Low interest rates - friend or foe?

In just a few months, the Reserve Bank of Australia (RBA) has slashed the cash rate from 1.5% to 1.0%. Low rates sound like a good thing. But are they? What does all the talk about an “inverted yield curve” mean?

Interest rates are one of the key tools the RBA has available to drive the health of Australia’s economy.  A rate cut puts cash back into the pockets of anyone with a variable rate home loan, and if that money is spent rather than saved, this can give the economy a valuable boost.

It’s not just about homeowners though. Businesses also borrow to achieve growth, and a lower rate will encourage this.

Right now, the RBA is eager to encourage spending to support economic growth and expansion. But that doesn’t mean the economy is in a tailspin.

Let’s look at the facts to gain a clear picture.

The Australian economy is in pretty good shape

The latest (July 2019) figures1 show our unemployment rate remains steady at a low 5.2%. Over 40,000 people found a job in July, with full-time employment rising by 34,500.

Moreover, the labour force participation rate rose by 0.1 pts to 66.1%. This matters because a rising participation rate means more people are actively looking for work rather than tossing in the towel and resigning themselves to unemployment.

Despite media hype, Australia’s economy is not going backwards

Our economy grew by 1.8% in the year to March 20192, and that’s on par with G7 economies, including the UK, US, Germany, France and Canada3.

That’s not to say it’s all smooth sailing in the Aussie economy.

Our economic growth is lower than it has been. One reason for this is the very low pace of wages growth (2.3%4) at a time when inflation is 1.6%5.

Recent tax cuts for low and middle income households are expected to make a difference. The RBA says that based on past experience, households will spend around half their tax savings, which will be a plus for the economy6.

The cooling of the property market in Sydney and Melbourne has also had a hand in lower household spending, as homeowners have become aware that they’ve lost part of their home equity.

The good news here is that values in Sydney and Melbourne have recorded an uptick in both June and July.  Moreover, property researchers CoreLogic7 say values in Sydney and Melbourne have risen 18.4% and 23.5% respectively over the last five years. So the reality is that long term homeowners are still in front financially – by a fair margin.

Pleasingly, first home buyers are heading back into the market buoyed by ultra-low interest rates and more affordable property values. That’s seen the number of loans to first homeowners rise by almost 20% over the month of May8.

Right now, some of the biggest threats come from overseas

The trade dispute between the US and China has been with running for almost two years, and while the direct impact of tariffs is not big, the issue is taking its toll on business confidence9.

Businesses around the world are taking a wait-and-see approach before they invest, and this is impacting global supply chains.

Australia is not deeply involved in the global supply chain, and the stimulus that’s been directed to China’s economy is boosting demand for our coal and iron ore. As a result, Australia’s terms of trade are at their highest level since 201310.

The upshot, is that from an economic viewpoint Australia is tracking reasonably well.

What about the inverted bond yield?

Much-touted media reports of an inverted yield curve can be confusing. What does it all mean?

At this point, it’s easy to get bogged down in economic theory. So let’s keep it simple.

The so-called ‘inverted bond yield’ means that long term bond yields have fallen below short term yields, and that’s not normally the case.

When bond yields have inverted in the past, it has sometimes – though not always – heralded the onset of a recession.

It’s worth stressing that inverted bond yields are not a 100% reliable indicator of a slowdown. While there are no obvious signs pointing to recession, it does flag risks to the global economy.  It’s time to take a planned approach but not to completely hide from spending decisions.

With interest rates at exceptional lows, and lenders that are hungry for new business – there are a wealth of opportunities if you’re looking to set your property plans into action.

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Posted in: Interest rates