Jacqueline Barton

Rising interest rates are almost always portrayed as bad news, by the media and by politicians of all persuasions. But a rise in rates cuts both ways. 

Higher interest rates are a worry for people with home loans and borrowers generally. But they are good news for older Australians who depend on income from bank deposits and young people trying to save for a deposit on their first home.

Rising interest rates are also a sign of a growing economy, which creates jobs and provides the income people need to pay the mortgage and other bills. By lifting interest rates, the Reserve Bank hopes to keep a lid on inflation and rising prices. Yes, it’s complicated.

How high will rates go?

In early May, the Reserve Bank lifted the official cash rate from its historic low of 0.1 per cent to a still low 0.35 per cent. The reason the cash rate is watched so closely is that it flows through to mortgages and other lending rates in the economy.

To tackle the rising cost of living, the Reserve Bank expects to lift the cash rate further, to around 2.5 per cent.ⁱ Inflation is currently running at 5.1 per cent, which means annual wages growth of 2.4 per cent is not keeping pace with rising prices.ⁱⁱ

So what does this mean for household budgets?

Mortgage rates on the rise

The people most affected by rising rates are likely those who recently bought their first home. In a double whammy, after several years of booming house prices the size of the average mortgage has also increased.

According to CoreLogic, even though price growth is slowing, the median home value rose 16.7 per cent nationally in the year to April to $748,635. Prices are higher in Sydney, Canberra and Melbourne.

CoreLogic estimates a 1 per cent rise would add $486 a month to repayments on the median new home loan in Sydney, and an additional $1,006 a month for a 2 per cent rise.

The big four banks have already passed on the Reserve Bank’s 0.25 per cent increase in the cash rate in full to their standard variable mortgage rates which range from 4.6 to 4.8 per cent. The lowest standard variable rates from smaller lenders are below 2 per cent.

Still, it’s believed most homeowners should be able to absorb a 2 per cent rise in their repayments.ⁱⁱⁱ

The financial regulator, APRA now insists all lenders apply three percentage points on top of their headline borrowing rate, as a stress test on the amount you can borrow (up from 2.5 per cent prior to October 2021).^iv

Rate rise action plan

Whatever your circumstances, the shift from a low interest rate, low inflation economic environment to rising rates and inflation is a signal that it’s time to revisit some of your financial assumptions.

The first thing you need to do is update your budget to factor in higher loan repayments and the rising cost of essential items such as food, fuel, power, childcare, health and insurances. You could then look for easy cuts from your non-essential spending on things like regular takeaways, eating out and streaming services.

If you have a home loan, then potentially the biggest saving involves absolutely no sacrifice to your lifestyle. Simply pick up the phone and ask your lender to give you a better deal. Banks all offer lower rates to new customers than they do to existing customers, but you can often negotiate a lower rate simply by asking.

If your bank won’t budge, then consider switching lenders. Just the mention of switching can often land you a better rate with your existing lender.

The challenge for savers

Older Australians and young savers face a tougher task. Bank savings rates are generally non-negotiable, but it does pay to shop around.

By mid-May only three of the big four banks had increased rates for savings accounts. Several lenders also announced increased rates for term deposits of up to 0.6 per cent.^v

High interest rates traditionally put a dampener on returns from shares and property, so commentators are warning investors to prepare for lower returns from these investments and superannuation.

That makes it more important than ever to ensure you are getting the best return on your savings and not paying more than necessary on your loans. If you would like to discuss a budgeting and savings plan, give us a call.

i https://www.rba.gov.au/speeches/2022/sp-gov-2022-05-03-q-and-a-transcript.html
ii https://www.abs.gov.au/
iii https://www.canstar.com.au/home-loans/banks-respond-cash-rate-increase/
iv https://www.apra.gov.au/news-and-publications/apra-increases-banks
v https://www.ratecity.com.au/term-deposits/news/banks-increased-term-deposit-interest-rates

Trying to time investment markets is difficult if not impossible at the best of times, let alone now. The war in Ukraine, rising inflation and interest rates and an upcoming federal election have all added to market uncertainty and volatility.

At times like these investors may be tempted to retreat to the ‘’safety” of cash, but that can be costly. Not only is it difficult to time your exit, but you are also likely to miss out on any upswing that follows a dip.

Take Australian shares. Despite COVID and the recent wall of worries on global markets, Aussie shares soared 64 per cent in the two years from the pandemic low in March 2020 to the end of March 2022.ⁱ Who would have thought?

So what lies ahead for shares? The recent Federal Budget contained some clues.

The economic outlook

The Budget doesn’t only outline the government’s spending priorities, it provides a snapshot of where Treasury thinks the Australian economy is headed. While forecasts can be wide of the mark, they do influence market behaviour.

