In much the same way as continuing strength in the Australian dollar above US90c indicates market confidence that commodity prices will hold up, recent reductions in fixed-term mortgage interest rates suggest that recent forecasts of higher interest rates next year may not be correct.
Following recent reductions, fixed-rate borrowers have access to three-year fixed rates for less than 5 per cent per annum, while one institution announced a five- year fixed rate of 5.5 per cent per annum. These are historically low levels and competitive with variable interest rates on offer.
The crucial thing for borrowers considering a fixed-rate loan is to factor in likely future movements in variable interest rates. If the additional cost for fixing the rate is modest as it is at present, the decision to fix will not be too costly unless variable rates fall in the future.
The prospect of rates falling was ruled out recently by one of the major banks which forecast that the next rate change would be an increase. The probability of this being an accurate assessment has been increased by a continuation of the housing boom and general improvement in the retail sector of the economy.
Also, the US Federal Reserve appears to be keen on reducing its cash creation via quantitative easing. This change of direction is already resulting in higher US interest rates. Just how significant higher US interest rates will be for the Australian economy will depend on their impact on the availability of offshore short-term money to our banking system.
The sanctions against Russia are already leading to a repatriation of funds from that country and other emerging market are likely to experience continuing outflows, particularly by US investors. Given that Australia still retains a favourable status and sound credit rating, there are reasons for confidence that the impact of the US monetary changes here will be relatively minor.
A much more important factor in determining movements in our interest rates is any future movements in residential house prices. If this already buoyant market becomes overheated, the Reserve Bank may be forced to start increasing rates sooner than expected.
Historical experience is that interest rate increases of more than 2 per cent quickly reduce the demand for residential housing. Even if the official short-term interest rate were to rise in a series of steps to, say, 4 per cent per annum, the impact on the demand for housing would still be significant.
For the present time, however, the general consensus is a rate rise is unlikely until next year. Over- committed borrowers might nevertheless still find it attractive to switch some or all of their loans to a fixed rate while attractive options are still available.