How the RBA and Inflation Impact the Property Market

With the odds of a further rate hike from the RBA getting slashed after inflation appears to be cooling down, it’s worth looking at how interest rates and inflation impact the property market.

Arguably the single largest factor in Australian property prices is how much it costs to borrow money to purchase real estate. This is driven by the interest rate you pay on your mortgage.

In recent years, we’ve seen interest rates fall to the lowest level on record, with mortgages reaching just 2 per cent. However, the tide has turned in the past 12 months, and the Reserve Bank of Australia is aggressively increasing rates in a bid to keep surging inflation in check, but it’s also put a bit of a damper on the housing market.

Over the past 40 years, we’ve experienced a record run of house price growth. There are a number of drivers of that growth with immigration being a huge factor, but also the fact that rates have fallen from the highs of around 20 per cent towards virtually zero, has meant that borrowing capacity has risen. In turn, home buyers have been able to spend more, driving up the price of houses.

In reality, the goal of the RBA is to keep inflation in check. Rising inflation, as most of us have experienced in the past few years, makes our lives a lot worse. Their goal is to keep inflation in a target band of between 2-3 per cent. Over the past few years, inflation has gotten out of control after the spending spree from the Government during the Covid lockdowns, the incredibly low interest rates, and supply chain interruptions that saw inflation push towards 10 per cent.

Therefore the RBA responded and has been hiking rates to try and tame the runaway inflation. Judging by the latest data from the Australian Bureau of Statistics (ABS), these rate hikes are working, and inflation has now fallen back to 6 per cent annually, from a high of 7.8 per cent.

That should be good news for mortgage holders, but it doesn’t mean that interest rates are going to be going back towards the record low levels that we saw during the COVID-era. More likely, we are going to see structurally higher interest rates for an extended period of time until inflation falls back towards the RBA’s target band. If they were to drop rates again, it could cause inflation to take off.

In some ways, using interest rates to control inflation is simply a lever and an incredibly blunt tool to reduce demand. When looking at it simply, raising interest rates has the most impact on people who have recently purchased a home and likely has very little impact on those older generations who have likely paid off their homes.

The way interest rates work to cool inflation is by effectively reducing demand for goods and services. When house prices are rising, the stock market is moving higher and people are out there spending money, this all adds to the overall level of demand and therefore inflation.

When rates are high, it means there is downward pressure on house prices and the stock market, which lowers wealth and pressures households' budgets. That means there is less spending and the economy cools down.

For property, this is a tricky situation. However, just because interest rates are trending higher doesn't mean this is not a time to buy property.

In the past six months, house prices have turned around and are now drifting higher. Despite the impact of higher borrowing costs, there are other factors at play that continue to put upward pressure on values.

In particular, the record influx of immigrants, which is expected to be nearly 1 million over the next few years, means that the already stretched supply of houses will continue to be challenged. And this means prices can still move higher.

Also, when home prices are down, thanks to higher rates, many homeowners opt to hold and not sell, which means supply stays constrained. Similarly, fewer new homes are built.

If you’re looking to invest in property, you also need to break down your search to a more localised level. While house prices might be lower across the entire country, there are still plenty of locations where demand is heavily outweighing supply and putting upward pressure on prices in those areas.

So despite the RBA keeping rates high, there are still great opportunities to invest in property right now. And when the RBA eventually decides to take their foot off the pedal and lower rates, you will then be in the driver's seat for another leg higher.