Why the record-breaking run of flat interest rates has further to go

In Philip Lowe’s time as governor of the Reserve Bank, he’s chaired 14 meetings of its high-powered board, and each has had the same result: no change in interest rates.

If you believe the financial markets, Lowe will do more of the same for much of 2018, and perhaps further into the future.

Great news for people with big mortgages, and bad news for those earning interest on their savings, right? Maybe. But if you dig into why this change has occurred, it’s a less rosy picture even for those with large debts, because the lack of change in rates is a reflection of very weak wage growth.

As 2017 has drawn to a close, there has been a significant shift in the arcane parts of the financial markets where people bet on the future course of official interest rates, those set by the Reserve Bank.

They still believe the next move in rates set by the RBA will be up. But there is an expectation the change will be smaller, and take longer, than previously thought.

It’s been quite a change of heart. Just three months ago, the markets were convinced 2018 would be the year in which rates finally rose, for the first time since 2010. That may still happen, but it’s no longer seen as a sure thing.

In September, the futures markets were betting that official interest rates would climb by 0.4 percentage points by the end of next year, which is another way of saying there was a good chance of two standard 0.25 percentage point increases.

Now, they are only betting rates will rise by 0.15 percentage points – meaning they are no longer sure there will even be one standard-size increase in rates.

The shift in expectations of how rates will move over the next two years has been more dramatic. Markets had previously priced in an increase of 0.9 percentage points in official rates by late 2019; now it’s only 0.4 percentage points.

The other signal that rates may stay lower for longer is the recent decrease in fixed rate mortgages by some lenders including Westpac, Bankwest and CUA.

What’s behind the shift in opinion?

Like so many issues in the economy, this one is tied up with the very low rate of wage growth, and inflation.

The RBA aims to keep inflation between 2 and 3 per cent – compared with 1.8 per cent today. It is unlikely to raise rates, which would dampen economic activity, until it is confident that inflation is well on its way to returning to the target range.

Lately, however, progress has been slow. Despite a reasonably strong economy, and healthy jobs growth, wage growth has barely picked up, and it’s still running at just 2 per cent.

Until pay packets start expanding more quickly, it’s unlikely that businesses will put up prices more quickly. That suggests inflation will remain low, too.

Importantly, it’s not all bad news. Last week’s national accounts showed strong growth in non-mining business investment; something the RBA have been wanting to see more of for years.

That should ultimately help to push wages higher, and nudge inflation back towards its target range. But it will be a slow process, and that suggests little or no change in interest rates.

Previously, the RBA hasn’t left the rates unchanged for more than 15 months. That record looks set to be easily broken under Lowe’s watch.

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