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Interest rates are rising - Should I panic?

Michael Yardney and Dr Andrew Wilson discuss rising interest rates.

Video transcript

MICHAEL YARDNEY: With the Reserve Bank of Australia raising the cash rate this month by more than many market commentators were expecting and the inflation marking its highest reading since the introduction of the GST the early 2000s, everyone now seems to be talking about how high interest rates are going to go, how high inflation is going to go, and how much property markets can afford.

Now, sure the Reserve Bank's decided to go early and go hard with rate rises in an attempt to control the highest inflation in decades. But what does it really mean for our housing markets? That's what I'm going to discuss today with Dr. Andrew Wilson, Australia's leading housing economist and chief economist of My Housing Market, in this week's Property Insider chat for Yahoo Finance. Hi, Andrew.

ANDREW WILSON: Hi, Michael. Yes, some very interesting news from the Reserve Bank. We certainly anticipated another increase. And a little bit of a surprise perhaps that the Reserve Bank decided to move away from its traditional 0.25% increment. And it's doubled that with an increase to 0.5 of a percent. In fact, the increase, Michael, was the sharpest increase in official rates since the year 2000, where we had issues because of the introduction of the GST, which spiked prices in the short term. The only higher increase that we have had was way back in 1994, where interest rates increased by 0.75%.

So this is a significant increase in the historical sense. The question is, will it work? And how high does the Reserve Bank have to go? That's the balancing act between creating an economic downturn and higher unemployment and controlling inflation. So it's trade off between one devil and the other devil. So it's going to be an interesting ride.

MICHAEL YARDNEY: Sure. Well, obviously the higher interest rates are to reduce demand in the economy. In other words, to slow down the inflation that we're having. But there is, as you say, the clear risk that if you reduce the demand too much and people can't spend, employers, businesses are going to have some challenges.

And what are they going to do to unemployment? But I think in the short term, the economy is well placed for the higher interest rates. We've got record low unemployment, slightly rising wages. Average household's well ahead in their mortgage payments. And the saving levels are high. But I guess it just depends, how high and for how long?

ANDREW WILSON: Well, that's right, Michael. But we are in a strong position to start with. But that's what got us into this high inflation to some degree was the COVID stimulus packages, which worldwide have created demand well in excess of supply, which has created those higher prices initially, particularly from oil. I notice the get out of jail card for politicians now is calling it the Putin oil increase. Well, oil was on the way up strongly before the Ukraine war. That certainly exacerbated it. It's a bit of a political scapegoat is to use the Ukraine war.

MICHAEL YARDNEY: Very much so, Andrew. If you think about it, the last quarter results that came out was March. And the war only started in February. So much of the inflation Australia had had already occurred before the war started.

ANDREW WILSON: And oil supplies hadn't been impacted materially early days in February and March. But as I said, it now becomes a political game because this is something that's going to impact political outcomes. And of course, the US are front and center in blaming Putin for higher oil prices. The government there is facing a very pessimistic mid-term election come November this year. And inflation is really biting hard.

Of course, this is a very severe inflationary environment. In fact, the latest monthly data out of the US was really terrible. No sign of any control. In fact, it was up higher at 8.7% over the year. 1% over the month inflation increased by the US. So that's annualized 12%. These are the highest results in 40 years in the US. And we will likely follow that pattern. It's interesting that we can say that the Australian economy is in good shape and the US economy is in good shape.

And the Reserve Bank is telling us that, well, it's OK. We can raise rates because we've got high savings that are falling, obviously. But we've also got full employment. And wages are rising. But that's not what the Reserve Bank wants. I'm not sure why they are using that as an exemplar in terms of their strategies because they actually want to see reduced demand. And reduced demand will only come if you're getting an impact on your household budget.

As you said, Michael, the end game here is for employers to have less demand than they've got now. It's a fine balancing act when you get to the point where employers say, well, we haven't got enough demand. So we'll have to start shedding labor. And that means higher unemployment. The point is that the Reserve Bank doesn't want those offsets. They want demand to start to fall.

And of course, that's the textbook strategy for reducing inflation. Maybe it's now the reverse of what we saw a few years back when lower interest rates weren't re-inflating the economy. Maybe now we're going to-- and all the economists were questioning, why isn't this working? This is what the textbooks tell us. And now, of course, we're at the reverse where galloping inflation is in prospect. And will higher interest rates work, as the textbooks say that they are supposed to? But as I said, it's a very uncertain outlook.

But not so uncertain are the, as you alluded to, the usual headlines regarding house price crashes. That's probably the one thing that we have more certainty over is the fact that house prices won't crash. They haven't crashed before. So why would they crash now? Of course, we've had a lot of growth, a lot of activity. A lot of demand's been brought forward. So a lot of demand's being satisfied.

But there are some positive drivers that will be, I guess in a sense, interest rate neutral. And that's first home buyers and investors. We're in for a winter of discontent to some degree, if I could use that term. But it's only really that the fear factor and, as someone once famously said about the Australian housing market and other things, there is nothing to fear but fear itself. So I'll run with that line again.

MICHAEL YARDNEY: So no doubt there will be fear mongers. The media is going to keep giving us those negative headlines because they're clickbait. So I look forward to having a chat with you each week. And let's bring some perspective to the market, Andrew.

ANDREW WILSON: Yes. Thanks very much, Michael.

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