Yahoo Finance 17% interest rates: Why it wasn’t as bad as it sounds
Back in the late 1980s, a period of high inflation resulted in the highest interest rate on record of 17 per cent in 1990.
For those around to experience it, it’s a period they would rather forget.
Now, in the wake of the first interest rate hike in more than a decade, it’s set the scene for another round of intergenerational conflict as older Australians recount the stress of paying double-digit interest on their mortgages.
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While each generation makes a compelling case for ‘who had it worse’, according to economists, the two eras are impossible to compare.
For AMP Capital chief economist Shane Oliver, context is everything when comparing the present day economic conditions with the period of high inflation and high interest rates more than 30 years ago.
“If we had 17 per cent interest rates today, it would be a disaster for the property market and some people with debt,” Oliver said.
That’s because mortgages and house prices are much larger than back in the 1990s, and a deregulated financial system has allowed people to borrow enormous amounts of money relative to their income.
In fact, almost one in four new mortgages are considered ‘risky’, according to data released by the Australian Prudential Regulation Authority (APRA) in March.
That is, households are taking on dangerous levels of debt relative to the amount they are bringing in, with debt-to-income ratios of six and over considered risky by the financial regulator.
But, back in 1990, according to Digital Finance Analytics principal Martin North, debt levels were a lot lower, relative to income.
House prices were much more affordable, relative to income, and tighter lending rules kept a lid on how much people were able to borrow.
Plus, wages were growing much faster. Because inflation was so high, North said people were negotiating higher salaries.
This all resulted in much smaller loans, relative to income.
“If you look at the sorts of repayments that people were making, even at the height of the interest rates, they're not a million miles off where they are now.”
Oliver agreed that these conditions made the period of eye-wateringly high interest rates, judged by today's standards, quite manageable.
“That's why people were able to withstand high interest rates without a massive round of defaults,” he explained.
However, it did ultimately contribute to ‘the recession we had to have’ in the early ‘90s.
That recession ushered in a period of much lower inflation, far lower interest rates, as well as lower wages, which has been the status quo up until now.
The big difference between now and then, according to Oliver, is expectations.
“High interest rates were sort of seen as the norm through that period,” he said.
So, what’s next?
Oliver said after the high-interest period of the ‘80s and ‘90s, house prices eased back a bit.
“And they may well ease back now,” he said.
However, he said we're unlikely to go back to a period of ultra-high interest rates.
“For the simple reason that the Reserve Bank is not stupid,” Oliver said.
“And, if they get an inkling that interest rates have gone up too much, then they will take the foot off the brake.”
Because debt levels are so much higher than 30 years ago, Oliver said households were likely to be much more sensitive to higher interest rates as a mechanism to curb spending.
“So you won't need to raise interest rates as much to get a slowdown in the economy in order to control inflation,” he said.
Still, an official cash rate of 3 per cent could lead to variable mortgages of around 6.5-7 per cent.
“And if that becomes a new normal, it's probably also going to be tough for the property market,” Oliver said.
That’s because as interest rates have gradually come down, people have been able to borrow progressively more.
With interest rates marching back upwards, Oliver said people wouldn’t be able to borrow as much.
“And that will act as a bit of a headwind for the property market.”
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