Some commentators have signalled the possibility that we could be faced with negative interest rates. While that may seem hard to believe, I guess the first thing we should address is what exactly are Negative Interest Rates?
How do negative interest rates work?
The Reserve Bank is responsible for Australia’s monetary policy. Monetary policy involves setting the interest rate on overnight loans in the money market (‘the cash rate’). The cash rate influences other interest rates in the economy, affecting the behavior of borrowers and lenders, economic activity and ultimately the rate of inflation.
We can say that Interest rates are a tool the RBA uses to stimulate the economy by either increasing or decreasing the cash rate. The RBA is currently sitting at a cash rate of 1.75% which is a long way from negative. Adjusting the cash rate to a Negative figure is also a tool the RBA could use as other Central Banks around the world have done.
Instead of earning interest on money left with the RBA, banks are charged by the central bank to park their cash with it. The hope is that this will encourage the banks to stop hoarding money, and instead lend more to each other, to consumers, and to businesses, in turn boosting the broader economy. As a tool though, Negative rates could well have an unintended impact on the economy over and above stimulating the banks to lend. For example, the Banks could choose to recover their costs by charging customers fees for having savings accounts. They could also look to riskier investments in an effort to boost their profits. For the customer though, being charged to store money in a Bank may lead people to become disenchanted with Banks that don’t pay interest and look for riskier alternatives.
Could the Banks even get away with passing on the Negative rates to customers savings accounts? Would you be willing to put your hard earned savings into a Bank account only to see negative interest rates decrease the balance?
It’s an interesting dilemma.
What could happen?
Introducing Negative Rates should, in theory, encourage Banks to lend more but only to those who meet the existing Credit Guidelines. As we know, the current criteria is quite strict at the moment, for investors more than most. In the age old battle between Risk and Return it may well be that Risk takes a back seat to Sales in the scramble to lend money. This is not necessarily a bad thing though as spending stimulates the economy which in turn may move us from the need for Negative rates in the long term.
However, having money available won’t help if the Credit Rules remain tight. And therein lays the crux of the matter. Having money available to lend only works if there is the willingness to lend and with the current rules in place it’s obviously difficult for investors.
Clearly Negative Interest rates would have a big effect on the economy but let’s look at what could happen to property and property investors in this situation.
We could hypothesise and say that easy access to Credit will fund a property boom but I think we should take the hard road and look at the possibilities that price growth may only materialise in specific areas rather than more broadly. Thus the cash flow skilled and educated investor is who will win looking ahead.
Long term, low interest rates coupled with long term capital growth in specific areas still provides plenty of opportunity for people to buy property; one must simply reach out to receive the right education and guidance.
Historically, property purchases are linked to the ease, or difficulty, of the cost of the finance. When rates are high it’s more difficult to finance a purchase and more difficult to afford as well. In theory, low rates take away the anxiety about repayments, improve affordability and could provide some incentive for people to buy. But investors who are looking for equity growth to fund a purchase, which has normally been the case, would find the low growth rate hampering their wealth creation.
The role of property in providing capital for investment would change. Rather than being capital focused, perhaps investors would change to become debt reducers. After all, low interest rates tend to favour property net cash flow as the rent assists with repayments so surplus funds are available to help with this. Debt reducers would then start to build up equity in property at a greater level than we have seen for decades. The normal practice to reduce Owner Occupied debt first could well be achieved faster which I am sure will please many people.
Looking ahead with lending criteria, those with good savings habits will be looked at favourably by the Banks. In fact, the First Home Buyers who are currently buying an investment property to leverage their way into the market may well be in a position to clear the debt much faster than they have anticipated. Maybe we would see the growth of a generation who can finally catch up after decades of high property prices.
Will they be the “catch up generation” perhaps?
Investors looking for growth properties could even end up exiting the market if they did not embrace the new market conditions. Capital growth has been the key to investing for so long that changing strategies, perhaps even recognising the need for change, could prove difficult for some investors.
If that was the case then money management becomes paramount. In fact you could say it deserves to go hand in hand with the finance. Efficient use of the available income carries more weight when the intention is to reduce debt. Less debt also makes you less vulnerable to changes in the economic cycle and should give more confidence in the future.
Will Negative Rates encourage people to become more thrifty?
Clearly, the use of Negative interest Rates by the RBA is a tool it has at hand to stimulate the economy. Whether it will ever need to go that far is open for discussion.
What would the Banks do? That remains the biggest question of all. What does look very likely is that low interest rates are here to stay for the medium to long term, so save well to build your equity and invest wisely!
Find out more about how the Australian property market is forecast to perform for the remainder of 2016 at our ‘New Financial Year’ keynote sessions in both Sydney and Melbourne. Hurry limited seats still available.