What if Interest Rates Stay Right Where They Are?

Can we all get used to a future in which interest rates stay exactly where they are now?

That is the real question after the Reserve Bank board held official interest rates steady and stated that it is fairly bullish and where it sees the Australian economy at the moment.

While financial markets might have been expecting the official cash rate to stay steady on 3.6% at the September meeting, they are more than a little surprised to hear that further interest rates cuts might now be put in the “possible” pile rather than the “probable” one.

Hints Rather than Tips from the RBA

Of course, Governor Michele Bullock didn’t say that in as many words – she was around when many interpreted previous Governor Philip Lowe as “promising” low COVID interest rates would last a long time and will have learned a valuable lesson.

However, even though Philip Lowe’s promise was always conditional on financial conditions, perceptions really matter and so there was no sign of direct language on the future direction of interest rates.

Instead, we get the comment that the economy is “still in a good spot” and the bank remained cautious on the chances of inflation reigniting.

Those tea leaves have pushed the chances of a November rate cut down from a 50-50 change to a 40% chance or lower and have buoyed the Australian dollar – a sure sign many investors see rates staying put for longer.

Governor Bullock also gently suggested that leaving rates steady may not be a bad thing if consumers spend up a little more and unemployment remains where it is.

Savings Improving as Consumers Reawaken

“We know that many households, for example, with mortgages, they’ve actually been saving rather than spending everything. So, as their mortgage repayments have come down, they’ve opted not to reduce their mortgage payments. They’ve maintained them. So that’s suggesting a bit of caution,” Bullock said.

“One upside scenario is a positive one, that they react to that and they start consuming again – that’s good for business, good for employment. So that’s not a bad news scenario.

“If that means that we don’t lower interest rates further, then I wouldn’t say that’s not necessarily a bad news story.”

The interesting thing about this is that most economists still regard official interest rates as restrictive – that is, above a neutral setting.

Rates Still Restrictive

Bullock herself said as much, “I think we feel that it’s still probably a little bit restrictive policy. We certainly don’t think it’s very restrictive […] so all we’ve got to go on, because we don’t know what sort of neutral is, is observing inflation, employment and what is happening to the economy.”

“I mean, we have inflation basically in the 2-3% range. The unemployment rate is holding at around 4.2%. We expect it will drift up a little bit, but we still expect it to be relatively low compared with history.”

All of that suggests that higher than expected inflation rates in October might delay any scope for interest rate cuts until next year, with economists at the Commonwealth Bank already picking no cuts until 2026.

Others are still expecting a cut in November but the real question is, could we tolerate rates staying around where they are for a longer stretch?

The RBA seems to think we could and is banking on improving consumer spending after the tax cuts and the slow unwinding of precautionary savings buffers as confidence slowly improves.

First Home Buyers Could Be Back

Another intriguing factor at the margins is the beginning of the Government’s expanded First Home Guarantee scheme to allow more first home buyers to buy with just a 5% deposit.

While there are fears from some that the higher borrowing levels could reduce loan quality and also force home prices higher, greater home ownership numbers also stimulate consumer spending.

The RBA quarterly review found that consumer confidence and spending is recovering well and is likely to continue to do so – again playing into the narrative that interest rates might be around the right level for now and possibly remain so well into the future.