Why Rates Won’t Be Coming Down Anytime Soon

This time three years ago we’d just come out of lock-down for the first time and red flags were beginning to emerge.

Not medicinal red flags, financial ones.

Here’s what happened…

When the pandemic first reared its invisible head in February 2020, governments started pumping rivers of stimuli into their economies and put every safety net in place, rendering it almost impossible for employers and employees to lose their shirts.

Consequently, while consumers worked from home, they were hoarding piles of cash with little opportunity to spend.

And by September 2020, the bond market (the best forecaster of interest rates) started heading north suggesting inflation was about to scream and rates would go up much sooner than 2024.

Incredibly, despite all the warnings, central banks around the world remained adamant rates wouldn’t go up until 2024.

And now, three years later, some within the commentariat are suggesting rates should start coming down because inflation has peaked.

It’s as if rates should be cut as a reward for lower inflation.

But it won’t happen.

Here’s why…

Firstly, I’m not convinced inflation is under control, especially with the recent spate of wage increases in the public sector.

Secondly, even if inflation was under control, I still wouldn’t expect rates to come down anytime soon for one simple reason…

Unemployment.

To help you understand the relationship between unemployment, inflation and rates, this is all you need to know.

When inflation goes up, rates go up to cool the economy.

But if rates go too high, unemployment starts to rise, and rates have to be cut to stimulate the economy to create more jobs.

But if rates go too low (pandemic), inflation takes off, rates go up and away we go again.

Put simply, you hike rates to fix inflation and you cut rates to fix employment.

And therein lies the problem for borrowers hoping for a rate cut, we don’t have an employment problem.

Our unemployment rate is a record low 3% which means it would be disastrous to cut rates now because it would only fan inflation.

So why have the banks been suggesting rates will come down in late 2023, early 2024?

It’s simple. The banks are in the business of selling money (loans) for the best possible price (rates). Therefore it’s in their interests to talk rates down, not up, to keep and attract more customers.

And don’t forget…

This time two years ago, the banks were climbing over the top of each other offering borrowers big, fat, wads of cash to win their business during the property boom.

And just like the RBA, they were BIG believers rates wouldn’t go up until 2024.

So, if the banks were so sure rates wouldn’t go up then, how can they be so sure they’ll come down now?

There’s no way I’m telling clients to expect a rate cut until we see at least a 50% spike in unemployment. i.e. an increase from 3% to 4.5%, minimum. A such, borrowers should assume rates will stay at these levels for another 12 months.

Exactly three years ago, the bond market fired the first warning shot about rates heading north much sooner than expected.

Recently, it waved another red flag suggesting we may get another one or two rate rises before we get a rate cut.

Have a great weekend!

Adam