping those champagne corks – because, after all, you can afford proper champagne now – there are downsides to the rate cut. The Reserve Bank does not giveth for no reason.

THE TANKING DOLLAR

For much of last year, the Australian dollar was buying around 93 US cents. It wasn’t parity but that didn’t stop Australian consumers from enjoying the wide range of goods available from international online retailers while those jetting off overseas were also snagging some great deals.

But then in early September, a precipitous drop started. Within a month, the dollar lost six cents and now it’s hovering around the 77/78 US cents mark. Ouch.

In the hour following the RBA’s announcement, the dollar tanked one-and-a-half cents to below 77 cents. It rebounded but the RBA is resolute in seeing the dollar sink further. Mr Stevens said that ‘the dollar still remains above most estimates of its fundamental value’ and a rate cut is designed to move the dollar in a downwards direction.

SHOPPERS

While a lower dollar is great for Australian exporters, it’s bad news for shoppers who buy a lot of imported goods.

For those who are accustomed to buying from overseas online retailers, the increase in prices has been immediate. For example, when faced with a checkout total of $US200 now, that amount will now show up on your credit card bill as $258. That great deal is looking less shiny.

But even if you don’t go click crazy, a whole raft of goods in Australian shops will see a price rise. Imported goods such as electronics, clothing and cars will all be shifting upwards over the next few months. Late last year, Australian Retailers Association executive director Russell Zimmerman told news.com.au that shoppers can expect to see increased prices around February and March.

There’s a few months lag in price increases as retailers will have purchased the products when the dollar was more favourable on imports. So if you’re thinking about buying a new TV or computer, now may be a good time to pick one up before it gets more expensive.

Australian travellers will also be slugged by the tanking dollar, especially for those going to the US or to many Asian countries.

SAVINGS

A lower interest rate is terrible news for people who are highly dependent on their savings, such as self-funded retirees. A low interest rate means a lower return. Or barely a return now that the official cash rate is almost level with inflation.

National Seniors chief executive Michael O’Neill said seniors living off simple investments would be the worst hit. ‘Seniors aged over 65 own 45.3 per cent of bank and financial institution term deposits and most of them are on low, fixed incomes. The cut simply means less money in the pockets of many, many retirees around Australia.’

For those saving for a large purchase, such as a house, the lower interest rate will hurt their medium or long term savings goals. Before the latest interest rate cut, term deposits were barely paying out 3 per cent, which isn’t ideal for anyone looking to grow their nest egg. Five years ago, term deposits were giving returns up to 8 per cent.

THE PROPERTY MARKET

Growth in various property markets around the country have slowed down in recent months, with the exception of Sydney. With unaffordability levels skyrocketing in the main metro markets, home ownership has become more and more unattainable for Australians, especially young people looking to break into the market.

An interest rate cut may very well fuel the property market as prospective buyers decide they can afford to borrow more money on the lower rates. This is in turn, can push prices as up as buyers bring their bigger kitty to auctions.

However, AMP Capital chief economist Shane Oliver said the effect on the property market isn’t a sure thing. ‘The RBA and Australian Prudential Regulation Authority have been trying to slow the property market down. The RBA is hoping it can cut rates without putting more steam back in the property market.’

Mr Oliver said the RBA and APRA have taken measures to rein in the property market, such as tightening borrowing terms. He said that even if demand for mortgages go up, supply may not rise as banks are more cautious about who they lend money to.

EAGER BEAVERS

Headlines screaming about historic low interest rates are sure to pique the interest of those looking to take out loans, especially for those who think they can afford to borrow more money than they previous could.

But there is a great risk in borrowers who don’t account for what happens when rates inevitably rise again.

Mozo director Kirsty Lamont warned: ‘Although it’s tempting to jump headlong into the property market or borrow at high levels when rates are low, you have to put it into perspective and ask yourself whether you’ll still be able to afford the loan when rates inevitably rise again. A home loan needs to be affordable over the long term and fit in with your other financial commitments.’

‘When you look back at four years ago, the average home loan rate was 7.32%. It’s now heading down to 5.00% as lenders pass through the latest cut. That’s a big difference in four years.

‘If rates rise to the 7% level again, borrowers would have to find an extra $400 each month to cover their repayments on a typical $300,000 loan. That could have a huge impact on the household budget.’

UNCERTAINTY

The reason the central bank has moved to cut the official cash rate is because the Australian economy is sluggish.

In his statement yesterday, RBA governor Glenn Stevens said available economic information suggests that growth is continuing at a ‘below-trend’ pace with domestic demand growth ‘quite weak’. He also pointed out that the unemployment rate has moved higher while the decline in terms of trade, such as the fall in commodity prices, has led to a reduction in income growth.

The consumer price index has also recorded its lowest increase for several years.

Mr Oliver said that everyday consumers may start to wonder about the state of the Australian economy and the rate cut could create uncertainty on that front.


Posted by Herald Sun on 5th February, 2015