As you can see in the table below, Australia’s economic growth is expected to peak at 4.25 per cent this financial year, underpinned by strong company profits, employment growth and surging commodity prices. Our economy is growing at a faster rate than the global average of 3.75 per cent, and ahead of the US and Europe, which helps explain why Australian shares have performed so strongly.ⁱⁱ

However, growth is expected to taper off to 2.5 per cent by 2023-24, as key commodity prices fall from their current giddy heights by the end of September this year, turning this year’s 11% rise in our terms of trade to a 21 per cent fall in 2022-23.

Table: Australian economy (% change on previous year)

^*Key commodity prices assumed to decline from current high levels by end of September quarter 2022
Source: Treasury

Commodity prices have jumped on the back of supply chain disruptions during the pandemic and the war in Ukraine. While much depends on the situation in Ukraine, Treasury estimates that prices for iron ore, oil and coal will all drop sharply later this year.

So, what does all this mean for shares?

Share market winners and losers

Rising commodity prices have been a boon for Australia’s resources sector and demand should continue while interest rates remain low and global economies recover from their pandemic lows.

Government spending commitments in the recent Budget will also put extra cash in the pockets of households and the market sectors that depend on them. This is good news for companies in the retail sector, from supermarkets to specialty stores selling discretionary items.

Elsewhere, building supplies, construction and property development companies should benefit from the pipeline of big infrastructure projects combined with support for first home buyers and a strong property market.

Increased Budget spending on defence, and a major investment to improve regional telecommunications, should also flow through to listed companies that supply those sectors as well as the big telcos and internet providers.

However, while Budget spending is a market driver in the short to medium term there are other influences on the horizon for investors to be aware of.

Rising inflation and interest rates

With inflation on the rise in Australia and the rest of the world, central banks are beginning to lift interest rates from their historic lows. Australia’s Reserve Bank is now expected to start raising rates this year.ⁱⁱⁱ

Global bond markets are already anticipating higher rates, with yields on Australian and US 10-year government bonds jumping to 2.98 per cent and 2.67 per cent respectively. However, the yield on some US shorter-term bonds temporarily rose above 2.7 per cent recently. Historically, this so-called “inverse yield curve” has indicated recession at worst, or an economic slowdown.^iv

Rising inflation and interest rates can slow economic growth and put a dampener on shares. At the same time, higher interest rates are a cause for celebration for retirees and anyone who depends on income from fixed interest securities and bank deposits. But it’s not that black and white.

While rising interest rates and volatile markets generally constrain returns from shares, some sectors still tend to outperform the market. This includes the banks, because they can charge borrowers more, suppliers and retailers of staples such as food and drink, and healthcare among others.

Putting it all together

In uncertain times when markets are volatile, it’s natural for investors to be a little nervous. But history shows there are investment winners and losers at every point in the economic cycle. At times like these, the best strategy is to have a well-diversified portfolio with a focus on quality.

For share investors, this means quality businesses with stable demand for their goods or services and those able to pass on increased costs to customers.

If you would like to discuss your overall investment strategy don’t hesitate to get in touch.

i https://www.commsec.com.au/market-news/the-markets/2022/mar-22-budget-sharemarket-winners-and-losers.html

ii https://budget.gov.au/2022-23/content/bp1/download/bp1_bs-2.pdf

iii https://www.finder.com.au/rba-survey-4-apr

iv https://tradingeconomics.com/united-states/government-bond-yield

A balancing act

Billed as a Budget for families with a focus on relieving short-term cost of living pressures, Treasurer Josh Frydenberg’s fourth Budget also has one eye firmly on the federal election in May.

At the same time, the government is relying on rising commodity prices and a forecast lift in wages as unemployment heads towards a 50-year low to underpin Australia’s post-pandemic recovery.

While budget deficits and government debt will remain high for the foreseeable future, the Treasurer is confident that economic growth will more than cover the cost of servicing our debt.

The big picture

The Australian economy continues to grow faster and stronger than anticipated, but the fog of war in Ukraine is adding uncertainty to the global economic outlook. After growing by 4.2 per cent in the year to December, Australia’s economic growth is expected to slow to 3.4 per cent in 2022-23.ⁱ

Unemployment, currently at 4 per cent, is expected to fall to 3.75 per cent in the September quarter. The government is banking on a tighter labour market pushing up wages which are forecast to grow at a rate of 3.25 per cent in 2023 and 2024. Wage growth has improved over the past year but at 2.3 per cent, it still lags well behind inflation of 3.5 per cent.ⁱⁱ

The Treasurer forecast a budget deficit of $78 billion in 2022-23 (3.4 per cent of GDP), lower than the $88.9 billion estimate as recently as last December, before falling to $43 billion (1.6 per cent of GDP) by the end of the forward estimates in 2025-26.

Net debt is tipped to hit an eye-watering $715 billion (31 per cent of GDP) in 2022-23 before peaking at 33 per cent of GDP in June 2026. This is lower than forecast but unthinkable before the pandemic sent a wrecking ball through the global economy.

Rising commodity prices

The big improvement in the deficit has been underpinned by the stronger than expected economic recovery and soaring commodity prices for some of our major exports.

