With interest rates at all time lows, inflation above the RBA’s target and the cash rate at 0.1% already the only direction interest rates can realistically head is up. Let’s put this in context and have a look at what effect a bottoming of the rate cycle and a move to rising interest rates has had on the property market in the past.
Since 1994 the RBA’s target has been to keep inflation (as measured by CPI) between 2-3% which it has done a remarkably good job at. The CPI is currently at 3.5% and there is a clear bias for raising rates to push the CPI print down.
However, it should be noted that most of the current inflation issues are a result of supply side shortages courtesy of the global shipping crisis rather than demand side drivers. It’s unlikely that an increase in interest rates will be the right policy decision. The likely outcome will be crushing demand and growth which are only just beginning to recover from two years of rolling lockdowns and supply chain disruptions. Nevertheless, an increase in interest rates is the likely outcome with the RBA chief Phillip Lowe waiting to see the ABS inflation data release later this week and wage-inflation data in May before committing to raising rates for the first time in a decade this year.
In any case any rate rises will be fairly limited as Australian households are already highly leveraged – as such it won’t take a large move in interest rates to shut down demand. And as asset markets are always forward looking both property and stocks have reacted and seem to have fully priced in the effect of a rate rise already with prices in both asset classes moderating in Q1 2022.
With the credit environment being a significant driver of property prices over the last 40 years what effect could a rate rise have?
We have often spoken about the bottoming of the interest rate cycle often being a signal for the beginning of property price appreciation on the highly correlated east coast capital city markets. And indeed, if we look at the sections highlighted in grey (bottoming of the rate cycle) we can see that they are almost invariable followed by property booms (sections highlighted in orange).
What we don’t often speak about is that more often than not the bulk of the property price increases occur as interest rates are rising (sections highlighted in red) with the peak of property prices occurring at the local peaks of the interest rate.
While we don’t have a crystal ball here are the possible scenarios.
- The RBA recognizes that the bulk of the inflation is from supply side imbalances and sits on its hands and waits for the supply chain issues to resolve themselves normally over the course of the next few years. This would see property prices continue to rise upwards over the course of the next few years. The RBA then raises rates which cools down asset prices as it has done in the past.
- The RBA raises interest rates to bring the CPI number down. This flatlines risk-on assets such as property and shares as well as hurting an already wobbly economy. The GDP drops and they immediately drop interest rates again and potentially reinstate the quantitative easing program. Asset prices re-inflate and we’re back to scenario 1.
Either way it looks likely that property prices on the east coast capitals will continue to grow until approximately 2026. The next few years should be good ones for Australian property investors.