All of these interest rates in turn influence economic activity, employment and inflation.
The lower the cash rate and other interest rates, the cheaper it is to borrow money because there is less interest to pay. However, less interest is also received when you save money. Lower rates mean the cost of using savings or borrowing to buy things, expand a business, or hire an extra worker has fewer downsides.
This helps stimulate economic activity as people are encouraged to buy and spend more. It can also reduce unemployment, because saving extra money by not hiring an extra worker has less benefit when the cash rate is lower and you can borrow more to expand your business without too much expense when the interest you pay on the debt is lower.
On the other hand, if rates are increased, it is riskier to spend money, expand a business, or hire someone, because more interest is lost from using l ‘saving. Or more interest is paid when the debt is incurred.
Lower interest rates can also increase inflation. This happens in several ways. One of them is when the lower cash rate reduces unemployment and workers have more power to ask for a raise. If there are very few unemployed workers, a company may have to work harder to attract the right person to their business – and may have to pay more to get them. They may also have to give more money to existing workers so that they are not lured elsewhere.
Some of the extra money the company pays workers could be “passed on” via higher prices. And just as companies have to work harder to keep their employees when rates are low, they have to work “less hard” to keep their customers.
When rates are lower, it’s easier for customers to borrow or spend more money, and rising prices affect them less when they don’t repay much on their loans or receive much on their savings. .
For example, if you lose A$10 in interest by taking money out of your savings to buy a new item, the “actual cost” of the item is the price + A$10. But if you only lose A$1 in interest, the “real cost” is the price + A$1. So if the price went up a dollar or two, you could still buy the product.
In many countries, inflation has risen sharply and is historically high. If inflation is too high, rising interest rates will help bring it down. Rising interest rates are essentially making many businesses and households think twice about their quick spending and hiring behavior, which in turn is slowing price pressures and inflation.
This is the main reason why several central banks around the world are already raising rates, including the Reserve Bank of New Zealand, the US Federal Reserve, the Bank of Canada, the Bank of England and the Bank of Korea.
In Australia, inflation is also rising, but it remains lower than in many other countries. This is one of the reasons why the RBA has evolved more slowly. However, with inflation hitting 5.1% YoY in the latest data, this has put additional pressure on the RBA to manage higher rates.
ANZ Research expects the RBA to raise the cash rate to 1.25% by the end of 2022 and to 2.25% by May 2023. At the height of the cycle around the mid-2020s , we could see a cash rate of 3% or above. That would be the highest since at least 2013.
For borrowers, such as households with mortgages, rising interest rates may seem like a bad thing because they may pay more interest on their debt, reducing the income they can spend on other things. things or save.
But when the cash rate goes up, it means the overall economy is doing well. Households and businesses spend and invest more, more people are employed and see their wages rise.
It’s also good for savers, as they get a higher return on their savings.
There are fears that if the cash rate becomes so high, causing mortgage rates to rise significantly, many households will not be able to meet their mortgage payments and may default on their loan.
But based on ANZ Research forecasts, household interest payments as a share of income are still expected to be similar to pre-pandemic levels by the end of 2023.
And the substantial savings that households have accumulated during the pandemic puts them in a much stronger financial position to deal with future rate hikes.
Adelaide Timbrell and Catherine Birch are senior economists at ANZ