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Interest rates have no impact on these two components of inflation

The Reserve Bank of Australia (RBA) restarted its interest rate hikes on 2 May after 10 consecutive rate rises. This hurts some parts of the economy, but some companies will benefit from higher interest rates.

Source: Bloomberg

The Reserve Bank of Australia (RBA) surprised the market with its latest interest rate hikes, but this may not be the last as ‘The Board expects that some further tightening of monetary policy may well be needed to ensure that inflation returns to target.’

However, further tightening may not curb inflation in rents and electricity.

Housing price may be bottoming but rental yields are rising

While the median dwelling price in Australia has been knocked down by 4.7% over the year to 31 March, according to CoreLogic, rental yields moved sharply in the opposite direction. According to Proptrack, advertised rents in Australia rose by 6.7% in 2022.

Higher interest rates won’t bring down rents; the return of international students and burgeoning immigration is driving demand faster than new dwellings are being built.

According to a report from the National Housing Finance and Investment Corporation’s State of the Nation’s Housing Report 2022–23, Australia will have a ‘household formation balance’ of -106,300, meaning thousands of newly weds will be living with their parents for the lack of houses.

It’s not clear whether this incorporates 64,000 more permanent, skilled, and state and territory visas in 2022-23 introduced by the Albanese government.

Other changes include allowing graduates to work in Australia an extra two years, further increasing demand for housing.

Electricity prices are rising due to a lack of low-cost production

Between 2012 and 2022, 16 of the 27 coal-fired power stations in NSW, Queensland, Victoria and South Australia were closed down and replaced with a combination of renewables, gas and diesel power.

Over the same period the average wholesale price for the eastern states jumped from $55-75 per megawatt hour (MWh) to $147-190 – around triple. Most of this rise was in 2021-23 with the closure of Liddel power station in NSW and rising coal prices.

Raising interest rates won’t alleviate the clear electricity shortage Australia will soon be facing. The 2.9 gigawatt (GW) Eraring coal-fired power plant – Australia’s largest – is to close it in 2025, seven years earlier than planned,

The Australian Energy Market Operator (AEMO) projected in its February update that NSW will breach reliability standards in 2027-28 and the entire east coast plus South Australia will breach reliability standards in 2029-2030, based on demand outstripping supply.

This means either prices rise enough that emergency diesel generators are turned on, or else the country experiences rolling brown-outs.

Interest rates have the biggest impact on investment

Even with rising electricity prices and rents making owning power plants and houses more profitable, rising interest rates discourage investment.

In January, new housing approvals fell to 12,169 – their lowest level since July 2012 and a rate that will house just a fraction of Australia’s new immigrants.

Similarly, rising electricity prices and the switch to renewables has failed to attract significant investment in the sector. According to the Clean Energy Council’s Q4 2022 report, Annual GW of financially committed generation projects was 3.6 gigawatts in 2022 – below the five-year average and barely half the 2018 high of 7.0 GW.

To put that into perspective, replacing the Earing power station’s 2,922 MW will take around 6,000 MW of wind power or solar, plus batteries. This is because the capacity utilisation factor of wind and solar power plants in Australia are around 30-37% while coal-fired power plants operate at around 60-80%.

Two stocks worth looking at: Stockland and APA

While borrowing money to build a house to rent out or solar farm to sell electricity looks a lot less attractive now than it did two years ago, the benefits of owning houses or solar farms generally increase with rising rents and electricity prices.

Founded in 1952, Stockland is one of the older companies in the ASX 200. It’s a diversified property group, owning shopping centres, residential communities and workplace and logistic assets.

Following a small loss in FY2020, Stockland bounded back with a $1.1 billion profit in FY2021 and a $1.4 billion profit in FY2022. The company’s guidance for 2023 is that it expects a similar result this year. If so, the company should be able to maintain its dividend of 26.6c, putting it at a forward yield of 6.04%.

APA Group is an integrated energy infrastructure company operating in the electricity and natural gas sectors. It has interests in gas-fired power stations, solar and wind farms, gas storage, gas processing, gas compression, gas pipeline and consumer gas connections.

Increasing demand for gas and higher electricity prices could be a boon for APA. As of April xx, it is trading at a dividend yield of 5.20%

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The information on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG Bank S.A. accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer.

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