Iron ore prices have jumped about 75 per cent since last November on strong demand from China, while wheat prices have soared 68 per cent over the year and almost 5 per cent in March alone after the war in Ukraine cut global supply.^iii,iv

Offsetting those exports, Australia is a net importer of oil. The price of Brent Crude oil prices have surged 73 per cent over the year, with supply shortages exacerbated by the war in Ukraine.^v Australian households are paying over $2 a litre to fill their car with petrol, adding to cost of living pressures and pressure on the government to act.

With the rising cost of fuel and other essentials, this is one of the areas targeted by the Budget. The following rundown summarises the measures most likely to impact Australian households.

Cost of living relief

As expected, the Treasurer announced a temporary halving of the fuel excise for the next six months which will save motorists 22c a litre on petrol. The Treasurer estimates a family with two cars who fill up once a week could save about $30 a week, or $700 in total over six months.

Less expected was the temporary $420 one-off increase in the low-to-middle-income tax offset (LMITO). It had been speculated that LMITO would be extended for another year, but it is now set to end on June 30 as planned.

The extra $420 will boost the offset for people earning less than $126,000 from up to $1,080 previously to $1,500 this year. Couples will receive up to $3,000. The additional offset, which the government says will ease inflationary pressures for 10 million Australians, will be available when people lodge their tax returns from 1 July.

The government will also make one-off cash payments of $250 in April to six million people receiving JobSeeker, age and disability support pensions, parenting payment, youth allowance and those with a seniors’ health card.

Temporarily extending the minimum pension drawdown relief

Self-funded retirees haven’t been forgotten. The temporary halving of the minimum income drawdown requirement for superannuation pensions will be further extended, until 30 June 2023.

This will allow retirees to minimise the need to sell down assets given ongoing market volatility. It applies to account-based, transition to retirement and term allocated superannuation pensions.

More support for home buyers

A further 50,000 places a year will be made available under various government schemes to help more Australians buy a home.

This includes an additional 35,000 places for the First Home Guarantee where the government underwrites loans to first-home buyers with a deposit as low as 5 per cent. And a further 5,000 places for the Family Home Guarantee which helps single parents buy a home with as little as 2 per cent deposit.

There is also a new Regional Home Guarantee, which will provide 10,000 guarantees to allow people who have not owned a home for five years to buy a new property outside a major city with a deposit of as little as 5 per cent.

Support for parents

The government is expanding the paid parental leave scheme to give couples more flexibility to choose how they balance work and childcare.

Dad and partner pay will be rolled into Paid Parental Leave Pay to create a single scheme that gives the 180,000 new parents who access it each year, increased flexibility to choose how they will share it.

In addition, single parents will be able to take up to 20 weeks of leave, the same as couples.

Health and aged care

One of the Budget surprises in the wake of the Aged Care Royal Commission findings, was the absence of spending on additional aged care workers and wages.

Instead, $468 million will be spent on the sector with most of that ($340 million) earmarked to provide on-site pharmacy services.

The Pharmaceutical Benefits Scheme (PBS) is also set for a $2.4 billion shot in the arm over five years, adding new medicines to the list. PBS safety net thresholds will also be reduced, so patients with high demand for prescription medicines won’t have to get as many scripts.

A $547 million mental health and suicide prevention support package includes a $52 million funding boost for Lifeline.

And as winter approaches, the government will spend a further $6 billion on its COVID health response.

Jobs, skills development and small business support

As the economy and demand for skilled workers grow, the government is providing more funding for skills development with a focus on small business. It will provide a funding boost of $3.7 billion to states and territories with the potential to provide 800,000 training places.

In addition, eligible apprentices and trainees in “priority industries” will be able to access $5,000 in retention payments over two years, while their employers will also receive wage subsidies.

Small businesses with annual turnover of less than $50 million will be able to deduct 20 per cent of the cost of training their employees, so for every $100 they spend, they receive a $120 tax deduction.

Similarly, for every $100 these businesses spend to digitalise their businesses, up to an outlay of $100,000, they will receive a $120 tax deduction. This includes things such as portable payment devices, cyber security systems and subscriptions to cloud-based services.

Looking ahead

With an election less than two months away, the government will be hoping it has done enough to quell voter concerns about the rising cost of living, while safeguarding Australia’s ongoing economic recovery.

The local economy faces strong headwinds from the war in Ukraine, the cost of widespread flooding along much of the east coast and the ongoing pandemic.

Much depends on the hopes for the rise in employment and wages to offset rising inflation, and the timing and extent of interest rate rises by the Reserve Bank.

Information in this article has been sourced from the Budget Speech 2022-23 and Federal Budget support documents.

It is important to note that the policies outlined in this publication are yet to be passed as legislation and therefore may be subject to change.

i tradingeconomics.com/australia/gdp-growth-annual
ii abs.gov.au/media-centre/media-releases/annual-wage-growth-increases-23
iii tradingeconomics.com/commodity/iron-ore
iv, v tradingeconomics.com/commodities