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- Will interest rates really rise 2 percent?
- Here is why I think that would be a long time off
- INTERNATIONAL ECONOMIC GROWTH
- AUSTRALIA’S ECONOMY
- HOUSEHOLD SECTOR
- OUR HOUSING MARKETS
- Our property markets are taking a breather
- TWO OF THE MAJOR DRIVERS FOR OUR HOUSING MARKETS:
- THE BOTTOM LINE:
- WHAT DOES THIS MEAN FOR YOU?
How well-positioned are you for a significant interest rate rise?
Each month the Reserve Bank meets to discuss the state of the economy and set official interest rates and then releases its minutes to explain the reasons behind their monetary policy decision and releases a chart pack which I summarise for you here at Property Update each month.
But before I share their latest Charts, I’d like to explain my thoughts on a comment in the minutes of their last meeting where the RBA announced it considered a neutral cash rate to be 3.5%.
Now the neutral real cash rate is essentially an official interest rate which essentially has no no impact on economic growth.
The current official interest rate of 1.5% is expansionary or stimulatory and eventually once these low rates work and the economy improves, employment picks up and inflation increases, the RBA will need to raise interest rates by up to 2% (to 3.5%) for them to be neutral.
In other words not so low that they stimulate the economy but not high enough to stifle the economic activity.
Will interest rates really rise 2 percent?
Former Reserve Bank of Australia board member John Edwards recently received significant publicity when he predicted that interest rates could hike eight times in the next two years (in other words 2%).
His comments are in line with the RBA’s thoughts that a neutral cash rate could be 2% higher that the current rate.
This has many economists worried as the effect of rising interest rates on the average Australian household is going to be far more dramatic than on previous occasions due to the sheer scale of Australia’s household debt.
Of course the RBA will only increase interest rates to slow down a booming economy, so if rates do rise significantly we would be in the comfortable position that everybody who wants to have a job would be able to get one, house prices would have increased even further and inflation would be creeping up.
Here is why I think that would be a long time off
Now I’m no expert on rates – every time I lock into a fixed interest rate facility rates seem to drop even further.
However, I see 3 reasons why it’s unlikely for rates to rise soon.
1. APRA and the banks are doing the RBA’s job for them.
In an effort to slow the runaway Melbourne and Sydney property markets APRA’s macro prudential controls have tightened lending criteria, especially for property investors creating a credit squeeze, which really has the same effect as raising interest rates.
At the same time the banks have raised interest rates for investors, meaning the RBA can keep its official rate low to help stimulate businesses and our economy.
2. The RBA wants a weaker Australian dollar
Currently the Australian dollar buys US0.79 cents, but the RBA would like the dollar to slide closer to US70 cents to help our exports.
Of course, raising interest rates would see cash flow into Australia lifting the dollar higher.
3. The world’s economy is still weak.
Australia does not operate in isolation, and overall world economic growth is still shaky and China’s medium term economic outlook is uncertain.
This does not bode well for our exports, meaning that Australia’s general economic growth will remain subdued and won’t be able to handle an interest-rate increase anytime soon.
We are in a low inflationary and low economic growth environment and in its minutes the RBA suggested it will be some time before it raises interest rates as inflation remains below their desired 2-3 per cent target band.
However it is likely the next movement will be up and, in the past, when the RBA raised rates they increased them increased them by 0.25% increments a few times in a row.
Are you ready for this?
Now let’s see what the latest charts show…
INTERNATIONAL ECONOMIC GROWTH
Of course Australia doesn’t operate in a vacuum, so it’s important to start with the international context…
Global economic conditions have picked up since the middle of 2016 and appear to be stronger in the first half of 2017 than they have been in recent years.
The economic growth of our major trading partners is forecast to be around its long-run average this year before easing slightly in 2018, even though growth in China is a little uncertain.
This week thee International Monetary Fund announced that it still expects global economic growth of 3.5 per cent in 2017 and 3.6 per cent in 2018, compared with 3.2 per cent growth in 2016.
However, the IMF has identified a number of potential risks to the global economy, including inflated asset prices, a growing trend toward protectionism and the outlook for the Chinese economy.
Meanwhile, the IMF has downgraded its growth forecast for the US economy by 0.2 per cent in 2017, to 2.1 per cent. Growth in 2018 is also expected to be 2.1 per cent, which is 0.4 per cent lower than previously forecast.
Headline inflation in the advanced economies rose sharply in late 2016 and early 2017, following the increase in oil prices during 2016.
However, with oil prices now declining, headline inflation also appears to have peaked recently and is likely to decline in coming quarters.
While core inflation generally remain low, there are a number of factors suggest underlying inflationary pressures are likely to pick up in the period ahead, including the ongoing tightening in labour markets in the major advanced economies, which has seen some measures of wage growth edge higher.
Unemployment is falling in the 3 biggest economic regions, meaning their economies are slowly improving:
In short the world’s economy is “behaving itself.”
While many of the previous concerns of a world recession have faded, we’re in a low growth, low inflationary, low interest rate environment which is likley to remain that way for some time.
