Why low interest rates are here to stay in Australia

WE haven’t had a recession for 25 years and record low interest rates have caused some people to worry that one is around the corner.

ANALYSIS

RECESSION or not, low interest rates are here to stay, and they will affect all of us.

This week’s Reserve Bank rate cut to a record low has sparked fresh fears that the nation may be heading for a recession. Australia’s run of 25 years without a recession is closing in on The Netherlands’ world record of almost 26 years, and RBA governor Glenn Stevens is not saying one is likely soon.

The RBA’s rate cut wasn’t because of a need to rescue the economy — currently growing at 3.1 per cent annually — but because inflation is lower than it would like, and the Aussie dollar is higher than it would like.

In theory, cutting interest rates lifts inflation through higher consumer and business spending, and makes our dollar less attractive to foreign investors. However, economic theories aren’t what they used to be.

There are plenty of doomsayers predicting a recession, caused by reasons as diverse as a house price crash to Donald Trump becoming US president. Some have been predicting one for decades.

A recession — defined as two successive quarters of negative growth — can strike at any time. We came very close during the GFC.

More worrying today is the fact that Australia is running out of financial firepower to fight a recession when it does inevitably hit.

Australia and much of the world has painted itself into a corner (not a bad trick for a round planet) by lowering interest rates so much that any rise back to earlier “normal” levels would cripple consumer spending, property markets and the country overall.

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For example, if you’re paying 4.5 per cent interest on a $400,000 mortgage today, it’s costing about $2300 a month. If rates reverted back to their 2008 levels, you’d be paying 9.5 per cent — an extra $1300 a month. Ouch.

The RBA wants inflation sitting between 2-3 per cent, because being stuck with low or negative inflation is bad. It reduces the incentive to invest for the future, and people are reluctant to buy stuff that they think will be cheaper down the track.

Low interest rates may be great for borrowers, but savers hate them, retirees hate them, and banks seem to use them to pocket extra profits.

Experts say low is the new normal, and economists have forecast more RBA cuts ahead. But if rates tumble further, how will the RBA be able to rev things up when the economy does take a dive?

Printing money? That may have worked in the US, which is the world’s reserve currency, but it didn’t go so well in Zimbabwe — where hyperinflation led to the 100 trillion dollar banknote before its currency was abandoned.

Australia is not the US, and definitely not Zimbabwe. Our economic record is envied by most of the western world. So enjoy low rates and low inflation but don’t wish for more, and don’t worry about the recession question for now.

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