Interest Rate Decrease to Stimulate House Prices... You Really Are Stooopid

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The Reserve Bank of Australia has dropped the official cash rate by 0.25% to bring the official number in at 1.5%.  There will be enough speculation around by many commentators suggesting that this will create a greater catalyst for property prices to escalate, but I’m not so sure.

The RBA has dropped the interest rates due to the state of the economy.  Their role in many respects is one dimensional.  They don’t have the economic levers available to them that a government does in trying to stimulate spending and growth.  Simplistically, their role is simply to provide the preconditions to keep the economy in the inflationary range of 2.0% and 3.0%.  This band is the apparent sweet spot for our advanced economy, however with the latest inflationary data coming in at 1.0% for the year, the economy is looking decidedly flat.

The real concern for both the government and the RBA is that the building approval data has peaked around the country and is now in decline.  This is after a strong resources boom that is now well and truly passed, despite recent soft growth in commodity prices.  The government is now trying to determine its new course of action…and here’s the rub.  What will our economy look like?  The last election really didn’t provide any insight.

If ever there was a time for a decisive political win, the opportunity that presented has now passed.  By all accounts we will now be entering another term where the decision making capacity of the country will be hindered.  Without strong leadership, the ability to make positive change will be increasingly more difficult.  Australia cannot remain at the cross roads for ever.  The longer we stand at this point, the further the nation slips backwards.

The RBA Governor makes a number of very good points in his summary.  One that stands out above others is, “Low interest rates have been supporting domestic demand and the lower exchange rate since 2013 is helping the traded sector. Financial institutions are in a position to lend for worthwhile purposes. These factors are all assisting the economy to make the necessary economic adjustments, though an appreciating exchange rate could complicate this.”  This rate reduction is as much about stimulating the economy as it is about keeping our exchange rate low to support the export driven industries.

This brings me back to the point that property prices and construction are slowing.  Whilst there is moderate price growth in most capital cities, the risk of supply imbalances continue to weigh in the over, rather than under scenario.  As a result, banks are more cautious in their lending to both developers and consumers.  The weight of apartments entering the east coast markets in the coming two years will almost certainly take the edge off rents.  Developers are also finding it more challenging as the cost of construction continues to escalate whilst the retail price for apartments has remained relatively flat.  As a result, margins are being squeezed to the point of being too risky.  The apartment boom has passed its peak, in many locations. Only those specialised developers will remain and the doctors, dentists, lawyers etc will again have to wait until the next cycle.

When one considers that 0.25% could be reduced from the overall mortgage, it really puts into perspective how little the impact will be in the housing market (the major four banks are unlikely to pass the whole discount on).  The public are not going to be dared into the investment market for such paltry amounts, particularly as rents are softening and vacancies increasing in many locations.  Owner occupiers are not going to take on larger mortgages if they are not confident in the broader economy and first home buyers who would like to access the low interest rates will continue to be met with resistance by financiers because they have little or no deposit, despite often paying more in rent than they would to service a mortgage.

So whilst many will suggest that this interest rate will stimulate property prices, the reality is that it will probably be little more than a statistical blip.  The real issue in the interest rate movement is the lack of business investment and an escalating currency.  Both of which continue to cause the RBA significant headaches, but only in the latter can they have any meaningful impact.  As we peer into the distance, the question remains, “How will this government stimulate business investment and how will it turn the economy around from one that is more aligned to part time employment rather than full time jobs?”  Solve these two problems and Australia will again start to see above average growth and a consumer that is willing to spend, rather than reduce debt.  By reducing household debt, the public is essentially saying it has limited confidence in the future direction the country is being taken.  So if you do believe that this interest rate will drive up prices, you will probably be happy catching Pokémon too.

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