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Inflation Hits 3.5% – So is a Rate Rise on the Cards?

The last time the Reserve Bank of Australia increased the cash rate was more than 11 years ago. Since then, the only way’s been down, with the RBA cutting the cash rate 18 times to leave it at its current record-low of 0.10%. That move was made in November 2020, as the RBA wanted to support the economy through the pandemic.

The near-zero cash rate has been great news for borrowers. Lenders slashed their home loans rates in response, which means the cost of servicing a mortgage has never been so low. But rates can’t stay this low forever, and many analysts believe the cash rate might soon increase.

Why? Well, one reason is the Australian economy has rebounded strongly, recovering faster than many have predicted. For example:

Then there’s the fact that inflation has spiked. The Australian Bureau of Statistics’ consumer price index (CPI) increased 1.3% in the December 2021 quarter, taking annual inflation to 3.5% (see graph).

What’s inflation got to do with home loan interest rates?

Inflation measures how the cost of living increases over time. It’s typically worked out by tracking how much more expensive a fixed basket of goods and services (known as the CPI) has become over a certain period.

If inflation rises too fast, it reduces the purchasing power of the dollar in your pocket. So the RBA aims to keep inflation between 2-3% per annum.

However, certain items within the CPI are known for having volatile price movements. For example, fuel was one of the biggest contributors to the recent inflation spike, as it increased by 6.6% over the quarter and 32.3% over the year

To reduce the impact of these inflationary spikes, the RBA uses something known as ‘trimmed mean inflation’. This measures ‘underlying’ inflation in the economy, by stripping out items with irregular price movements from the CPI.

Trimmed mean inflation is a key economic metric to watch, because the RBA has repeatedly said it won’t increase the cash rate until underlying inflation is “sustainably” between 2-3%. Trimmed mean inflation in the December quarter increased from 2.1% to 2.6%, putting it in the middle of the RBA’s target range – as the graph below shows.

 

Does this mean a rate rise is on the cards?

But that doesn’t mean the Reserve Bank will raise interest rates soon. That’s because the RBA doesn’t just want inflation to be between 2-3%; it wants inflation to be “sustainably” between 2-3% before it acts. And for that to happen, the RBA believes annual wages growth needs to be at least 3%.

The bank forecasts wages growth in Australia to reach 2.75% this year and 3% over 2023, compared with the current rate of 2.2%.

However, Westpac disagrees.

“Our forecasts are significantly different to the RBA’s forecasts and expect that if our forecasts prove correct the case for the first rate hike in the next tightening cycle by the August board meeting in 2022 is strong,” Westpac chief economist Bill Evans said in a research note.

Westpac has pencilled in two rate rises this year: one hike of 0.15 percentage points in August and another of 0.25 percentage points in October.

That would take the cash rate to 0.50%.

Only time will tell if Westpac is right. That said, even if the RBA keeps the cash rate at a record low of 0.10% for the foreseeable future, many lenders have already started raising their home loan interest rates.

Should you fix your home loan?

When interest rates rise, so do your monthly repayments

Let’s imagine you have a $600,000 owner-occupier principal-and-interest loan. You’re paying the loan back over 30 years at a variable interest rate of 2.59% (the average for new loans in November 2021 according to the RBA). That means your monthly repayments are $2,399.

But if your interest rate increases to 3.09%, your monthly repayments would rise to $2,559.

That said, if you’re on a fixed-rate deal, your repayments would stay the same until your fixed term ends.

So you might be wondering: should you fix your interest rate now to protect yourself from possible rate rises in the near future?

As always, it depends on your financial circumstances.

The main reason borrowers fix their home loans is to protect themselves from rate hikes. But while you won’t have to worry about rates rising, there are some drawbacks to these types of mortgages:

  • Less flexibility – you might not be able to make extra repayments without penalty
  • Fewer features – many fixed-rate loans don’t come with offset accounts or redraw facilities, which can help you pay less interest

Refinancing can also be an issue when you have a fixed-rate loan. That’s because many lenders charge break fees if you terminate the mortgage before the fixed period expires.

At Shore Financial, we can help you do the sums to see if fixing or refinancing are right for you.

Talk to a broker by calling 1300 416 700, emailing info@shorefinancial.com.au or filling in this form.

Shore Financial can help you find a loan that suits your personal circumstances.

 

To discuss your options, you can call us on 1300 416 700, email us on info@shorefinancial.come.au or fill in this online form.






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