What would another rate rise do to house prices and rents?

With recent higher-than-expected monthly inflation data for the year to May 2024, there’s speculation the Reserve Bank of Australia (RBA) could hike rates at its next board meeting in August. 

However, analysis by property data specialists CoreLogic shows another 0.25% lift in the cash rate may have a limited effect on residential property prices, which grew 8% nationally over the past year.

CoreLogic’s analysis also seems to suggest that another rate hike may actually put more upward pressure on rents.

The details

The Reserve Bank of Australia has kept the cash rate on hold at 4.35% since November last year when it delivered the 13th straight interest rate hike in its campaign to fight inflation. 

Even though official interest rates are now at a 12-year high, the RBA has consistently warned that it will do “whatever is necessary” to prevent another inflation blowout in Australia.

With the only real tool in its locker being the movement of official interest rates, that means the central bank is prepared to put up rates again if it doesn’t think the economy is on track to return to the RBA’s inflation target range of 2-3% by the end of 2025.

The recent release of May CPI data from the Australian Bureau of Statistics (ABS) showed that annual inflation grew faster than expected, coming in at 4% over the year to May 2024, up from 3.6% in April and 3.5% in March.

Worryingly, the RBA’s preferred measure—"trimmed mean” inflation—came in at 4.4% in May, the fourth straight month it’s trended upwards. 

“While the monthly CPI indicator isn’t as complete a measure as the quarterly inflation result, there is concern that inflation is back on the rise, which could necessitate another increase in the RBA cash rate target,” says CoreLogic Australia’s Head of Research, Eliza Owen.

Ms Owen has been considering the possible implications of another RBA rate rise of 0.25% in August.

Home prices

Eliza Owen says that the Australian housing market “has been fairly resilient despite higher interest rates.” 

She references the chart above to show the cumulative change in national home values from May 2022 (when the RBA first started raising the cash rate).

It shows how the residential property market fell 7.5%, bottoming out in January 2023.

Then, despite the cash rate increasing a further five times, home values consistently rose, “staging a recovery by November 2023, and rising further to be 4.6% higher than in May 2022.”

While there was an initial reaction to a higher interest rate environment, after about 8 months, borrowers shrugged this off and “housing values have continued to rise even as the cost of debt has risen, and borrowing capacity has eroded.” 

Ms Owen attributes this seemingly contradictory picture—higher home prices at a time of a 12-year interest rate peak—to several factors, including “low supply relative to demand.”

“Tight labour market conditions and an accumulation of savings through the pandemic have broadly underpinned mortgage serviceability, mitigating a need to sell as rates have increased,” she says.

“The construction sector remains squeezed and unable to deliver a large backlog of dwellings, and strong population growth has increased demand for housing, both for purchase and rent. 

“The composition of buyers may also be propping up purchases, with higher deposit sizes indicating the current buyer profile may be less debt-dependent than when interest rates were at record lows,” she says.

However, Ms Owen does say the pace of home price growth is slowing, pointing out that while national home values were up 1.8% in the June quarter, this is slower than a 3.3% rise in the same quarter last year, “when the market was rising off a lower base.”

Eliza Owen also points out that demand seems “generally skewed to cheaper markets, with Perth now being one of the primary markets driving growth in the capital cities.”

Nevertheless, CoreLogic figures show that in the June quarter of 2024, around 127,000 homes were purchased, but only about 125,000 new listings were added to the market. 

So even if rates are hiked in August, “as long as there are more people willing to purchase a home than sell, prices should theoretically continue to rise,” Eliza Owen says.

Rental prices

CoreLogic's latest monthly report found that “rental growth is easing but remains well above average with the national rental index recording a monthly rise of 0.4% and an annual rise of 8.2%.” 

Rival number cruncher PropTrack’s latest Market Insight report calculated capital city rental prices rose 10.3% in the year to June 2024. 

If you read between the lines of Eliza Owen’s latest analysis, it’s clear another 0.25% rate rise from the RBA would not necessarily slow rental growth, as it might mean some prospective property buyers might find themselves priced out of buying and continue as tenants in an already hot rental market.

“Another 25 basis point rise in the cash rate in August, all else being equal, would take monthly repayments on the current median dwelling value to over $4,000 per month,” she says. 

“Not only is this further out of reach for prospective buyers, it would likely also represent a further blowout in the premium of holding a mortgage relative to renting.”

CoreLogic estimates the difference between the monthly median dwelling value mortgage payment and the median rent value in June was $1,172.

Assuming rents and housing values are steady in August, CoreLogic says a further 0.25% increase in average variable mortgage rates would push that “mortgage premium” to $1,276.

“The bigger that premium becomes, the weaker demand for purchases may become relative to renting, despite rent growth still sitting well above average.”

In other words, small numbers of price-sensitive buyers might move from being tenants into becoming homeowners, meaning less turnover in an already very tight rental market.