Wednesday, April 7, 2010

Why Interest Rates Are Going Up, Even Though It Hurts

The decision by the Reserve Bank to increase interest rates was not unexpected. Even those who believed that the Bank might leave rates unchanged acknowledged that such a reprieve would be temporary. It was never a question of if, only of when. Of course, that hasn’t stopped the outcry today in response to the increase. Obviously, mortgage holders will feel the pinch, with record levels of mortgage stress already being registered, as well as business groups expressing concerns that the series of rapid increases in rates could undermine what is quite clearly a fragile economic recovery.

There seem to be two main reasons why the Reserve has taken the decision it has. One is the ongoing minerals boom, driven by demand from China and other developing countries. Mineral exports are so strong that the overall economic figures are given the appearance of robust growth. Unfortunately, that is a distortion, because most of us don’t have a direct stake in the mining sector, and the real economy, the retail economy which does affect us all directly, is still showing signs of weakness. Retail sales are thin, and while unemployment has been kept to reasonable levels, it is concealing an underlying problem with underemployment.

The second contributing factor to the Reserve Bank’s decision has been clearly articulated by the Bank’s Governor Glenn Stevens in that past few weeks. He has repeatedly expressed his concern about house prices, and the speculative investment bubble which seems to keep driving them up. While others are talking up the property market, including the government which has a vested interest in staving off a price collapse because of all the first home buyers it encouraged into ownership, Glenn Stevens is one of only a very few who are prepared to tell the truth about house prices.

The truth is that house prices are too high, and the only solution for that dilemma is for them to fall in relation to average incomes. Such a fall is of course a disaster for those who have already bought into the market, especially those who have borrowed heavily to do so, but the truth is that propping up those prices can only lead to an even greater disaster ahead. Already it is impossible for a family on an average income to buy an average house. While prices keep rising, speculators will keep chasing profits, leaving ordinary Australians who just want to buy a home for the family frozen out indefinitely, unless they are prepared to take a gamble and risk everything by borrowing beyond their means to achieve the Great Australian Dream.

Of course, that is exactly what the government has encouraged by providing the recent boost to the first home owners grant. Total mortgage debt is now 85% of Gross Domestic Product, as compared to 20% twenty years ago. That means that more Australians owe the banks more money than ever before. That means that the supernatural price of property has been overinflated by a big fat balloon of debt. That’s the problem that Glenn Stevens has been talking about, and that’s the problem that he must address by discouraging us from taking on any more debt. The only way he can do that is to put interest rates up.

The trouble is that already 40% of first home owners are now experiencing mortgage stress even before yesterday’s rate rise, and you can bet your bottom dollar that will only get worse over the coming months.

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