The era of rising interest rates

The month of May marks the following significant events in Australia:

1. Federal Election – Saturday, 21st May
2. First interest rate rises in more than 11 years.

These two events are significant, and we appear to be entering into a time of increased economic uncertainty.

With some analysts predicting both a Labor Government victory and up to eight (8) interest rate rises over the next year, I thought I’d put forward a few scenarios of what we may see in the next 12-months.

A Change in Government

Over Australia’s political history, periods of economic uncertainty tend to increase spending by governments. If this trend rings true, the following risks may arise:

• With an increased interest rate environment, government interest bills would rise dramatically when debt is re-financed.
• When new government bonds are issued, they immediately reflect interest rate increases in the current market.
• Continuous excessive government spending would put pressure on interest rates in the long-term.

This may mean that governments will be forced to significantly curb spending or introduce a sort of wealth tax to pay off the debt which has been incurred.

Interest rate increases

Given that the Reserve Bank only a few months ago indicated there would be no interest rate rises until 2024, its announcement to begin moving the cash rate substantially, in my view, is quite astounding.

In saying that, some economists, like Macquarie Bank’s Global Head of Strategy, Viktor Shvets, now believe that the Reserve Bank’s signalling of at least 8 interest rate rises will subsequently result in interest rates going back down, when the Reserve Bank finds the economy is not as strong as it first thought. In fact, inflation targeting was first dreamt up by economists in the late 1970s and has been a strategy used to keep inflation under control using a sledgehammer approach.

Is the setting of a narrow inflation target of 2-3% helpful given that most inflation to a global economy is generated by external factors rather than how much we spend?

Given these predictions, it may be best to start focusing on the following:

• Evaluate all your investment goals and ensure that you are not taking excessive risks which require large borrowings. With large increases of interest rates over a short period of time, many projects believed to be profitable may become unprofitable
• Don’t borrow too much for a house, a business, or a car.
• Accumulate cash where possible to take advantage of situations where others are forced to sell, because they have borrowed too much.
• Don’t go to house auctions for the next 6-months as you may find the emotional experience of buying an auction are inflating prices in some situations.

It’s time for a pivot in our thinking and a revaluation in what our investment strategy is.

Remember, the world has changed, and we are starting to move into a new stage of the economic cycle, so caution is required.

If you need assistance in navigating the rise in interest rates, please don’t hesitate to reach out to our offices on 1300 365 125 or email us at [email protected]