How quickly the outlook for interest rates can change

Few economists were surprised when the Reserve Bank held official interest rates at 4.5% at it’s recent August meeting, but there is still a lot of conjecture as to just how high interest rates might climb over the next two years.

It’s interesting how quickly the outlook for interest rates can change.

Only a few months ago, leading economists were claiming that historically low unemployment levels and escalating commodity prices would see Australia’s inflation rate soar, forcing the RBA to up interest rates in an attempt to keep a lid on our overheating economy. Some forecasters were predicting a horror retail rate of 10% by 2012.

It wasn’t that long ago – back in April this year, that both Macquarie Bank and CommSec economists forecast a cash rate of “pre-crisis highs” around 7.25% by 2012, which would have meant that variable mortgage rates could climb to 10.1%; the highest they’d been since 1996.

Understandably, these reports caused growing concern among homeowners. If rates were to hit 10%, this would mean a $300,000 mortgage that was costing a borrower $1,887 per month when rates were at a low 5.75% just last year, would jump to $2,726 – an increase of $839 per month.

However, fast-forward a few months and it’s a whole different ball game, with a much more optimistic spin and suggestions that interest rates won’t increase again for awhile.

So should we worry about the future of interest rates, or do we take these latest developments as a good omen and remain confident in our housing markets?

Of course it’s difficult to know what’s around the corner for Australia’s economy – especially considering all the issues happening overseas – but many economists have done an about face and now expect interest rates to remain on hold at least until November, when the next set of inflation figures are released.

This more favourable prediction comes as inflation fell to 2.7% for the June quarter, well within the RBA’s target range of 2% to 3%.

Seemingly, Australia is in the throes of a two-speed economy, which is helping to keep inflation in check and ensuring the RBA don’t sting us with yet another rate rise in the near future.

If you’ve been keeping track you’d know that while the commodities sector continues to enjoy boom conditions – even though there has been a decline in demand from China as they attempt to keep their fast growing economy under control – the retail sector has slumped significantly.

Adding to a more optimistic outlook for interest rates were comments from Reserve Bank Governor Glenn Stevens who said, “The current setting of monetary policy is resulting in interest rates to borrowers around their average levels of the past decade. With growth likely to be close to trend, inflation close to target and the global outlook remaining somewhat uncertain, the board judged this setting of monetary policy to be appropriate.”

Now that inflation seems to be under control, many strategists have put a more positive spin on their previous, dire interest rate forecasts.

In a recent statement to news group Reuters, Macquarie Bank’s Rory Robertson said with regard to the RBA’s decision to hold rates for the time being, “There’s not a lot new in the statement. Last week’s CPI told the story – with inflation clearly under control they were always going to be comfortably on hold.

“They are likely to stay on hold for the next few months at least, and probably well into 2011. It would take a really disturbing inflation reading for Q3 [the third quarter] in late October to get them moving again.”

But history will repeat itself (as it always does) and interest rates will once again start rising, but maybe not quite as soon as many were predicting just a few months ago.

Currently there is a window of opportunity that hasn’t been available for a long time. Now may be a good time for investors and home buyers to hedge their bets against potential further rate rises and consider fixing part of their mortgage.

You see, the cost of fixed rates loans have come down recently and the difference in variable and three year fixed rates is currently only 0.5% in some instances. Maybe it’s time to consult your mortgage broker or finance professional and consider structuring your borrowings so that a portion of your loans – maybe 50% – is fixed for a three year term. This could prove to be a smart move and provide some insurance against the inevitable rate rises that will occur down the track.