Interest rates are on the rise in Australia after annual inflation surged by 5.1% over the March quarter – its highest level in more than two decades.
In response, the Reserve Bank of Australia started increasing the cash rate in May, bringing an end to the era of rock-bottom interest rates.
RBA governor Philip Lowe said it was the “right time” to begin withdrawing some of the extraordinary monetary support put in place over the pandemic, as the economy had proved more resilient than expected.
“And it’s good news. I know many people don’t like rising interest rates but it’s a reflection of the underlying strength of the economy that we can move off these emergency settings,” he said.
Dr Lowe also signalled more rate rises are likely, saying the RBA’s board was “committed to doing what is necessary to ensure that inflation in Australia returns to target over time. This will require a further lift in interest rates over the period ahead.”
How far will interest rates rise in Australia?
To answer this question, you have to understand why the RBA lifted interest rates in the first place.
As Australia’s central bank, the RBA has three goals:
- Price stability
- Full employment
- The prosperity and welfare of the people of Australia
To achieve this, the RBA aims to keep core inflation between 2-3% on average, over time.
Core inflation is the Reserve Bank’s preferred measure of inflation, as it excludes volatile items such as food and energy. As a result, it’s more accurate than the headline inflation rate in measuring underlying inflation trends.
At the time of writing, core inflation is currently 3.7%. So to try and reduce it down to 2-3%, the RBA is using the main tool at its disposal: the cash rate.
The cash rate reflects the market interest rate that banks pay to each other when they borrow money overnight to meet their daily cash needs.
When the RBA increases the cash rate, borrowing money is more expensive, but it can also lead to more returns on savings. As a result, consumers are, in theory, encouraged to save money rather than spend it – slowing down inflation.
So how far and how fast the RBA tightens interest rates largely depends on core inflation.
The most recent RBA minutes indicated that the cash rate might rise to 1.75% by the end of 2022 and 2.50% by the end of 2023.
The central bank expects this series of rate rises will help bring core inflation back to below 3% by mid-2024.
How property investors can prepare for rising interest rates
If the cash rate climbs to 2.50%, real estate investors will have to accept home loan rates with a ‘5’ in front of them.
But that doesn’t mean there’s nothing you can do to prepare for this situation.
As a property investor, hopefully you’re in a positive cashflow situation, with more money coming in than going out. If that’s you, now’s the time to use that passive income to build a large financial buffer, which can help cushion the blow of future rate rises
The buffer should be liquid, so you can get your hands on the money should your weekly rents take a while to catch up to your increased borrowing costs or if something unexpected happens.
Looking for a positively geared property that brings in more investment income than it costs to run?
At High Income Property, we are property investment specialists and can provide you with well considered strategic advice on all aspects of investment property.
To find out more about buying investment property and impacts of interest rates, get in touch with us at firstname.lastname@example.org or call us on (02) 8007 4001.