Karina Barrymore: Only a third of households benefit from lower interest rates

Interest rates are just a good old fashioned battle of tug of war — there’s always a winner and a loser, especially after the Reserve Bank cut the cash rate this month, writes Karina Barrymore.

Interest rates can affect consumers’ spending power.

INTEREST rates are just a good, old-fashioned tug-of-war battle. Some people are happy that the Reserve Bank cut the official cash rate this month, others are unhappy.

Some households will be better off, hooray! But, unfortunately, most could be worse off.

Despite their status as something of a holy grail of economic bounty, interest rates are no longer a magic elixir to be poured out by central banks to quench all economic woes. They are just a centuries-old financial game of price control.

The interest rate lever is supposed to control people’s spending power — and therefore control prices.

According to the theory, higher interest rates means people will spend less in shops because their debt repayments soak up more of their pay. This keeps inflation low.

On the flip side, lower interest rates are supposed to mean people will spend more because they have more money in their pockets.

This can sometimes mean prices rise because there is more demand; more employment as more people spend in the shops and restaurants; and this flows on to wider economic growth.

That’s all well and good for the text books, but in the real world, that’s not how it always works — especially not right now in Australia.

Interest rate cuts have less impact, than ever.

Australia has a hefty percentage of the population that relies on interest rates for income.

In fact this group of savers, retirees and investors is probably greater in size and influence than the group that relies on interest rate cuts to reduce their debt payments.

That’s because when it comes to the debt, it’s mainly only home mortgages that are the target of lower interest rates.

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In Australia about a third of the population has paid off in full the house they live in, about a third is paying a mortgage for the house they live in and about a third rent.

So already, the power of this interest rate cut is limited to the third who has a mortgage. Two thirds of the population won’t directly benefit.

But wait, I’ll stretch the theory a bit more to keep the economists happy.

Indirectly, the economists say, private renters could benefit from a rate cut.

Um, such as at the end of their 12-month lease, the landlords might reduce the rent and give away the extra profit they have been earning from paying less for their investment mortgage. Ah, amd pigs might fly!

OK, let’s stretch a bit more for the sake of the theorists. Let’s factor in credit card debt.

Almost every household has credit card debt, right? Right.

Theoretically, the RBA interest rate cut could be passed through to credit card customers. In reality, wrong. I can’t remember the last time a credit card company reduced its rates in line with the Reserve Bank cut.

In fact the gap has got wider and credit card rates now average 17-20 per cent, even though the official cash rate is 1.25 per cent.

So let’s just unhitch the renters and the credit card households from any benefit from interest rates and tell the economists to concentrate their efforts on jobs and wages instead.

This benefits most households and increases spending.

Simples.