Interest Rates Still On Hold. Why?
The RBA has left the official cash rate on hold at 1.5 percent for the sixth meeting in a row. This was widely expected, despite recent reports pointing to a more positive trend in economic growth. The RBA cut rates twice last year but hasn’t increased rates since November 2010.
Why Hold Steady and What Does It Mean?
It is first important to observe that in our economic culture, interest rates are not shifted by market forces, although they are influenced by them. Rather, they are manipulated by the Reserve Bank. We would, therefore, be wise to listen to comments that come from that organization. Just last month, the RBA Governor, Philip Lowe, spoke about keeping rates on hold to balance the need to boost inflation while maintaining financial stability amid record household debt.
As inflation remains below the RBA’s 2 to 3 percent target band, there is no pressing need for our policy makers to increase rates, particularly in an environment where both the jobless rate remains steady and growth in wages is extremely weak. Recent reports indicate that our household savings rate is steadily falling, which means that increases in consumer spending are coming out of savings.
Australians today are working the same amount of time for the same amount of money, but prices are rising and so is household debt. This is hardly a recipe for long-term prosperity and improvements in quality of life. There seems little doubt that any significant increase in interest rates in this environment would be catastrophic for large numbers of people.
But Our Economy Is Growing!
Is it really? Let’s have a look at the numbers in the context of the wider economy. Our economy grew 1.1 percent in the December quarter, which means over the past year, it has expanded by 2.4 percent. Interestingly, the main contributions to growth came from a strong iron ore price, household consumption, and government spending.
It is also instructive to note that over the past year our population has grown by 1.4 percent, putting economic growth per capita at less than 1 percent. Why is this relevant? After adjusting for inflation and the increase in our population, the truth is our economy contracted. It’s not the rosy picture some in media have painted.
Is Inflation Good For The Economy?
How can the RBA think it’s good for prices to be going up when growth in wages and employment is stagnant? Furthermore, how can prices go up if people have no greater buying power?
The fact is, inflation is good for anyone who has debt because that debt becomes easier to pay off as time goes on. In an open market, interest rates are supposed to reflect this and gradually increase to balance this out. But the market for money is not open.
Perpetual inflation, which is the stated aim of the RBA, leads to fewer insolvencies in the private sector and amongst individuals. Of course, the other side of this is that people who invest unwisely and deserve insolvency remain solvent.
Inflation also makes repayments easier for an indebted government, not only because the value of that debt decreases with time, but also because bracket creep increases Government revenue over time. Inflation is unambiguously good for Government, but for the rest of us, there are winners and losers.
How Does Inflation Affect Property Prices?
Property investors generally benefit from inflation as most have incurred debt, but even unleveraged investors generally also benefit. To understand why it is important to recognize that there are two different types of inflation.
Price inflation is caused by fluctuations in demand and supply. A good example is what happened to the price of bananas after cyclone Yasi in 2006. Most of the Queensland banana crop was ruined. Demand remained the same, but supply was devastated and consequently prices rose very sharply. This drove the market to plant more bananas, and eventually, supply and demand came back into equilibrium and prices came back down to within a normal range.
Monetary inflation relates to the supply of money in comparison to the demand for goods and services within the economy. This relationship is made more complex because the supply of money is affected by the speed with which transactions take place, the amount of money in circulation, and the amount of new debt being created. During 2017, our money supply increased by 7 percent according to statistics supplied by the RBA.
While demand for residential property fluctuates between different locations, steady population growth is constantly feeding demand, while low interest rates make properties affordable to a greater number of people, pulling future demand into the present. Government initiatives such as those designed to assist first home buyers as well as tax incentives for investors also boost demand.
At the same time, the construction of new dwellings is constantly inhibited by various bureaucratic processes and urban planning laws. A suppressed supply together with more and more money becoming available in the economy invariably leads to rising home prices.
What Does All of This Mean For Investors?
In the short term, unless there is a major catastrophic event, interest rates are likely to remain low. If they were to rise substantially, there would likely be a sharp correction in property prices, but this does not seem likely in the short term. Over the longer term, monetary inflation can be expected to drive strong returns for holders of real estate.
As always, it is best to be conservative with your investing, as it’s difficult to pinpoint when our money supply will stop expanding; but there is also no need to panic. Those who constantly look to strengthen their financial position and mitigate the risks of catastrophic events can expect to continue outperforming the wider population in terms of wealth creation.
If you would like to discuss your current financial position and how you can best use leverage to take advantage of future opportunities, while also minimising your risks, please fill out the expression of interest form at the following link:
www.PropertyInvestingFinance.com
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