Making sense of the interest rate hype

4th Feb 2015By: Charles Tarbey

It’s been a particularly exciting start to the year for the Australian real estate market. Notably, the Reserve Bank of Australia (RBA) has this month decided to cut the official cash rate from 2.5%, where it has remained for an impressive 18 months since August 2013, to a new historical low of just 2.25%.

The decision to cut the rate caused quite an uproar in the media. Prior to the announcement, a number of financial commentators were quoted placing probabilities on a rate cut versus a rate hold. The ASX RBA Rate Indicator, a percentage probability of a rate change based on market expectations, was frequently published as it shifted in the lead up to the announcement. This included a movement from just 22% two weeks preceding the announcement, to a much higher 67% just days prior.

Further to this, there was also a great deal of speculation as to which decision would be the most prudent. In an article in the Sydney Morning Herald, Bank of America Merrill Lynch chief economist, Paul Eslake, expressed concerns about the possible negative impacts of a cut. On the other hand, Westpac Banking Group’s chief currency strategist, Robert Rennie, was quoted in the same article as saying that there was a “compelling case” for the RBA to cut the rate.

With all of this somewhat confusing and seemingly contradictory chatter, it can sometimes be difficult to understand what it all means for the property market. Certain speculators have jumped on the opportunity to proclaim that this move is sure to send the market into property bubble territory – again. I would again remind readers that these negative naysayers have been making such claims for many years by now, and have so far never been proven correct. Others are wondering what it all means when viewed in combination with other macroeconomic factors, such as falling oil prices, and the softening Australian dollar.

Below are my thoughts on some of the impacts I believe may be felt by different market segments by this current range of economic conditions.

DOMESTIC PROPERTY OWNERS

Obviously many of those currently invested in property may be feeling fairly happy with the cut. As an example, someone paying off an average $300,000 mortgage on a variable rate (given their lending institution passes on the complete 25-basis-point reduction) could see an extra $50 or so in the wallet each month. When considered in tandem with falling oil prices, which have been estimated as providing an extra $15 to $30 per month of savings to the average Australian consumer, this could provide a great opportunity to create a financial buffer of sorts.

This buffer could be achieved by using the extra cash to make additional repayments on a mortgage, shore up an offset account, supplement savings which could be used for a deposit on a new home, or even renovating or upgrading an existing property. Rates will of course not stay down forever, however, so it may be worthwhile to take advantage of the cheap money currently available.

PROSPECTIVE BUYERS

Over the past year I’ve witnessed a great number of Australians sitting on the property market fence. Many have been umming and ahhing about whether it is truly the best time to enter the market, and many of these people may now be experiencing a degree of regret not having already purchased, given the strong capital gains experienced in a number of locations throughout 2014.

I believe one impact of the RBA cut may be that a portion of this segment could see it as the stimulus needed to finally enter the market. While this could be a positive move if it means that someone who is ready and financially able has the confidence to take that first step, I would still advise a degree of caution. Again, rates will inevitably rise, and this inevitability must be budgeted for when making the purchasing decision.

FOREIGN INVESTORS

I believe the activity of foreign investors is being influenced not just by the rate cut, but also by the softening Australian dollar. This softening of the currency is making Australian real estate appear to be an extremely attractive option, particularly to investors from the US and the UK, who are able to make their currency stretch further in our market than in their own.

I don’t believe we’ll notice an enormous change in the activity levels of this segment, however, as they have been fairly active in the market for some time now already.

A LONG TERM APPROACH

At the end of the day, however, people tend to buy property with a long-term approach in mind. This is a highly beneficial attitude to take. By keeping your eyes to the horizon, and remembering that economic peaks and troughs are inevitable, I believe a prudent property owner can face any market condition that arises. This might be achieved by locking in a low interest rate, or taking the opportunity to build financial buffers, or ensuring people are placing themselves in the best possible position to face the more difficult times, should they eventuate. This could simply be a matter of planning for the occurrence of difficult times in the first place, and not believing interest rates will be low forever.

I wish everyone seeking to transact property over the next months the very best of luck.

Charles Tarbey is the owner of Century 21 Australasia (www.century21.com.au) and Century 21 New Zealand (www.century21.co.nz).