Wed Feb 19

Official interest rates have been cut, but not everyone is a winner

Written by Isaac Gross, Lecturer in Economics, Monash University

The Reserve Bank’s decision to cut interest rates for the first time in four years has triggered a round of celebration.

Mortgage holders are cheering the fact their monthly repayments are now slightly lower, while the Albanese government hopes the small easing in the cost of living will lift voters’ moods ^[1].

This is despite the Reserve Bank’s warnings that further rate cuts may not eventuate ^[2], depending on how much further progress is made on taming inflation.

But it’s important to remember not everybody benefits from an interest rate cut. Some will be worse off.

Savers lose out

Not all Australian households are net borrowers. Many are net savers, retirees or prospective homebuyers, who actually lose out when rates fall.

For starters, only about a third of households ^[3] are in hock to the banks when it comes to a monthly mortgage repayment.

Another third of households have paid off their mortgage entirely, and so don’t benefit from a reduction in mortgage interest rates. And the remaining third are renters, who also don’t pay a mortgage.

So while this news is generally a good thing for borrowers, a fall in mortgage rates only directly benefits a minority of households.

Here are some of the ways lower interest rates might actually hurt rather than help the typical Australian household.

Higher house prices

One of the most immediate effects of lower interest rates is their impact on the housing market. With cheaper borrowing costs, more buyers can afford larger loans, bidding up house prices. This is great if you already own a home, but terrible if you’re still trying to buy one.

For young Australians locked out of home ownership, a rate cut makes things even harder. It drives prices higher, forcing prospective buyers to stretch their finances further just to get a foot in the market. Reserve Bank calculations ^[4] suggest that, in the long run, higher house prices from lower rates can outweigh the benefit of lower mortgage repayments.

Lower returns on savings

If you’re a saver rather than a borrower, interest rate cuts are unequivocally bad news. Whether you’re saving for a home deposit, retirement, or just an emergency fund, lower rates mean you earn less on your bank deposits. The money in your savings account is now growing more slowly, making it harder to build wealth over time.

Term deposit rates have already been cut. Joel Carrett/AAP

Indeed, more than 20 banks actually cut their term deposit rates in advance of the Reserve Bank’s decision on Tuesday, according to Canstar research ^[5].

Analysis of HILDA data, which surveys household wealth and income ^[6], suggests net savers tend to be younger households without property, retirees living off savings, and those who are not in full-time employment. For these groups, lower rates mean less income and fewer financial opportunities.

Retirees will feel the squeeze

Many retirees rely on income ^[7] from interest-bearing assets such as term deposits or cash savings. When rates fall, their returns shrink. The cost-of-living crisis has made it harder for retirees on a fixed income to fund their lifestyles, and a rate cut only makes things worse.

While some retirees have exposure to the stock market via superannuation, many prefer the stability of cash savings. With rates falling, they face the tough choice of either reducing their spending or taking on more investment risk in their old age.

Bad news for the dollar, and overseas travellers

When the Reserve Bank cuts rates, it tends to weaken the Australian dollar ^[8]. A weaker dollar makes overseas travel more expensive for Australians. That pint of beer in London, that piña colada in Puerto Rico, or that shopping trip to New York all become pricier.

For Australians planning international holidays, rate cuts are a blow. A strong Australian dollar makes travel cheaper, and lower rates work against that. So while mortgage holders might celebrate, anyone hoping to travel overseas finds themselves worse off.

A weaker dollar will make overseas travel more expensive. Shutterstock ^[9]

More expensive imports

Just as a weaker Australian dollar makes travel more expensive, it also increases the cost of imported goods. And Australia imports a lot – especially cars and petrol.

Since the closure of domestic car manufacturing, all new vehicles sold in Australia are imported. Petrol, the second-largest import, is also sensitive to currency fluctuations. When the Australian dollar weakens due to lower interest rates, the cost of these essential goods rises. For the millions of Australians who rely on their cars for daily life, this is a significant financial burden.

This isn’t to say rate cuts don’t benefit a large portion of Australians. Anyone with a significant mortgage debt will find themselves with lower monthly repayments, and that’s undoubtedly a financial relief.

But the public narrative around interest rates tends to treat cuts as a universal good, ignoring the many Australians who are left worse off.

Falling interest rates are a sign the high inflation that has caused the cost-of-living crisis has abated. That is an economic success ^[11] that ought to be celebrated. But that now rates are falling again, we should at least acknowledge the costs that come with them.