Interest rates crash course: What's the relationship to the property market?
Today is the fifth Reserve Bank meeting of 2014.
RBA Day, as it’s unofficially called here at the Property Observer office, has the whole industry pausing to check in at 2.30 – regardless of how sure they are that any change, or non-change as has most recently been experienced, is likely to be announced. Until 2.30, it's anyone's guess what could happen - and of course, "anyone" does indeed guess.
Forecasting, predicting or, indeed, downright guessing the RBA's next move, is now a favourite pass time of everyone from economists from the head of our big four banks, to the first home buyer tuning in to the news. We regularly survey different experts and ask them to explain their reasoning, which has provided some interesting insight into how the Reserve Bank may balance the different market forces in their own decisions.
However, just as it's not always clear when the RBA will make a change, and what that change might be, it’s also not always clear what the impact actually is.
Can extended periods of low interest rates really cause a property bust (as warned by some economists in this article here)?
Do lower interest rates actually cause people to jump into the property market (as was discussed at the Bloomberg Australia Economic Summit here)?
The real impact of interest rates is heavily debated. Observer Catherine Cashmore, back in January 2013, argued that interest rates actually have very little effect on property. And then, last month, observer Pete Wargent called interest rates more important now than ever before.
"Pundits like to argue that in theory interest rates have little impact on housing markets, but due to the deregulation of the Aussie financial system and higher household debt today, this is incorrect, as partly evidenced by the impact of rate cuts since 2010," said Wargent.
"Shifts in interest rates were formerly somewhat limited in their ability to impact housing markets - since both lending and deposit rates were strictly controlled - yet today the availability and expectations around the cost of capital can be a key driver of market sentiment," he explained.
Regardless of who is right or wrong, it doesn’t stop the first Tuesday of the month being of fascination across the country and something that may have at least some impact on sentiment, if nothing more material.
Quick terminology
RBA: The Reserve Bank of Australia. Also, The Reserve Bank, Reserve Bank, The Reserve.
On hold: No change from the Reserve Bank
Basis points: One basis point equals one hundredth of a percent. So 100 basis points equals 1%. You’re most likely to hear this in terms of 25 basis points (0.25%) or 50 basis points (0.50%) as these are routinely the most used changes from the RBA.
The Official Cash Rate (or Cash Rate): The term describing the rate of interest on which the Reserve Bank charges on loans to banks. Some use this term interchangeably with interest rate.
Quick answers to FAQs
When does the Reserve Bank meet?
The Reserve Bank meets on the first Tuesday of the month, excluding January. They announce their decision at 2.30pm.
Why did they make a decision?
Currently, Governor Glenn Stevens publishes his meeting minutes at the same time. You can read these on Property Observer. They use a range of different data sets to make their choice, including looking at the housing industry.
Does this mean my home loan rate will change?
While some years ago it was expected that the banks would change their interest rates in line with the Reserve Bank, in recent times this has changed. The banks and lending institutions now have their own meetings to decide on whether to pass on changes, or to cut or increase rates out of cycle. You can see how far out of step they tend to be with the Reserve Bank in this article.
The latest movements
The Reserve Bank has been on hold for an extended period of time. Having plotted the last 27 meetings (since February 2012, the first meeting for that year) including today’s, we’re in one of the lengthier periods of stability.
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The last interest rate increase was November 2010, when a 25 basis point change increased the cash rate to 4.75 from 4.50. 10 meetings of no change ensued until one year later, November 2011, the rate cutting cycle began, bringing the rates back to 4.50 and then to 4.25 after the December meeting.
The other decisions are visible in the graph above, bringing us to our record historic low interest rate of 2.50. In May, RBA governor Glenn Stevens said that it is likely the most prudent course of action to have a long period of interest rate stability.
This low, and the general direction of the rates from the banks on offer being historically low as well, basically means that you can potentially aggressively pay down your principal to give yourself some later breathing room and build some equity, with extra repayments or even by retaining your usual rate of repayment that you had prior to any decrease.
How low can it go and where are we heading from here?
As we're currently at lows that would have been seen as unprecedented, it's unsurprising that many do not believe it can fall much further, despite 1300HomeLoan managing director John Kolenda suggesting that this new low interest rate environment might just be the new normal.
“Prior to the global financial crisis the norm for the RBA's official rate was around the 5% mark,” Kolenda said in April.
“The historical rates over the last 30 years have been much higher than for the previous few years. Consumer confidence is playing a bigger role in determining rate movements.”
However, if it isn't the new normal - and rates return to previously seen highs, such as those during 2008 where the rate hit 7.25, home loan repayments could rise by up to 40%, according to Fitch Ratings. Bad news for those stuck with the repayments, and bad news for those lending if they don't bear this in mind.
And, in fact, the next movement is actually likely to be up - although there have been no alarmists suggesting a return to GFC-style 2008 interest rates as of yet.
According to a recent survey of economists and property experts from Finder, which included our editor at large Jonathan Chancellor, every single one of the 16 on the panel accurately believed there was to be no change this month.
However, nine of those surveyed forecast an increase for next year (including AMP, ANZ, Bank of Sydney, ING Direct, RAMS, UBS, Heritage Bank, Moody’s Analystics and ME Bank).
A further five respondents said that cash rate would likely be increasing this year (Commonwealth Bank, Commsec, Urbis, HSBC and St George Bank).
And observer articles, such as from Robert Simeon, are tending to suggest that there could be significant interest rate increases over the next year.
For borrowers, this prompts the consideration (particularly for those on variable rates) as to how to handle interest rate increases, particularly if you haven't really thought about it until now. If you're in this category, you can read our "How To: Prepare for an interest rate rise" article.
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