Interest rate cuts might have less impact than thought
Changes in interest rates may have less impact on household spending than traditionally thought; This means the Central Bank may need to raise interest rates or make harsher cuts to achieve its goals.
Despite the RBA increasing interest rates in one of the sharpest tightening cycles in decades after the COVID-19 pandemic, Australians have only cut their spending by a relatively small amount, the e61 Institute found in a research paper published on Friday.
This is because mortgage holders can use their offset accounts as a buffer to smooth out expenses.
The findings challenge conventional wisdom that the mortgage market is a particularly sensitive transmission pathway for monetary policy to influence inflation, as Australia has a relatively large amount of variable-rate mortgages.
“Household spending has barely decreased,” said Gianni La Cava, co-author of the report.
“Australia’s experience shows that the transmission of monetary policy can be weaker and slower when mortgage flexibility and large savings buffers come into play.”
There was little change in spending between variable-rate borrowers and fixed-rate borrowers, whose repayments increased by an average of $14,000 over 18 months.
Australia’s mortgage market is unusually flexible; Nearly 90 percent of variable-rate mortgage lenders save money through refinancing facilities, providing borrowers with a liquidity buffer as repayments accelerate.
“According to household survey data, only seven per cent of variable rate borrowers were experiencing liquidity difficulties during the rate hike cycle,” Dr La Cava said.
“The RBA tightening took longer to take effect because savings were abundant.”
The same effect could also work in the opposite direction, reducing the RBA’s ability to boost economic activity by cutting interest rates as borrowers choose to rebuild buffers rather than increase spending.
“Although interest payments for variable rate borrowers have decreased, most people have not automatically reduced their scheduled payments,” Dr La Cava said.
“This means that rate cuts may provide a less abrupt increase in spending than textbook models predict.”
Following a record tightening cycle, the RBA began cutting interest rates in February, with inflation under control and unemployment slowly rising.
But inflation has since risen above the central bank’s forecasts.
Household spending also rose faster than expected, rising 0.9 per cent in the June quarter compared with the RBA’s forecast of 0.6 per cent.
The Central Bank is now expected to keep the cash rate constant until at least mid-2026.
Some economists even predict that after Tuesday’s interest rate cut, the next move will be up, not down.
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