How Monetary Policy influences the property market

screen-shot-2016-10-29-at-5-10-19-pmTweaking the monetary policy including interest rates inevitably impacts the property cycle.
screen-shot-2016-10-29-at-4-59-59-pmOn 13th July 2016, Bank Negara Malaysia (BNM) announced the adjustment of the overnight policy rate (OPR) by 0.25% to 3% (previously, it was 3.25%) at the Monetary Policy Committee (MPC) meeting. The following few days, Maybank and CIMB decreased their BR/BLR by 0.2%.
Ever wonder how OPR, BR/BLR and monetary policy impact our overall economy and property market?
Every country has a central bank. In the US, it is called Federal Reserve (also known as Fed). In Europe, it is the European Central Bank, ECB. In Malaysia, our central bank is Bank Negara.
What are the functions of Bank Negara? A central bank has two most important tasks:
1. To regulate and oversee the nation’s commercial banks by making sure that these banks have enough money in reserve to avoid bank closure.
2. Control over Monetary Policy, which is increasing or decreasing the money supply to either speed up or slow down the nation’s economy.
Monetary Policy is what makes Bank Negara so influential.
Interest rate is the price of borrowing money. When banks give out loans, they expect to be repaid the amount they have loaned out (principal) and a percentage of the principal to cover inflation and to make some profit. That percentage is called interest rate.

Loan Repayment = Principal + Interest

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screen-shot-2016-10-29-at-5-01-53-pmThere are different levels of interest rates for car loans, personal loans, housing loans and business loans. Most Malaysians who run a business and buy a car/house, do so with loans from the bank. When interest rate is low, borrowers will find it easy to pay back loans, so they may eventually borrow more and spend more. When interest rate is high, people borrow less and therefore, they spend less.
In Malaysia, Bank Negara does not have control over interest rates that banks can charge customers. The banks can decide the Base Rate (introduced in January 2015 as new reference loan rate) based arbitrarily on their own internal “cost of funds”. This “cost of funds” is in line with the Overnight Policy Rate (OPR) as determined by the money supply from Bank Negara, which again, depends on the current state of the global economy and its objectives.
When Bank Negara increases the money supply, there will be more money for banks to loan out and so, interest rates will be lowered to encourage more borrowers. A decrease in money supply has a direct opposite effect; less money supply means that banks have less money to loan out. As a result, interest rates will go up.
It is the same globally. When a country’s central bank wants to boost the economy, they increase the money supply, which will lower interest rates, resulting in more borrowing and increased spending. This is called Expansionary Monetary Policy. When the central bank decreases the money supply, less money is available, interest rates go up and spending decreases. This is called Contractionary Monetary Policy.


The chart here shows a bad property market vicious cycle. During the Supply Booming Cycle, Property Market transactions happen at a very high frequency, property prices shoot up and people get used to it.
But once it moves to the Supply Corrective Cycle, transaction frequency slows down, property prices remain stagnant and fear is induced when people see the drop in transaction frequency. Investors hesitate and transactions get fewer and fewer thus the cycle keeps looping.
Can we break the chain and stop the vicious cycle? The answer is YES.
Breaking the bad property market vicious cycle is simple. Everyone needs a place to stay. They can either buy or rent a property/house. The root factor that slows down property market transactions is Affordability.
Theoretically, if we can make it affordable to buy property, this will stimulate the market. Once the transaction frequency goes up, so will property prices and this will create good Market Sentiment among investors.
Now, this is what happens, lower interest rate (BR/BLR) will make property easier to afford. When consumers pay less in interest (including mortgage loan), this gives them more money to spend, which can create a ripple effect of increased spending throughout the economy.
Property market transactions will eventually increase, as lower interest rates increase affordability.

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