What do interest rate cuts mean for the housing market and beyond?

While the banks don’t always pass on the entirety of the RBA’s rate cuts, lower interest rates are seen overall, improving home buyer confidence. For example, the most recent interest rate cut in October could see the average household with an income of $150,000 with an extra $12-14,000 borrowing capacity. This has the potential to increase demand, reduce supply and push property prices up.

An increase in property prices is good news for developers as they can take on more construction jobs with a higher projected income from their projects. This, in turn, creates more work and employment opportunities in the construction, engineering, architecture and related fields. With more new properties this can also promote retail spending as these owners want to furnish their new homes.

One of the main reasons the RBA reduces interest rates in times of economic slowdown is to encourage consumer spending. When interest rates are low there is a pseudo-psychological effect on homeowners who now feel they have more money in their pocket. This feeling of wealth then leads to increased consumer spending, which accounts for around 60% of Australia’s GDP.

However, is this really what’s happening now? with interest rates at record lows. And is it healthy for the economy and house prices to be so dependent on emergency level interest rates?

The banks at least aren’t taking the record low-interest rates as all good news. They know they’re being manipulated in the same way as consumer spending. Low and even negative interest rates are undeniably an unconventional monetary policy. It is these unconventional policies which encourage banks to take more risks in the hopes of greater returns.

For example, most banks will hold large cash reserves to allow them to cover a potential ‘run’ on their assets, insurances, pensions funds and more, being withdrawn. These reserves are held in the central bank. Unconventionally low-interest rates are designed to encourage banks to approve lending and generate income, rather than building up excess reserves.

However, the banks are very aware of what happens when lending increases, especially to those who haven’t been able to previously afford it. It is easy for homeowners wanting to upgrade and potential first home buyers shopping around to be seduced into the property market by the lower interest rates. It is therefore up to the lenders to assess their ability to repay their loan into the future, and up to ASIC to keep responsible lending laws in place.

Business investment is more affordable thanks to lower interest rates. This should mean businesses invest more in growth and employment, which should be good for the economy. However, the unemployment rate remains high at 5.3% which is heading towards the more than 11% rate Australia saw in the early 1990s after those record-high interest rates. Inflation remains low at less than 2%.

This goes to show that even though the official interest rates are at the opposite ends of the spectrum, consumer confidence won’t be fooled into thinking that the country is in any better shape than it was 30 years ago. If the RBA is setting interest rates at emergency levels this gives the appearance of the country being in a state of emergency, which is not the way to encourage consumer spending.

Besides in the real estate market, interest rate cuts have been good for the Australian dollar. A low Australian dollar adds greater value to recent iron ore exports which will help to strengthen the economy. Visiting tourists will be encouraged to spend that little bit more while they’re Down Under, injecting extra earnings into areas such as restaurants, accommodation and tourism businesses and tours. The lower Australian dollar also has the potential to attract more international students, who stimulate the economy with their own spending, as well as that of visiting family and friends.

However, the level of the Australian dollar does see it undervalued against the US dollar and the Euro. This has the potential to damage companies which rely on import sales; as the value of the Australian dollar decreases, so will their profits. This can, in turn, affect the share price of that company as their earnings have been compromised. Commodities prices are also generally set in US dollars, so companies who trade in or consume these commodities will have their budgets and profits affected by a disparate Australian dollar. For those companies which are dual-listed on the share market with their primary listing outside of Australia, their Australian share value will also be affected.

A drop in official interest rates has historically been a reason for Australians to celebrate. However, following record-high interest rates of the ‘80s and the Global Financial Crisis of the Noughties, Australians seem to have become savvier with their spending. Where once lower interest rates would have encouraged consumer spending and stimulated the economy – especially in the lead up to Christmas – retailers are still seeing the weakest spending since the 1990s recession. With interest rates remaining fixed in November, retail sales volumes were projected to increase by 0.2%. However, sales increased by just 0.1%, as they had in three of the previous four quarters, putting retail sales volumes lower than they were 12 months ago.