How the rate cut could spur first home buyers and help property investors

Nearly all of the pundits – especially property market pundits – had been expecting an interest rate cut this week, with most pencilling in 50 basis points. But none predicted the largest movement in rates since October 1994. When I heard the news, my jaw dropped. Literally!

The more I think about this development, the more it strikes me what a clever and strategic move the Reserve Bank of Australia has made, although not everyone agrees. Reserve Bank Governor Glenn Stevens has sent the world the unequivocal message that Australia is in charge of its economy and will remain open for business.

Of course, it’s after an event like this “surprise” cut that it is easy to see logic at work. If it had been a 50-point cut, as expected, the “pass-through” to mortgage rates is more likely to have been in the order of 20 points or less.

But with 100 points to play with, Australia’s major banks will now be able to pass on a significant proportion of that cut to stimulate investment and consumer demand while their own profitability, damaged by escalating wholesale funding costs, is more likely to be solidly underpinned.

Some lenders have already moved: Westpac has cut rates by 80 basis points, Aussie Home Loans by 75.

Moreover, even after yesterday’s cut we still have considerable fat in our interest rate environment unlike the US, for instance, where official rates are 2.5%. Our official interest rates give room for further reductions if need be.

My prediction is that the “flight to safety” impetus for property buyers will now become immediate. For serious first-home buyers, this is the best incentive they’ve had in years, and a welcome reduction in net funding costs.

With so many first-home buyers clogging the rental market due to a woeful combination of high interest rates and low affordability, the interest rate move will provide welcome relief and renewed incentive to resume their home search, freeing up the rental market to a healthier level of vacancy. Rental income for investors is, however, likely to remain solid.

The simple equation of renting a property at a gross 4% of capital value with borrowing rates significantly reduced, suddenly makes owning a home – or buying an investment property – more feasible than it was last week. First-home buyers’ re-entry will ripple up through higher price categories over the ensuing months once the wheels start turning again.

The funding differentials for investors is now also easier to swallow. For dedicated property investors who have been sitting on their hands, or the more safety-conscious investors fleeing the sharemarket, the rate drop will prove to be a pivotal event. Demand and therefore prices are likely to begin rising again as a result of increasing investor activity adding to the renewed demand from first-home buyers. And it’s first-home buyers that are the initial drivers of widespread price growth.

Just for the record, when the Reserve Bank inflicted the last 25 basis point rise in March, I expressed concern that it had gone one rise too many. The next challenge is for the Reserve Bank not to flip flop too much in the other direction. We do need to keep some “fat” in our interest rates if we want a resilient economic base.

My final message to would-be property investors is this; take full advantage of the demonstrated safe-haven of prime (emphasis on prime) residential property. Gear conservatively. Repay debt. And once you’re in, sit tight!

This article first appeared in Eureka Report