Falling interest rates helps households but hurts business

Lower costs for mortgages, car finance and credit cards suit households, but business owners might see it differently. Sure, a lower cash rate means a lower cost of capital. But a rate reduction means the RBA is forecasting some hits to the Australian economy and is reducing the cost of money so that the economy will keep breathing when these threats materialise.

From a business owner’s viewpoint a weakening economy translates to fewer orders, less work, lower revenues and reduced business activity. A reduction in interest rates means a slowing economy.

This puts our business community in a nervous state, which is no good. I would make two points about the current situation. Firstly, while the RBA’s rate reductions of 0.75 percentage points in two months means there’s a potential slowdown on the way, the Aussie economy is actually very strong.

We have low unemployment by the standards of developed economies, our currency is strong, we have very low government debt as a percentage of GDP, and our biggest trade partners are developing nations, whose economies are forecast to grow rapidly.

Perhaps our greatest strength and weakness is our cash rate. At 3.5%, it is significantly higher than comparable economies such as Canada, US, eurozone and Japan, which have cash rates ranging from 1% to effectively zero.

Australian business owners face higher capital costs than their global counterparts. However, the strength of this higher interest rate policy is that the central bank in Australia has the room to stimulate the economy by monetary policy rather than by inflationary fiscal stimulus.

The central banks in other developed economies have already reduced their official rates to rock bottom – their only economic stimulus option is now fiscal, and some of them are simply printing money to achieve this.

The second point is that the RBA can force interest rates to go as low as it requires.

The major banks’ variable interest rates were in lock-step with the RBA during the Howard and Rudd governments, but this no longer occurs. This creates volatility, which feeds into one of the most important factors influencing business owners: sentiment.

Sentiment can turn an economy for better or worse, and business owners generally have stronger sentiment when they feel the certainty to make informed decisions. This is particularly the case when it comes to borrowing to expand, the lifeblood of economic growth.

Even when official interest rates were rising through 2010 and 2011, business owners could make a decision about capital costs based on the Reserve Bank.

It worries me that Aussie business owners will hesitate because they don’t know what official interest rates mean to banks’ rates.

Perhaps the Reserve could look at changes of 0.3 or 0.4 percentage piont, in order to shift variable rates to where they have to be?

With 2.7 million business owners in this country, the last thing we should be doing is confusing them about the cost of money.