3 Reasons Why Interest Rates Will Stay Low

The future direction of interest rates is a topic that the mainstream media is always talking about. The monthly Reserve Bank of Australia meetings are highly publicised and during the lead up to each meeting economic commentators in the mainstream media go into overdrive where their thoughts on the future direction of interest rates.reserve bank

My analysis of the current interest rate setting indicate that rates will stay low in Australia for at least the next 5 years and possibly longer. At the moment the official cash rate is 2.5% and I believe it will remain around that level for a long term.

Here are 3 reasons why interest rates will stay low for a long time.

  1. The level of Australia’s debt

Back in 2008 the Federal government debt was around $60 Billion now it is around $320 Billion so it has increased sixfold in 6 years. This means that if interest rates go up then the repayments on the government debt will also go up. Given the problems the government already has in trying to reduce the budget deficit the last thing they want is for their interest payments to increase.

This means that the RBA is caught between a rock and hard place and is in no position to raise interest rates. I believe this situation will last for at least the next 2 years. There will be times in the next couple of years when the Reserve bank will state that they may raise interest rates but they will ultimately sit on their hands.

  1. The Japanese experience

Japan provides a very interesting case study on how low and for how long interest rates can go. The Japanese stock and property markets collapsed in 1989 and since then the Japanese Central bank’s benchmark interest rate has been around 0.50%. Their central bank has made numerous announcements over the years that a rise in interest rates is imminent but nothing ever happens. The reality is that the Japanese economy is in a kind of limbo, neither growing nor shrinking, therefore the Japanese Central Bank will not increase interest rates. This situation has lasted for 25 years and will continue for many more.

  1. Interest rates in Europe and the US

A couple of weeks ago it was announced by the European Central Bank that they were cutting the benchmark interest rate to -0.10%! In effect this means that if you put your money in the bank you will earn no interest on it and you will have to pay an annual fee for the privilege. Given the mainstream media is always reporting that the recovery in the EU is underway this provides a flashing indicator that all is not well in Euroland.

The situation is the same in the US. Latest figures show that economic growth has slowed to a halt. Although the Federal Reserve is hinting that interest rates may rise sometime in the future. The US has a debt problem the same as Australia but the actual amount of debt is a mind boggling $17 Trillion. This is an astronomical amount of money to be repaid and if interest rates were to increase by only a couple of per cent then the US government would have to default on their debt repayments.

The reality is that interest rates in Australia will stay low for at least the next 2 years. Factors such as the increasing government debt and a fragile economy will force the reserve bank to keep rates low. Given the experience of Japan, the EU and the USA rates could be low for a whole lot longer than people think is possible.

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