Future Expectations of Interest Rate Rises

The real world implications of interest rate rises are far more impactful than what we have seen so far. 

 

Effect of Inflation on Goods

While inflation has risen, this has increased the cost of goods, however as this inflation marker reduces, it is expected that the cost of goods and services may also reduce back to more normalised levels. 

 

Lag of Interest Rate Changes Versus Inflation

Country cash rates and interest rates have inherently risen in a lagging manner to that of the inflation rates. Interest rates are still rising around the world even though inflation seems to be slowing and reducing, this exhibits the lag effect of inflation against interest rate rises. 

 

Effect of Inflation

Countries, companies and individuals with borrowed capital are experiencing increased interest rate costs. There are several lag effects coming into play in the real world, one is the lag against inflation rises, but the other is a cliff face of fixed interest rate terms which were locked in at lower rates. 

 

Effect of Fixed Interest Cliff

As the fixed rate loans expire, loans will need to be refinanced into current interest rate conditions. On the face of it, the costs will be increased significantly, particularly if the payback figures were already stretching the client, but that isn’t all. 

 

The Trouble of Refinancing

Serviceability

Banks have stringent requirements that need to be met in order to safely offer a loan to the client, meaning that the serviceability of their income or profits must be able to cover the new interest rate and principle, plus a safety net for any higher movements in the interest rates. 

 

Interest Rates Buffer

Given the rate increases were measured against lower rates with a buffer added on for maximum serviceability, clients that took the maximum loan amounts will now be unable to be classified as able to service the new loan based on today’s rates plus an added buffer. 

 

Valuations 

As valuations decrease in property sectors, this means the margin or loan to value ratio may have decreased, meaning more cash could be needed to maintain the required LVR. If the valuation of a property is now $50,000 less, but the loan amount is still at the original figure (less any principal repayments), this could add pressure to the lending situation since the asset is worth less than the original application. 

 

Squeezing the People

As people eat into savings through higher living costs and interest rate costs, the values of properties reduce and the interest rates go higher, the ability to sustain the same lifestyle and obtain refinancing reduces. This puts the squeeze on people and companies, which can be sustained for some time for those that held savings or other assets, however eventually the energy required to push hard while net worth is decreasing can be a massive challenge.

 

The Lag 

While interest rates are lagging, so too is the effect of people’s repayments, shift in savings and asset values. We are not at the end of the rising interest rates just yet, but even if they are sustained at these levels for a while, this will apply more and more pressure to asset owners with debt. 

 

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