The RBA uses interest rates primarily to control inflation. Their goal is to achieve an economy that is not to hot or too cold, which is sometimes referred to as the goldilocks economy.
When economic growth, spending and expansion is in danger of going up too fast, the RBA increases interest rates to reduce spending and to slow down growth in the economy.
On the other hand, when the economy looks like it might slow down too much, the RBA cuts rates to free up money and keep consumer spending ticking along.
2009 saw low interest rates which helped fuel a property price boom with some suburbs in Melbourne and Sydney increasing by over 40%. Worried the RBA pulled the interest rate lever to slow the unsustainable levels of growth.
During 2010 we saw the average bank rate increase from 6.0% to 7.8% with an average inflation rate of 2.8% which is just below the 3% target set by former treasurer Peter Costello and the RBA.
What happened to property prices?
In most capital cites we saw property prices start to cool off. The Reserve Bank raised interest rates to dampen inflation which peaked at 3.1%, just over the target inflation rate and put the brakes on property price growth.
It worked. Today capital growth in most capital cities is falling, and with increased interest rate rises predicted later this year, we expect this trend to continue.
During periods of rising interest rates it is first time buyers who are affected the most. We have already seen some evidence of interest rates affecting demand in the first home buyer segment. As a result this causes the balance of supply and demand to swing in favor of buyers once more as there is now less competition. This leaves the door open for investors to buy quality property close to our cities for a discount they wouldn’t have seen six to twelve months ago.
Housing finance commitments for investors were up in November highlighting the surge in investor numbers in the market as first home buyers wind back. In all likelihood we will see investor numbers continue to improve over the rest of the year. Additionally, we are likely to see the continued trend of more upgraders returning to the market as both these segments are much less price sensitive to rate rises.
Rising interest rates also mean rents will start to increase. Rents always play catch up to capital gains; we saw tremendous growth in 2009 and the beginning of 2010, now we expect rents to increase in 2011.
Today first home buyers are sitting on the sidelines due to economic fears from overseas and rising interest rates here in Australia. If people are not buying today then they will be forced to rent tomorrow. This can only lead to a tightening in rental supply as more people look to rent in suburbs close to their job and public transport. This process will push rents up especially in our inner and middle city suburbs.
According to Tim Lawless of RPData, when residential property market values were growing rapidly in 2007 mortgage rates were between 8% and 8.55%. In the boom of 2001 to 2003 mortgage rates went as low as 6.05% and were averaging 6.6%. The market will tolerate successive increases in interest rates to a certain point, however if mortgage rates break the 8% mark there would likely be a more serious dampening of demand in the market.
Rising interest rates is not something investors should shy away from. In many parts of the country there is an oversupply of properties listed for sale compared to the number of current active buyers. This presents a great opportunity for investors to buy property below its intrinsic value today and see short term rental growth during 2011 and long term capital growth in the years ahead.