Interest rates, much like the seasons, they have their ups and downs. Currently, we find ourselves, both at the tail end of winter and, at or near the peak of an interest rate cycle, where rates are higher than they have been since Early 2012. With higher than ever debt levels this has caused concern for many, but it's important to remember that just as winter gets lazy and eventually yields to spring, interest rates will eventually come down. An important concept to understand is that while higher rates hurt those with mortgages, they’re a sign of a strong economy!
Understanding Interest Rate Cycles
Interest rate cycles refer to the regular pattern of interest rates rising and falling over time. These cycles are driven by a complex interplay of economic factors, including inflation, central bank policies, and the overall health of the economy. When the economy is booming, demand for goods and services increases, often leading to higher inflation. Central banks then raise interest rates to curb inflation and prevent the economy from overheating.
On the other hand, during economic downturns, recessions, or periods of low to no inflation, central banks lower interest rates to encourage borrowing and spending, which helps stimulate economic activity. We saw this in a big way in Early 2021 as the RBA tried to keep the economy from stall while the government locked us all in our homes! This process of adjusting interest rates is a crucial tool that central banks use to maintain a balance between economic growth and stability.
The Current Scenario: At the Peak (or very close)
As of now, we are experiencing the peak of an interest rate cycle, which means that interest rates are higher than they have been in recent years. This can have a noticeable impact on various aspects of our financial lives, from mortgage rates to credit card interest rates. Many people are feeling concerned about the increased costs associated with borrowing in such an environment.
Reasons for Higher Rates
Several factors contribute to the high-interest rate environment we currently find ourselves in:
-Quantitative easing: This is the government printing money to pump into the economy. Over the past few years, we’ve seen government printing so much money that there is now a “surplus” of money this has been a key component in the inflation issue that we have been fighting.
-Economic Expansion: The global economy has been experiencing a period of growth and recovery from the recent recession. As demand for goods and services increases, central banks are more likely to raise interest rates to keep inflation in check.
-Central Bank Policies: Central banks, such as the Reserve Bank of Australia (RBA), use interest rate adjustments to manage economic stability. In a growing economy, they may opt to increase rates to prevent excessive inflation.
-Global Factors: International events, such as changes in trade dynamics or geopolitical tensions, can influence interest rates. These external factors can impact the supply and demand for investments, which in turn affects inflation and therefore rates.
You may have noticed that the underlying issue that all of the above point to is “Inflation”, and raising or cutting interest rates is the tool of choice for the RBA to keep inflation in their target band of 2-3%.
Recommended by LinkedIn
Staying Steadfast: Weathering the Peak
While higher interest rates might initially appear daunting, it's important to remember that interest rate cycles are just that—cycles. They follow a predictable pattern, and history has shown us that after every peak, there comes a decline. Here's why you can take comfort in this knowledge:
-Temporary Nature: Interest rate cycles are temporary phenomena. Just as the seasons change, interest rates will eventually start to come down as economic conditions evolve.
-Opportunities Ahead: Higher interest rates can lead to attractive yields on savings accounts and fixed-income investments. Savvy investors can take advantage of these opportunities to grow their wealth.
-Long-Term Perspective: In the grand scheme of your financial journey, the current high-rate environment is just one phase. By maintaining a long-term perspective and sticking to your financial plan, you can navigate this peak with confidence.
-Inflating away your debt: This is a bit of a more advanced concept, and article in itself perhaps. In short, if you borrow money, and inflation reduces the value of that money you have borrowed, while the asset you have purchased with that money appreciates, you are getting ahead! This is a concept that Governments around the world use, you may have heard the term, to inflate away their debt. (Happy to explain this one further if anyone is interested)
The below is a chart of the RBA rates since 1990. You will see an initial tear down from ~17% to ~5%, then we can see a long-term average of just below 5%, noting the peaks and drops in 94-95, 97-98, 08-09 and dare I say 23-24.
The current high-interest rate cycle may be challenging, but it's crucial to remember that it's part of a natural ebb and flow. Just as winter yielding to spring, interest rates will eventually begin to decline. It may not be in 23-24, but we are starting to see the initial signs of economic slowdown, the signs that trigger the RBA to consider bringing down rates, bringing new opportunities and a more favourable borrowing environment. By staying patient, informed, and true to your financial goals, you can confidently weather this peak and look forward to the promising seasons that lie ahead.
If you are struggling with your mortgage or any other debt, there are some steps you can take to get you out of the slump. Don’t stick your head in the sand, reach out and I can get you in touch with the right people.
