The interest rate divide

Interest is simply the cost of money. And speaking of interest, it’s been an interesting month for the big four banks in regard to interest rates. On the 7 February 2012, the Reserve Bank of Australia (RBA) announced that it would be keeping official interest rates on hold at 4.25%. However, shortly afterwards each of the big four banks announced they would be raising interest rates on some of their products which seemed to be breaking with the tradition of keeping pace with the Reserve Bank and what they set the cost of money at.

Depending on which side of the divide you fall, rising interest rates can either be negative or positive. In this edition of Keeping in touch, we thought we’d have a look at the interest rate divide.

When an interest rate increase is negative news

If you’re paying off a mortgage, a rise in the interest rate is unpleasant news. It means that to pay off your loan within the same timeframe, you need to increase the amount of your monthly repayments, if you have a variable or partially variable home loan product. As a result, you need to pay greater attention to your budget, but with the right planning, you should have enough breathing room to meet the increased mortgage repayments and any other expenses.

When an interest rate increase is positive news

At first glance, there doesn’t seem to be anything good about an interest rate rise. But if you are an investor or term deposit holder, there certainly is. A rise in interest rates means that the cost of money is becoming more expensive, and a bank is likely to offer higher returns on your term deposit.  This is a good thing for those people relying on term deposits to provide them with income. Essentially you’re able to get a better return without taking any extra risk. We’re currently seeing this occur with some bank interest term deposit rates being set at a higher rate than the RBA’s 4.25% cash rate. So if you fall on this side of the divide, we imagine you’d be quite happy at the moment.

Why don’t the banks always follow the RBA?

In Australia, the banking sector operates in a free market. This means they are allowed to create their products with the interest rates they choose. As a result, consumers have the opportunity to review and change providers. New rules introduced by the Government recently has made this process a lot more easier for consumers. So, like with any purchase decision you make, take the time to shop around for the best deal.

It’s also important to note that the official cash rate is just one factor the banks consider in setting their interest rates. They also have debtors, wholesale funding requirements,  deposit competitiveness and shareholders they need to give consideration to.  In a recent media release (dated 10 February 2012), ANZ Australia CEO Philip Chronican commented on the interest rate divide: “This month we faced a serious dilemma in our review, balancing the rising cost of bank funding including deposit customers’ interests in receiving highly competitive rates, and the expectation of borrowers that we keep lending rates as low as possible.”

We are currently seeing the interest rate divide in action. But this is a minor issue when compared to the challenges that the European banking system have been dealing with. Generally speaking, banks within Europe have never really been well regulated, which means they are not making profits. The fact that the Euro Area interest rate is currently at only 1% says it all we think. So perhaps we’re not travelling too badly after all.

If you like this article, please feel free to share it.

Posted in Keeping in touch and tagged , , .

Switch to our mobile site