Interest rates for deposits lag behind cash rate
The Reserve Bank of Australia (RBA) has revealed that Australian banks have only passed on about three-quarters of the increase in interest rates since May 2022 to depositors, while borrowers have faced higher debt repayments. The RBA’s cash rate has risen by 400 basis points since the central bank began lifting rates to curb inflation and cool down the overheated economy. The increase for deposits – roughly 300 basis points – is in line with previous phases of interest rate rise, and compares favourably with New Zealand and the US where the proportion passed by banks has been 50% and 35%, respectively, according to RBA assistant governor Christopher Kent.
Kent said in a speech on Wednesday that the difference between economies may reflect Australian banks’ focus on variable-rate borrowing and lending. He also explained how higher interest rates work to slow demand in the economy and help lower inflation, which has been persistently above the RBA’s target range of 2-3%. He said that many borrowers have had to cut back on spending to meet higher mortgage payments, while also feeling the pain of rapidly rising living costs. Businesses with high levels of debt may also have reined in their investment spending.
Debt servicing ratio exceeds previous peak
Kent said that the share of household disposable income that goes towards debt repayments had risen from 7% to almost 10% during the past 17 months. That share exceeded the peak reached in 2008 when the cash rate was 7.25%, he said, adding that households with large mortgages were paying a much larger proportion of income on debt servicing. “Required payments will continue to rise a little further in the period ahead as fixed-rate loans taken out during the pandemic reach the end of their fixed-rate period,” he said.
About half of the loans on low fixed interest rates have now adjusted to higher rates as their terms expired, with the rest due to roll over during the next 12 months. Kent said that the RBA estimated that lifting the cash rate from 0.1% to 4.1% now will have reduced overall household spending by around 0.4–0.8% per year through the so-called cash-flow channel. Similarly, recent RBA modelling indicated that the rate rises would contribute to business investment being around 4% lower than otherwise after two to three years, he said.
Asset prices also affected by higher interest rates
Kent also discussed how higher interest rates affect asset prices, such as stocks, properties and other investments. He said that higher interest rates reduce the present value of future cash flows from these assets, making them less attractive to investors. He also said that higher interest rates increase the opportunity cost of holding these assets, as savers can earn more from bank deposits or bonds. He said that these effects tend to lower asset prices and reduce spending via the so-called wealth effect.
Kent said that the RBA’s research suggested that a 100 basis point increase in interest rates would lower house prices by around 3% after two years, and lower equity prices by around 10% after one year. He said that these effects would reduce household consumption by around 0.2–0.4% per year through the wealth channel. He also said that lower asset prices would reduce collateral values for borrowers and lenders, making credit conditions tighter and dampening economic activity.
