By Natgen Managing Director, Steven Goakes
Speculation on the future of interest rate policy and market movements is a hot topic at the moment – both in the media and within financial circles.
We at Natgen have been watching these developments closely, given the fact that we have been following our interest rate risk management strategy for some time now.
The basic tenets of our strategy are as follows:
- The assumption is that the next interest rate movements will be upwards.
- Governments and the banking/finance communities worldwide have a vested interest in keeping interest rate movements within a tolerable band for mortgage holders in particular.
- Our base case assumes a doubling of effective interest rates within the next interest rate cycle, meaning in increase over the coming years of approximately 2% per annum.
- The speed of interest rate increases is unable to be accurately determined, so we use the market rates for BBSY between 90 days and 10 years as an indication of the market view of the expected rate of rise in interest rates.
- Our financial models for Natgen investment trusts assume a commencing interest rate above the current short term BBSY (bank bill swap rate) and provide an increase in this rate during the latter years of Natgen investment trusts based on advice from financiers, other market participants and Reserve Bank guidance.
- The response to this interest rate information may vary. For example, Natgen has chosen to fix the interest rate of the debt for the Kingsthorpe Central Shopping Centre for the term of the loan, whereas the interest rate for Rededge Goodna will remain variable in the short term, pending further market indications. Both these responses are based on our interpretation of available information and our consideration of the best outcomes for our unitholders in each individual case.
Current interest rate market indications
Following the most recent inflation figures, medium term fixed interest rates jumped significantly, indicating that the market is factoring in a series of increases earlier than previously expected.
The consensus view of bank economists is bringing interest rates increases forward from 2024 into 2023 and to some extent into the latter part of 2022. The Reserve Bank, on the other hand, is taking a somewhat more conservative approach. In its latest Statement on Monetary Policy (November 2021), the Reserve Bank has made observations about the international environment, domestic economic conditions and domestic financial conditions which are consistent with it’s conservative growth expectations on interest rates.
Whilst a multitude of factors are at play, my reading is that the RBA sees the current inflation spike as just that – a spike, which has been caused largely by supply constraints as global supply chains re-start following Covid-related shutdowns on all continents. The Delta strain further extended supply constraint conditions. However, as supply chains recover, the expectation is that the inflation spike will normalise and long term inflationary pressures will return to closer to pre-pandemic levels. Even widely-publicised labour market shortages are expected to have only moderate impacts in Australia, given our predominantly services based economy and reintroduction of foreign students and workers into the economy in 2022.
In the end, only time will tell whether the market response or RBA analysis is correct. Notwithstanding this uncertainty, we at Natgen will continue to take a risk-managed approach to interest rate decision making, with unitholder return and risk reduction as the central considerations.
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