Most central banks have been trying to stimulate their individual economies with low interest rates, but in general this has been to no avail.
Of course it’s much the same in Australia – our low interest rates are not stimulating the economy as much as the RBA would like – hence my earlier suggestion that I can’t see a rate rise any time soon.
There has still been a noticeable slowing in Australian growth momentum over the past few months- our economy is fragile.
Annual growth is currently around 1.7 per cent, which is well below the long term averages, more in line with the lower growth environment the rest of the developed world has experienced since the GFC.
Economic conditions continue to vary across the states.
Recently, economic growth has been strongest in New South Wales, ACT and Victoria and weakest in Western Australia.
And like the rest of the world, Australia is in a low inflationary environment which is of course one of the reasons the RBA can keep official interest rates so low.
The sluggish household sector is a concern.
Household consumption has growing at around 2% helping our economy, but this has come from running down savings rather than from higher wages.
Poor consumer confidence suggests there will be a reluctance to continue running down the saving rate.
However household income growth has remained weak, and there has been a further decline in the household saving ratio.
Low growth in household disposable income continues to weigh on spending.
Households’ perceptions of their personal finances have declined since late 2016.
Surveys indicate that households believe that paying off debt is currently a wiser place for saving than investing in real estate
Having said that Australian households are amongst the wealthiest in the world, with our assets (primarily in real estate) increasing in value faster than our liabilities 9due to low interest rates).
The graph below shows the interesting effect of our current low interest rate environment.
Despite record high levels of household debt, falling interest rates means that this debt is more affordable than ever with average household debt as a percentage of disposable income being at an affordable level.
However consumer sentiment remains fickle, and currently more people are pessimist about their future than people who are optimistic.
When people don’t feel confident about their jobs or their future, they don’t spend.
OUR HOUSING MARKETS
As our mining boom slowed down the government facilitated the current property boom by encouraging the non-mining economic sector, in particular the building industry, to take up the slack.
This has mostly come through the high-rise apartment building boom, which is now coming off the boil.
The decline in higher-density approvals has been concentrated in New South Wales (where housing activity has been quite strong of late) and Queensland (where conditions have been less favourable.)
This is a good thing as supply of new apartments is currently running ahead of demand, particularly in the Melbourne and Brisbane CBD’s.
Our property markets are taking a breather
The CoreLogic Home Value Index results confirmed that the capital gains trend has slowed over recent months with dwelling values edging 0.4% higher over the three months ending May 2017.
Australia’s capital cities saw a cooling of housing market conditions over the seasonally weak month of May with the CoreLogic hedonic home value index reporting a -1.1% fall in dwelling values across the combined capitals.
The month-on-month fall was largely the result of declines in Sydney and Melbourne, where dwelling values have recorded significant gains over the current growth cycle to date.
The past three months has seen capital city dwelling values rise by a modest 0.4%, with four of the eight capitals recording a fall.
Housing finance and credit data confirm investor interest in the housing market has started to drop off.
Affected largely by Australian mortgage lenders rationing credit to the investor segment, the lifting of mortgage rates is also starting to bite .
It remains to be seen if this slowdown lasts or, if once the rationing of credit eases, the investor segment of the market returns to residential property.
TWO OF THE MAJOR DRIVERS FOR OUR HOUSING MARKETS:
Our housing markets are very dependent on consumer confidence.
There is a direct link between consumer confidence and housing turnover and rising prices.
Consumer sentiment has fluctuated widely recently, and has slumped recently as more of us have become pessimistic.
Australia’s labour market strengthened in early 2017, and employment growth is lifting after a sharp pullback in 2016 and the unemployment rate — while volatile — also appears to be edging lower.
But this statistic is a little misleading since it understates the degree of labour market slack due to the large number of part time jobs that have been created with many Australians working fewer hours than they would like, while others have been discouraged from looking at work at all.
This has created a situation where wages growth remains low and unemployment varies considerably between states.
Of course the states with highest job growth and lowest unemployment have the better performing property markets.
All in all, our economy is sound and we’re now in a period of low economic growth with low inflation, low wages growth and low interest rates.
By the way…the rest of the world has been operating in this environment since the GFC
We were sheltered from this by an extraordinary mining boom and our economy’s resilience to transition from this has been surprisingly impressive.
Of course there are still risks out there…
Which means the RBA is unlikely to increase interest rates for a while as I explained at the beginning of this article
But the banks, under pressure from APRA, are raising their rates and at the same time causing a “credit squeeze” in an attempt to slow down the Melbourne and Sydney property markets.
This means as property investors for the foreseeable future we can’t expect the type of strong capital growth in property prices we experienced recently.
By the way…this doesn’t mean it’s the wrong time to invest in property.
What it does mean is that careful property selection is critical as you can’t count on the market to do the heavy lifting.
It also means a more stable property environment without the booms and busts.
WHAT DOES THIS MEAN FOR YOU?
Clearly owning property – your own home and investment properties is the way to wealth in Australia
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