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03 Jun 2021

Understanding how the Reserve Bank of Australia impacts the property market

By Damon Frith, content editor for Citi RBA decisions influence house prices and understanding why can help drive better property decisions

The Reserve Bank of Australia (RBA) is the nation's central bank, and is responsible for the formulation of the country’s monetary policy - policy concerning the supply of money in the economy and the cost of money as embodied by interest rate levels.

This confers the RBA with immense influence over the national economy, given that monetary policy is one of the biggest factors that determines the mood and performance of markets.

For this reason it is imperative for Australian investors to understand the motives and reasoning behind the RBA’s actions - especially when it comes to the property market.

What Are the Monetary Policy Goals of the RBA?

The RBA shares much in common with the Federal Reserve - the central bank of the United States of America - when it comes to the explicit objectives of its monetary policy.

The two primary objectives of the RBA’s monetary policy are firstly the prevention of excess inflation - by maintaining the stability of the Australian dollar, and secondly the maintenance of full employment in Australia by supporting economic growth.

The challenge for any central bank however, is that these two objectives are often at odds with each other. Containing inflation entails curbing the excess economic growth which drives up the price of goods and assets. Maintaining high employment levels means doing the opposite however, by supporting economic growth in order to create jobs.

Consequently the RBA, like any other central bank that shares these objectives, must maintain a fine balancing act between supporting growth to keep employment at reasonable levels, and restraining growth in order to prevent rampant inflation from undermining the value of the Australian dollar.

How Does the RBA Implement Monetary Policy?

The chief means by which the RBA implements monetary policy is by setting the target for Australia’s policy interest rate - which is better known as the cash rate.

The cash rate is the interest rate that banks charge each other for unsecured, overnight loans, and is considered to be the risk-free benchmark rate (RFR) for credit denominated in the Australian dollar.

The RBA sets targets for the cash rate, and then attempts to meet this target via open-market operations (OMO) that involve buying or selling bonds from banks, or using repurchase agreements to either borrow or lend money using debt securities as collateral.

These OMO operations alter the supply of cash in the banking system, and thus have the effect of adjusting interbank borrowing costs.

How Does the RBA’s Monetary Policy Affect the Property Market?

The cash rate has a decisive influence on the Australian property market as well as the broader economy, because it determines the price of credit and how much it costs for borrowers to obtain funds.

Commercial banks set their other rates, such as their loan rates, deposit rates and rates for home mortgages, based on the cash rate.

When the RBA’s monetary policy reduces the cash rate or sets it at a low level, this serves as an incentive for both households and businesses to borrow and spend. In the case of the property market it serves to spur prospective homebuyers to take out mortgages for the purchase of residential housing.

Low cash rates also serve as a spur for broader growth in the economy by making it easier for businesses to borrow funds to expand, and households to borrow funds to spend on consumption. The broader health of the economy can in turn provide a boost to the property market.

Conversely, when the RBA raises the cash rate, this increases the cost of borrowing for Australian businesses and households, making it more expensive to obtain funds for spending.

This usually presages an easing of growth in the housing market, as well as a slowdown in broader economic activity.

What Do the RBA’s Current Policy Settings Mean for Property Investors?

The COVID-19 pandemic has prompted the RBA to keep the cash rate at record low levels, which has already had a strong impact on the property market.

The RBA reduced the cash rate from 75 basis points to 50 basis points in March 2020, just as the pandemic began to spread globally. It then further reduced it to an unprecedented 10 basis points by November of the same year, where it has remained ever since.

This historically low rate has already helped to drive a record boom in Australian housing prices since the start of 2021. Average home prices saw a 2.8% rise in March according to data from CoreLogic, for the biggest monthly gain in more than three decades.

In March RBA governor Philip Lowe further indicated that the cash rate is not likely to be increased until 2024, in order to support a return to full employment in Australia. This means that the Australian property market could remain buoyant for the next several years at least, as households capitalise upon record low rates to make home purchases.

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