How will another interest rate rise affect the market?
January 23, 2008
Article from RPData
Yesterday's CPI release hints at another rate rise in February and potentially another during the first half of 2008. With affordability already at crisis levels, the impact on the property market is likely to hit first home buyers and low income families the hardest.
The Australian Bureau of Statistics released the December quarter inflation figures yesterday which revealed that consumer prices have increased by 3.0% nationally. This puts headline inflation levels at the top of the Reserve Bank's target range of between 2.0 and 3.0%. Underlying inflation, which is a measure of price movements excluding volatile items such as fuel, fruit and vegetables, has been trending upwards since mid-2004 when annual growth in consumer prices was just 1.8%.
An increase in housing costs was one of the primary components of the rise in consumer prices. During the 2007 calendar year the housing component of the Consumer Price Index increased by 4.8%, reflecting ongoing inflation in the cost of purchasing and renting a home. Transportation costs represented the largest rise in consumer prices largely due to a 14.3% increase in fuel costs.
With both headline and underlying inflation now at 3.0% the Reserve Bank is likely to seriously consider a rate rise when it next meets on February 5th. What makes the rate rise almost certain is the fact that the Reserve Bank's preferred measure of inflation, the weighted median and trimmed mean (which take into account seasonal factors in price changes) are now at 3.8% and 3.4% respectively - well outside the target range of 2.0 to 3.0%. Yesterday's partial recovery in share prices has also increased the likelihood of a further rate rise during the first week of February.
If a rate rise does transpire, consumer confidence is likely to fall further. Measures of consumer sentiment are considerably lower than six months ago due to the volatility in the share market and US economy and also due to local pressures including higher fuel and mortgage prices. A fall in consumer confidence generally means the market becomes more cautious: large expenditure items such as housing are often put on hold until greater confidence in local and international conditions return.
The average standard variable home loan rate in Australia is currently 8.55%. A further twenty five basis point rise in rates will lift the average variable rate to 8.8%. Based on the average home loan size being $236,600, another rate rise will mean an additional $590 per annum or $11.37 per week to service the interest payments on the loan. While this sum may seem small to some, it needs to be viewed in context of previous rate rises. Since May 2006 rates have been raised five times or by 1.25%. A further rise in February will bring the total level of interest rate increases up to 1.5% equating to an additional $3,550 per annum ($68.25 per week) to service the interest payments on the average home loan. In addition, these figures do not include rate increases by the banks independent of any Reserve Bank decision.
Demand for housing will be further dampened by ongoing decreases in affordability. Nationally, it already takes over one third of the household income to service the interest payments on a home loan. Another rate rise will reduce this ratio further, making it all the more difficult for households who are struggling to enter the market. Lower levels of demand for housing will translate to subdued price growth in the market during 2008.
