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How will further interest rate increases affect Australia’s housing market?

by xyonent
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Property Market 2.jpg

Key Takeaways

Monthly CPI readings suggest inflation has risen in the year to May, potentially calling for a further increase in the RBA’s interest rate target.

The Australian housing market has remained fairly strong despite rising interest rates, with house prices rising from the start of the rate hike cycle through to January 2023.

Tight labor markets and savings buildup through the pandemic are supporting mortgage repayment capacity, while strong population growth is boosting demand for housing. Buyer mix may also be supporting purchases, with larger down payments indicating a current buyer profile less reliant on debt.

Further increases in interest rates would slow demand for housing, but some cracks are already showing, and buyer demand appears to be skewed towards cheaper markets, with Perth currently one of the main markets driving growth in the metropolitan area.

If interest rates rise another 25 basis points in August, that could push monthly payments on the current median home price above $4,000, further increasing the advantage of having a mortgage compared to renting.

While the RBA has stated it has a low tolerance for inflation, a rate hike in August is not yet guaranteed, and a decision on this could also depend on quarterly inflation, labour market reports and retail sales data.

Even if interest rates do not rise further, home buying will likely slow as economic conditions worsen and home buying constraints increase, affecting the savings buffers of homeowning households.

Monthly CPI readings point to rising inflation in the year to May, while the “trimmed mean” of the annual inflation measure rose to 4.4% from 4.1% in April.

Annual Inflation Rates Comparison of Monthly Inflation Rate Indicators and Quarterly CPI

While the monthly CPI reading is a less complete indicator than the quarterly inflation results, there are concerns that inflation is trending higher again, which may call for a further increase in the RBA’s cash rate target.

Why are home prices rising even as interest rates rise?

Australia’s housing market has remained fairly strong despite rising interest rates.

Figure 2 shows the cumulative change in national house prices from May 2022, with an initial peak-to-trough decline of -7.5% from the start of the rate hike cycle through January 2023, the lowest point of the house price decline.

Cash rate targets and cumulative change in national house prices

From the start of 2023, cash rates will increase by a further five times, but house prices will rise steadily, recovering by November 2023 and being 4.6% higher than in May 2022.

There are several explanations for why home prices continue to rise despite rising debt costs and reduced borrowing capacity.

Part of the reason is that supply is low compared to demand.

Tough labor market conditions and savings accumulated through the pandemic have broadly supported mortgage repayment capacity and mitigated the need to sell as interest rates rise, the construction sector remains under pressure and unable to service a large backlog of housing supplies, and solid population growth is increasing demand for both home purchases and rentals.

Around 127,000 homes were purchased in the June quarter, but only around 125,000 new properties were put on the market.

As long as there are more people wanting to buy homes than people wanting to sell, prices should theoretically continue to rise.

The mix of buyers may also be supporting purchases, with larger down payment amounts suggesting that the current buyer profile may be less reliant on debt than when interest rates were at historic lows.

Other demand-side factors influencing home buying include the dominance of adjustable rate mortgages in Australia.

Buyers may be buying at the peak of the interest rate cycle and pricing future lower cash rates into their purchase decision, with the hope that mortgage rates will fall over time.

From this perspective, further rate hikes would certainly dampen demand and signal to the market that interest rates have not yet peaked, or at least that they are likely to take some time to come down.

If interest rates rise further, demand for housing will slow, and cracks are already showing.

Despite the strong headline figures, some say demand is already weakening.

Nationwide house prices rose 1.8% in the June quarter, slowing from the 3.3% increase in the same period last year as the market was rising from lows.

Buyer demand appears to be generally biased towards cheaper markets, with Perth now being one of the main markets driving growth in the metropolitan area.

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