Interest rate cuts are saving us billions

April 10, 2013

By Stephen Koukoulas

Each percentage point reduction in interest rates has saved Australian borrowers about $25 billion a year. The Gillard Government might like to point this out to voters, writes Stephen Koukoulas.

It is surprising that the Gillard Government is not focusing attention on interest rates as part of selling its economic management credentials.

The Government should be shouting “low interest rates” from the roof tops as a huge economic influence on dealing with cost of living issues for mortgage holders and as a boost to cash flow for the small business sector.

Interest rate levels are a critical part of the economic landscape. Around one third of the population has a mortgage and a fifth have a business loan, on which they all, of course, have to pay interest.

For all of these borrowers, the lower the level of interest rates, the better their financial position will be.

You don’t need to have the economic nous of John Maynard Keynes to realise that lower interest rates will have a huge benefit on the cash flow of an individual or business with a loan used to buy a house or set up and expand a business.

According to the Reserve Bank, total household debt is currently a little over $1.4 trillion, while business credit from financial institutions is around $730 billion. Australian business borrowing in the domestic financial markets, effectively the corporate bond market, is an additional $430 billion.

For the household sector, each 1 percentage point reduction in the interest rate paid is worth $14 billion a year; or around $1.2 billion a month in additional cash flow; or, as is increasingly popular, accelerated repayment of the principle. Either way, it is good news.

For the business sector as a whole, each percentage point reduction in the interest rate they pay on their debt delivers savings around $11.6 billion a year or close to $1 billion a month.

Simply put, a 1 percentage point reduction in interest rates is a saving to borrowers throughout the whole economy of something close to $25 billion a year. This is equal to around 1.7 per cent of GDP. It shows how monetary policy can and should work because, of course, that amount of money would be “taken out” of the economy if interest rates were to rise by 1 percentage point.

When Labor took office on December 3, 2007, after winning the election nine days earlier, the standard variable mortgage interest rate was 8.55 per cent. Such was the force of the inflation momentum that was aided by the Howard government’s fiscal stimulus measures in the few years before then that just seven months later, the mortgage interest rate spiked to 9.6 per cent.

A range of factors, but most obviously the onset of the global banking and financial crisis, saw interest rate cuts flow shortly thereafter.

Fast-forward to today and the standard variable mortgage interest rate is 6.45 per cent, some 3.15 percentage points lower than in mid-2008.

For the current level of household debt, this 3.15 percentage point lower interest rate is adding a staggering $43.5 billion in extra cash or cash flow to the household sector on an annualised basis.

For those with a mortgage of $200,000, the lower mortgage rate is a saving of around $5,160 a year or $430 a month. For an average $300,000 mortgage, the saving is around $7,525 a year or $627 a month. For a Sydney-type mortgage of $500,000 a year, the lower interest rates now are saving the borrower $12,516 a year or $1,043 a month.

These are huge savings, adding to cash flow, lowering debt and leverage, and moving borrowers towards a comfortable financial position. The fact that house prices are starting to move higher and the share prices have surged around 25 per cent from the 2012 low point is also adding to the well-being of the population.

It is little surprise, therefore, that consumer sentiment and retail spending are on a march higher in the early months of 2013.

For the business sector, the small business overdraft rate was 11.0 per cent in December 2007 and was on its way to 12.25 per cent in the middle of 2008 as the RBA played catch up when reeling in the inflation pressures. Currently, the rate is 10.0 per cent, some 2.25 percentage points lower. The RBA measure of the weighted average interest rate paid by small business of the credit outstanding is currently 7.2 per cent compared with 9.1 per cent in December 2007 and 10.1 per cent in the middle of 2008.

The business sector rarely complains in the current environment about interest rates as being a constraint on them doing business.

For the Government, which has delivered the sharpest contraction in government spending seen in more than 40 years, it has played its part in dampening inflation pressures and with it, overseeing the lower interest rate structure.

While the RBA is independent of the government when it comes to setting interest rates, the shrinking of government demand has been a factor cited by the RBA in various assessments of growth and inflation risks.

That is where the Government, so clearly in dire straights in the polls, should be working to claim credit.

There are five more RBA Board meetings between now and the September 14 election. The probability of an interest rate hike in this time is miniscule. The RBA in fact has a bias to cut interest rates if there is to be any move in rates over that time.

It seems a no-brainer for the government: highlight how it has helped keep inflation in check and how as a result, it has played a critical part in getting interest rates lower.

It might just swing a few votes back its way.