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Why the RBA cares about house prices and how it affects interest rates

By Anthony Hartshorn

Most countries in the world have a central bank whose main role is to maintain economic stability by overseeing interest rates, issuing bank notes and managing interest rates. Our “central bank” is known as the Reserve Bank of Australia (RBA). On the first Tuesday of every month, except for January, the RBA board meets to determine whether it should change the official cash rate.But what does this mean for us? And should we be concerned about future increases in rates?

Below I have answered frequently asked questions about the RBA and its very important role.

What is the cash rate?

The cash rate is the rate at which the RBA provides overnight loans to commercial banks and the setting of this rate is one of the RBA’s most important roles. When this rate is changed, it has a flow-on effect to the rest of the economy as it directly affects how much people can borrow, the incentives to spend or to save and the actions of businesses. For this reason, it’s a tool used to help maintain stability in the economy.

The official cash rate is at 1.5 per cent (a record low)

Why does the RBA increase or decrease the official cash rate?

The interest rate is a tool used by the RBA to make changes in the Australian economy. Lowering interest rates makes it more attractive to take on more debt and invest, because repayments on the amount borrowed are smaller. Cutting rates gets the economy going again it helps jobs and investment which drive the national economy.

The opposite is true when the RBA lift’s interest rates, this restricts our spending because we are paying more off our debt and have less “expendable income”. When the RBA raises interest rates, it is worried about inflation. The target is to have inflation at 2 to 3 per cent on average. Currently, inflation is low at 1.5%.

If the RBA keeps rates on hold, it is because they are happy with how the economy is tracking or they are waiting for more data to see where it is heading.

Just a few of the factors the RBA takes into consideration when deciding on interest rates are:

  • The housing market
  • GDP “gross domestic product“
  • The Australian dollar
  • Unemployment
  • Inflation
  • Imports and exports
  • Investment
  • The global economy

Why has the housing market become such a big focus?

During the past three years, the housing market in the major cities – particularly in Sydney – has been a focus of the RBA.

In 2016, even then RBA governor Glenn Stevens admitted Sydney’s house price growth caused him some discomfort and needed to be weighed up against the rest of the economy when making rate decisions. The reason for this is the clear relationship between the cash rate, housing construction and property prices. When interest rates are low, more people can afford to build, which increases construction jobs, which has a flow on effect to the rest of the economy. This is usually an ideal outcome for the RBA when cutting rates, as it helps boost employment.

Low interest rates don’t just allow people to borrow more to buy and build new properties, they can afford to spend more on established homes. This “side effect” can push prices up. When we have nothing left after paying the mortgage and bills, we can’t go out and spend, so if our personal debt levels are too high it can prevent economic growth. It’s a two-way street, housing has an impact on the economy, but interest rates also impact on housing.

The RBA is aware that when it cuts rates it will stimulate housing, but it’s interested in the total economic picture for Australia. The latest price boom in capital cities, in particular Sydney, has largely been driven by the fundamental of supply and demand – fewer homes were built for several years, high rates of immigration and higher rents. When you add lower interest rates to the mix, you have the ingredients for a house price boom.

How does this affect me?

For those who aren’t in the housing market, it can seem as though the changes in interest rates are irrelevant to their everyday life. However, all Australians are directly or indirectly affected by the RBA’s decisions.

If you’re a “saver” with money in the bank, you will tend to find the interest rate on your savings declining when the official cash rate is dropped. This concerns retirees and first-home buyers in particular, as well as those who have additional funds sitting in a savings account as a cash investment.

If the RBA reduces interest rates, people are forced to look at non-cash investments to maintain the same return. These non-cash investments include the sharemarket, and the housing market – meaning those who can afford to buy are more likely to jump into an investment property. This can cause prices to rise, leading to an even more difficult situation for first-time buyers. But if you’re a home owner, this can have the direct opposite impact – you pay less each month in your mortgage repayment.

Rising interest rates have an opposite effect – savers are better off, but those repaying loans on a variable rate will find the cost of holding on to debt increasing.

It’s also worth noting that lenders have been increasingly out of step with the official cash rate since 2008, at times increasing their standard variable rates even when the RBA has not changed rates.

Credit to:

https://www.domain.com.au/news/

http://www.rba.gov.au/

https://www.finder.com.au/

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