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Interest rate increases being fuelled by inflationary pressures

Posted by: Danielle Moore at December 08, 2021

As Covid has rampaged across the world over the past 18 months, one of the greatest fears has been the impact of the pandemic on Australia’s economy. Rolling lockdowns and log-jammed supply chains have put the brakes on business and manufacturing, causing federal and state governments great concern about our country’s growth prospects.

To neutralise the potential threat to our economy, the Australian government turned to a common and popular option early on to keep the fires burning – government stimulus. This is known to most of us as good, old fashioned spending.

This stimulus is captured in the Australian Government’s Economic Recovery Plan, which is designed to create jobs and support individuals and households financially. Some specific initiatives include business incentives, workforce training, and tax breaks.

For example, the 2021-22 federal budget allocated an additional $15.2 billion for major infrastructure projects across the country. Overall government funding in the latest budget increased to $507 billion, including support for a Modern Manufacturing Strategy to help Aussie manufacturing scale up, become more competitive and build supply chain resilience.

Growth stimulated by government spending and lower interest rates

But it’s not just spending that’s been used as a tool to help lift our economy out of the Covid-inspired doldrums. The Reserve Bank of Australia (RBA) also weighed in with quantitative easing (QE), which supported lower interest rates on loans and savings and stimulated spending in the economy.

Together, these two tools have proved very effective in helping the Australian economy bounce back from recession. Growth (GDP) is projected to rise by 3.8% this year and 4.1% in 2002, after a drop of 2.5% in 2020.

As the Australia Economic Snapshot from the OECD says: ‘As the recovery continues, labour market conditions will improve, and spare capacity will be absorbed. Wage and price pressures will subsequently build.’

Excessive growth leads to inflation and higher interest rates

This is where the danger lies. While government stimulus is good for helping economies when they’re struggling, when they’re on the rebound it can be too much of a good thing. The wage and price pressures the OECD describes can lead to inflation, which is where an increase in the price of goods and services reduces the purchasing power of your money.

Signs of price inflation are starting to be seen in Australia and around the world. Just look at house prices, equity markets, and even Bitcoin. Producer price inflation is also on the rise; examples include more expensive semi-conductors, iron ore, and shipping costs.

One consequence of a healthy economy and increased inflation is rising interest rates. In the same way that the RBA lowered interest rates to stimulate Australia’s economy when times were tough, now that our economy is strong, and inflation is rising it’s a question of time before they start raising them. This stops the economy from overheating and prevents a boom and bust cycle.

Although the official cash rate hasn’t been raised yet, financial markets are betting that official interest rates will rise from a record-low of 0.1% today to about 1% by the end of next year. Australian lenders are starting to raise their rates in anticipation, with all four of the big banks no longer offering sub-2% fixed mortgage rates.

This trend of increasing interest rates is likely to find its way into all types of lending in coming months and years. Our recent blog on the rise of machinery costs highlights why it’s important to secure financing for any type of business investment before interest rates take off.

A reputable capital partner can advise you on the best interest rates, debt structure, and loan terms, so you get the best capital solution available. Get in touch with us to find out more about what’s happening with interest rates, so you can plan reliably and securely for the future.

Danielle Moore

The Trustee for the Rebus Capital Partners Unit Trust ABN 88 452 904 420. Authorised Credit Representative 523233 under Australian Credit Licence 536100.