New interest rate cut unlikely to stimulate spending

The powers that be have decided that Australia's economy needs a fix and accordingly the Reserve Bank dropped rates by another 0.25%, with hints of another cut to come next month.

The reasoning is that the rate cut will pour money into the economy and offset the negative effects of the bushfires and the coronavirus.

Well, it might be good in theory, but I'm racking my brains to think of anybody who will be induced to increase their spending by this strategy.

Let's start by considering first-home buyers.

A minuscule rise in the rate they can earn on their savings will make no difference to how long it will take them to save a deposit, but it will put pressure on the already overheated first-home buyers' market and push up prices.

That will put their first home further out of reach and force them into a bigger mortgage when they eventually get enough money together to make the purchase, negating any savings that could come from lower interest rates.

Now think about homeowners with an average mortgage of $400,000 - a cut of 0.25%,would save them $83 a month.

If they are good money managers, there is no way they would reduce their home repayments and spend the excess.

They are far more likely to stay with their present payments, creating a safety buffer in case of financial problems down the track.

And if their financial situation is so bad now that they need an extra $83 a month to get by, imagine the strife they will be in when rates eventually rise again.

NO HELP: Cutting interest rates will not help first-home buyers close in on a home.

NO HELP: Cutting interest rates will not help first-home buyers close in on a home.

Next, consider investors. Interest rate changes don't affect them as much as they do homeowners, because the interest they pay is tax-deductible. In any event, the main goal of the canny investor is to get a great property at a cheap price.

Does the Reserve Bank seriously think 0.25% will be the make or break factor in a property deal?

Retirees will be the worst affected by the rate cut.

Most of them inherently regard shares as a bit of a punt, and the market shenanigans in the last couple of weeks would have reinforced that belief.

They now face reduced earnings on their money in the bank, and will be hard pressed to find banks that pay them the 1% or 3% on which their savings are being assessed by Centrelink under the deeming rules.

You can bet they will tighten their belts.

And there is another factor in play - the wealth effect.

When things are booming and property and shares are doing well, people feel wealthy and are more inclined to spend up.

But when markets fall, the opposite happens: people feel poorer, and restrict their spending.

This will happen here irrespective of any actions from government.

The Reserve Bank can cut rates as much as it likes - but don't expect any lift in the economy until the share market starts to recover.

There is, however, one simple thing the regulators could do which would make a massive difference.

As I pointed out recently, 730,000 interest-only loans are due for renewal in the next year, and borrowers will be forced onto principal and interest loans, which will substantially increase their monthly payments, dragging cash out of the economy.

All the government has to do is tell lenders to encourage people to maintain their interest-only payments - now that would be a real stimulus!

Obviously, it's highly unlikely this rate cut will achieve anything - nor will the one that is supposed to be coming next month.

After that, when the cash rate hits 0.25%, the Reserve Bank has hinted about qualitative easing. If that happens, fasten your seatbelts.

  • Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance.