What does the cash rate mean for Australian property?

What is the official cash rate?
One of the RBA’s main objectives it to control inflation through monetary policy. This involves determining the interest rate on overnight loans in the money market – more colloquially known as ‘the cash rate’.

The cash rate in Australia does more than just determine the rate changed on overnight loans – it also influences other interest rates in the economy (such as those charged by the banks on home loans), affects the behaviour of lenders and consumers, and has a bearing on economic activity and the rate of inflation.

In its quest to maintain price stability, full employment and economist prosperity, the RBA has an inflation target. Over the medium term, the central bank aims to keep consumer price inflation in the economy between two and three per cent.

Keeping inflation within these parameters preserves the value of money and ensures that any economic growth is strong and sustainable over the longer-term.

Why does the official cash rate move?
RBA board members meet on the first Tuesday of every month – except January – and announce their cash rate decision at 2:30pm.

The decision to alter the cash rate, or leave it on hold, is influenced by a range of economic factors – including inflation, the performance of the Australian dollar, the state of the housing and lending markets, the country’s gross domestic product (GDP) and consumer and business confidence.

The board assess these factors, along with many others, in relation to their inflation and prosperity objectives, and decide whether to alter the cash rate.

On the most basic level, the RBA is likely to keep the official cash rate on hold when inflation remains within the board’s target levels and the economy is growing at a sustainable and satisfying rate. If the economy is generally in good shape and doesn’t require stimulation or forced stagnation, then the cash rate is likely to be left on hold.

If the RBA is keen to encourage Australians to spend more money, thus stimulating economic growth, they may consider lowering the official cash rate. If, for example, consumer confidence is low and taxpayers are saving large portions of their weekly wages, then businesses will suffer due to a lack of spending and economic activity.

This in turn affects the money available to businesses to pay wages, which ultimately has negative outcomes for employment across Australia.

On the flipside, if the RBA thinks the economy is overheating and needs to take action to cool it down, it may consider raising the cash rate in an effort to control consumer spending levels and thus slow down the rate of inflation.

The effects of a change in Australia’s cash rate can take time to reveal themselves. Changes to the cash rate can affect the saving and spending behaviours of businesses and households, the supply of credit, asset prices and the exchange rate – but it does take time for businesses and consumers to adjust their behaviour.

There are no hard and fast rules about how the country’s monetary policy and cash rate changes directly affect the economy, but the RBA has identified “a general negative association between interest rates and both demand growth and inflation”.

The RBA’s research and figures indicate that substantial rises in interest rates (which are “designed to restrain inflationary booms”) are “followed by contractions in demand and a reduction in inflation”.

In addition, interest rate reductions are generally followed by “periods of significantly faster growth”.

The RBA monitors the economy and the implementation of its monetary policy carefully and has concluded that monetary policy has “a powerful influence on aggregate demand and inflation in the economy”.

What does the official cash rate mean for interest rates on home loans?
Homeowners, property investors and those with various forms of debt often closely watch the official cash rate, but you could be forgiven for not understanding how it all relates to how much you’re paying on your mortgage each month.

In the days after the RBA announces a change to the official cash rate, the media closely monitors the banks and reports on whether their home loan rates have been adjusted in line with the central bank’s changes.

It is generally accepted that banks and other lenders across the country use the RBA’s official cash rate as a benchmark for the rate they will offer on their suite of variable rate home loan products. Economists and stakeholders often discuss whether the bank will ‘pass on’ the RBA’s full rate cut or ‘hold on’ to some of the reduction.

Anecdotally, many borrowers joke that a rate increase is ‘always’ fully passed on to the consumer, whereas decreases in the official cash rate are less likely to be fully absorbed by the bank.

It’s not hard to see how rising interest rates would affect homeowners with a home loan, or investors with multiple mortgages. A higher variable rate means that each month your mortgage will cost you more. These higher repayment amounts ultimately mean you’ll be paying more over the life of the loan.

Similarly, a reduction in a bank’s variable home loan rate can be a welcome relief for borrowers and homeowners. While the rates remain lower, mortgagees will pay less each month and will thus have additional funds for other pursuits.

In recent years, however, the relationship between the official cash rate and the interest rates changed by banks on their variable rate home loan products has become less clear, and a shift from the central bank doesn’t guarantee borrowers’ interest rates will follow suit.

The banks have faced increasing pressure from regulators, such as the Australian Prudential Regulation Authority (APRA), to reduce their housing-related risks and exposure.

In 2015 APRA increased its public scrutiny of Australia’s lending institutions and said “the current economic environment for housing lenders is characterised by heightened levels of risk, reflecting a combination of historically low interest rates, high household debt, subdued economic growth, and strong competitive pressures. Many of these features have been emerging over a number of years, and APRA’s supervision has been intensifying in response”.

The regulator said housing-related risks have potentially grown in Australia in recent years and many banks have since taken action to reign in their residential property lending activity – with many raising interest rates and reducing the discounts available to borrowers.

Does the official cash rate affect property prices?
A range of factors, both economic and social, affect property prices. The cash rate is often cited as a key driver of activity within the housing market – but it’s important to remember that the cash rate is implemented nationwide, and not all property markets across the country perform the same at any one time.

Indeed while prices may be skyrocketing in one capital city, they could be stagnating or even falling elsewhere in the country.

Nevertheless, the historically low cash rate of recent years, combined with the low interest rates offered by the banks, have been continuously cited as reasons for increased investor activity and climbing property prices.

It’s easy to see the correlation. If borrowers have access to ‘cheap money’ (in the form of low interest rates), then they can afford to borrow more capital and invest it into more properties.

With more active investors in the market, demand grows, with no corresponding rise in supply. Prices thus climb as competition increases for the same stock.

Conversely, if money is ‘expensive’ to get a hold of, then fewer people can afford to borrow and they will likely be less inclined to overcommit themselves to multiple property purchases.

The relationship between the official cash rate, bank lending rates, consumer confidence and property prices may not be as clear cut as some think – but investors would do well to keep an eye on these trends and be aware of how it could affect their plans for their portfolio.