Interest rate

Australia is the first OECD country to lift interest rate.

Glen Steven, the Governor of Reserve Bank of Australia appears to have looked through the conventional monetary policy focusing on the core inflation.

In many of his speech, he expressed concern over a seemingly ever-increasing residential property price in Australia. He warned against property bubble and feared many Australian will soon be unable to afford a home.

Glen is a very handful central banker around the global who targets asset prices or at least starting to.

The number one reason for rising asset price is availability of cheap credit. This was precisely the reason behind the US housing bubble induced global financial crisis.

RBA's decision to increase interest rate should be welcomed as a stabliser for the future prosperity of Australia economy. As interest rise, debt becomes more expensive to service hence tapper off the demand for cheap credit.

However, the other critical factor government appear to miss is the availability of credit or the ability to lever up. Consider the following scenarios:

What can $50,000 saving buy?



(LVR = Loan to valuation ratio)

With the same amount of saving, the ability to leverage is astounding.
At 90% LVR, one can leverage up to purchase $500,000 property.
At 95% LVR, one can leverage up to purchase $1m property.

So you just see how 5% difference in LVR can do to the property one can afford.

In my opinion, a more effective way to control the property price from growing out of control is to restrict the maximum leverage banks can provide to customers.

This will have significant impact on the property market with a very positive long term outcome.

Reduction in maximum LVR will force potential home buyers to save longer and save more for property purchase. This also leads to a lower leverage which will significantly reduce the case of household financial stress and bankruptcy.

This in turn has a positive contribution to fostering a healthy, responsible and sustainable economy for many generations to come.

With added bonus, the reduction in LVR is likely to reduce the property price to some extent which makes the property more affordable for living instead of speculation.

Increasing interest rate will no doubt have some downward pressure on prices. However, increasing interest rate will also have negative impact on business investment which will contribute to improvement in productivity and real economic growth and prosperity.

Inflating property price will only be beneficial to a handful of property owners at expense of many hard-working Australians such as nurses, fireman, policeman and other public servants who devote their life to society.

If there is anyting we need to learn from the GFC, number 1 lesson is to constrain use of credit. Saving is the key to prosperity not credit.