One of the most potent influences on the economy, business and investing are interest rates. It takes up a large part of the cost of using borrowed money, along with the fees and charges that banks and other financial institutions levy their clients today. Interest rates are also part of the government’s toolkit for managing the economy. Through the Reserve Bank of Australia (RBA) the government uses interest rates to enhance activity in the economy, encouraging investing and business activity; or, it will use interest rates to slow down the economy and stop it from over-heating.
The RBA also uses interest rates to help control inflation so the value of the money we use every day is not eroded. In some countries experiencing very high inflation, everyday items like groceries, for example, can often end-up being significantly more expensive from one day to the next. In Australia, however, the RBA has used interest rates to control inflation for a long time and we have very stable prices for the everyday things we need to live.
Interest rates are also used to help the government manage the exchange rate so we can balance the costs of buying imported goods and services, keeping them relatively inexpensive, while also being careful to make sure our own goods and services are cheap for export markets to buy.
It’s an extraordinary balancing act, and often even a small change in official interest rates is enough to send a signal to the economy to either lift activity or lower it. For property investors, interest rates can have an enormous effect on the decisions they make – from whether to buy an investment property, where that property should be located, and the amount that can be paid for it.
The Signals We Have Been Receiving
While the capital city property markets, especially in Sydney and Melbourne, have been booming in recent years with sharply increasing prices, the federal government has wanted to be seen to help residential first home buyers break into the property market amid concerns about price rises. For 18 months we have heard the RBA and the federal government cautioning about likely interest rate rises. Yet, we have not seen upwards movement in interest rates. Is this due to there not being a need for rate rises? Or, is something else taking up the federal government’s and RBA’s attention, focusing their efforts elsewhere?
Analysing Interest Rates: Where are We Now and Where are We Going?
Matt Ivers, from Vision Property & Finance, advises investors about their property investment strategies. Investors’ goals can be affected immediately by any change in interest rates and so Matt makes it his business to understand what is happening with interest rates. He has a good idea about what is driving interest rates and where they are likely to head in the next few years, and this informs part of his approach as an advisor. Matt thinks the danger of sharp interest rate rises has probably passed.
“Even though we have been hearing about the likelihood of rate rises in the near future, we haven’t seen any change during 2017 as many have predicted. People may understandably be asking why all of the pundits have been wrong, but I look at what has been happening and can see why there hasn’t been a movement in interest rates, and why there is unlikely to be a move upwards in rates soon.”
There have been some fundamental changes in the property markets and the wider economy. These have impacted on the RBA’s decision-making when it comes to increasing interest rates.
“The federal government decided to try and manage demand for property loans by tightening approvals policy with the Australian Prudential Regulation Authority, the body that regulates the finance industry. Consequently, the restrictions on lending for property investment, have led to a cooling in demand for property from real estate investors.”
This hasn’t been the whole story, says Matt, and there have been more influences on interest rates in 2017 that should spill-over into 2018.
“The Sydney property market, in particular, has cooled after coming off the peak of the market earlier in 2017. I was calling the top of the market for 12 months, however, the long run continued into 2017 fuelled by overseas interest. Chinese property investment has not been as strong due to a crackdown on funds leaving China. Eventually, local property investors were turned-off by lower yields in the Capital markets such as Sydney and Melbourne. There is just better value elsewhere now; with Queensland looking like it is offering good property investment potential at a big discount to Sydney.”
The Interest Rate Outlook for 2018
Looking ahead to 2018, Matt doesn’t see a huge variance in the fundamentals driving the property market. Interest rates rises are always something he risk manages with clients, however, the danger of rates rising in early 2018 has now passed.
“Although the employment numbers have been good toward the end of 2017, there has been no real growth in wages. For rates to rise I would expect to see much stronger growth in wages. The RBA will usually respond to stronger wages growth by putting rates up so inflation can be controlled. We are not likely to see quite as strong house prices in 2018 with the market post-peak, and the RBA won’t risk damaging the economy by letting the dollar increase and causing our exporters to suffer. Things might be different toward the end of 2018 but I think the odds are we will see stable interest rates for a while yet.”