John McGrath - Why Interest Rates Will Stay Low
Sydney and Melbourne home values have regained their COVID losses to reach new record highs, as the lowest mortgage rates in history power a national boom led by upgraders and first home buyers.
Sydney is the most frenetic of the capital city markets, with extraordinary results continuing to amaze us, including homes selling for more than a million over reserve at auction. A lack of stock for sale nationwide is contributing to strong competition but interest rates are the key element.
When you’re only paying 2% interest on your new loan (that’s just $2,000 for every $100,000 you spend), it’s no wonder people are willing to go high with their offers to secure their next home.
It’s also comforting for buyers to know that interest rates are going to stay around these levels for several years. So, even if you pay above budget, you’ve got time to get used to your new loan and there’s the opportunity to pay down principal with excess income while rates are so low.
However, there’s been a lot of speculation in the media recently that perhaps interest rates will go up sooner than expected because the economy is recovering faster than anticipated.
This speculation has caused a rise in long term bond yields both here and in the US, which has caused ructions in equity markets as many shares investors switch to the perceived safety of bonds.
Regardless, I think it’s important to listen to what the man who sets interest rates in Australia says.
RBA Governor, Dr Phil Lowe has repeatedly stated that the official cash rate is not expected to rise until “at least 2024”.
It doesn’t matter if the economic recovery is faster than expected right now. We are still yet to see the fallout from JobKeeper ending, as well as the impact of negative population growth. Dr Lowe says the recovery will be uneven and periods of positivity and negativity will result.
His emphatic message has been that rates are not going to rise until the RBA sees sustainable changes in three specific and slow-moving components of our economy - jobs, wages and inflation. This means you’ll know when rates are going to rise, so you can alter your budget accordingly.
The RBA wants inflation sustainably within 2-3% (now 1.25%); as well as unemployment in the low 4% range (now 6.4%); and wages growth above 3% (now 1.4% - a record low). ‘Sustainably’ means they’ll look past blips in the data. We need to hit these numbers and stay there.
For these three things to occur, we need more than economic recovery from COVID. Problems such as weak wages growth existed around the world long before the pandemic. Globalisation and technology have changed the way advanced economies work. Low unemployment used to go hand-in-hand with wages growth but now it doesn’t and no one knows how to fix it.
So, I think buyers can rely on rates being this low for an extended period. Of course, the banks can raise their mortgage rates independent of the RBA, however right now they’re focused on leveraging record borrowing levels to gain market share, so they’re very competitive on rates.
Rising long term bond yields do have a direct impact on funding costs for longer term fixed rates, which is why several banks increased their four-year fixed rates recently by 0.2%-0.3% (adding $2,000-$3,000 per year in interest to a $1 million loan). But they also reduced two-year rates.
The RBA has also signalled that it’s not going to raise rates if the property market overheats. The cash rate has to stay low to benefit the broader economy.
Macroprudential controls, whereby APRA instructs the banks to restrict credit, are far more likely. They’ll probably restrict the number of new interest-only loans or reduce the debt-to-income ratio for new borrowers, things like that. There are many levers they can pull.
But that’s a long way off, in my view. Sydney and Melbourne home prices are only just past their previous peaks and other capitals, particularly Perth, are enjoying a long-awaited catch-up on capital growth.
This is actually helpful to the economy because of the psychological ‘wealth effect’ that rising home values creates. People feel richer and spend more at the shops, which creates jobs.
Plus, when (not if) stock levels increase, the market might settle down on its own.
Let me tell you, APRA intervention and credit controls would be much preferred to what New Zealand has decided to do to calm their property market, following 20% house price gains in a year.
Prime Minister, Jacinda Ardern has announced plans to remove tax deductibility on investment loan interest payments (except new builds) not just for future buyers but existing landlords, too.
When budgeting for your next purchase, always keep a cash buffer to cover the unexpected. It’s also very important to determine your comfortable maximum budget, as you’re likely to pay it in today’s strong market. Also seek advice from an experienced mortgage broker to get the best loan for you.
The views expressed in this article are an opinion only and readers should rely on their independent advice in relation to such matters.
This article originally appeared in The Real Estate Conversation (April 06, 2021)
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