While a December inflation rate of 3.2% might initially seem like a positive development, it could spell trouble for Australian home loan borrowers. Here’s why:
- Pressure on the Australian Dollar: If the financial markets think the RBA is going to reduce rates, the Dollar drops. History shows whenever the Federal Reserve (FED) maintains higher interest rates than the Reserve Bank of Australia (RBA), it creates pressure on the Australian Dollar (AUD). Investors seek higher returns, and if they think the RBA’s cash rate will be lower, the AUD becomes less attractive. This depreciation can lead to a weaker AUD, which has several implications.
- Risk-Adjusted Returns: The difference in interest rates between the US and Australia affects the risk-adjusted returns for investors. To compensate for the lower returns in Australia, the AUD may need to depreciate significantly. Some economists see the AUD falling to as low as US 50 cents, if the RBA starts cutting rates before the Fed.
- Impact on Inflation: While a weaker AUD is good for exporters it means that imported goods become more expensive. This can lead to a rebound in inflation, as the cost of imported goods and services rises. Higher inflation can erode the purchasing power of consumers and increase the cost of living, which is not good news for home loan borrowers who are already managing their mortgage repayments.
- Potential for Higher Interest Rates: If inflation rebounds due to a weaker AUD, the RBA may be forced to increase interest rates to control inflation. Higher interest rates would increase the cost of borrowing, making home loans more expensive for borrowers. This could lead to higher monthly repayments and increased financial pressure on households.
- Economic Uncertainty: The interplay between the RBA and FED rates, and the resulting impact on the AUD, adds a layer of economic uncertainty. Home loan borrowers may find it challenging to plan their finances in an environment where currency fluctuations and inflationary pressures are unpredictable.
In summary, while a lower inflation rate might seem beneficial, the broader economic context and the interplay between RBA and FED rates could create challenges for Australian home loan borrowers. A weaker AUD and potential rebound in inflation could lead to higher interest rates and increased financial pressure.
