Get all your news in one place.
100’s of premium titles.
One app.
Start reading
Jason Murphy

RBA raises interest rate to 3.35%. But what’s on the horizon?

On Tuesday, the Reserve Bank of Australia (RBA) raised the official interest rate to 3.35%, reaching a 10-year high. It is the bank’s ninth rate rise since the cycle began in May last year.

Is this the top? Are we done? The answer is: probably. And if not, there’s likely to be only one or two more rate rises after this. We will get to an official interest rate of 3.6% or 3.85% and then pause. 

The big question is what happens then. Will house prices pause too? Or will they keep tumbling as the reality of high-interest rates hits continues to dawn on borrowers? While share prices snap around, rising and falling 5% in a day’s trade, house markets are slow to adjust. 

House prices are the tortoise

House prices fell about 1% in Sydney in December. That’s a fraction of the movements in the sharemarket, which fell 4%. Only a tiny fraction of housing stock changes hands each week. You can’t expect the market to adjust immediately.

Usually, instead of house prices snapping down in a weak market, volumes dry up. The number of homes sold has been well below usual levels recently. Sellers don’t want to sell in a down market and buyers are keen to wait to buy when prices bottom. So there’s a sort of truce, an uneasy standoff. One house on my street had a for sale sign for ages, but in the end the owners couldn’t find a buyer — tenants live there now.

The fast-adjusting part of the market is sales, not prices. But sales can’t be held down forever. Eventually sellers must accept that market prices are the new normal, and buyers must accept that prices are not going to fall much more — and houses must change hands.

When buyers and sellers all finally relent and return to the playing field, where will prices be?

One way to answer this is to look at lending. The banks were lending record amounts during the pandemic, when interest rates were at zero, as the next chart shows. As rates rise, that has to come down. 

If we assume lending will return to pre-pandemic averages, then the market still has a way to go. 

The hit to budgets

Imagine a young family with a budget for mortgage repayments of $3000 a month. They could afford to borrow $705,000 back when interest rates were 2%. With interest rates at 5.5%, they can borrow $487,000. That is a huge sum knocked off their purchase budget. If we assume they have a deposit of $200,000, instead of being able to spend $905,000 on a house, they can spend $687,000. A 24% fall.

Faced with a 10% fall in house prices and a 24% fall in their budget, such a buyer might be on the sidelines for now. Not many people have the emotional and cognitive flexibility to quickly lower their expectations for a house they want to buy. So it is no surprise we see first-home buyers making up less and less of the market, down by half since January 2021.

Of course, families like that are not the only kind of buyers. An upgrader planning to move from a $1 million home to a $2 million home and sees them both fall in price by 10% now needs to find an extra $900,000 to make the upgrade, not $1 million. That softens — but does not erase — the effect of rate rises. 

Likewise, an investor hoping to pay off a rental property using rental income will also find the interest rate rise is softened, with rents up by 11% in capital cities over the past year, according to CoreLogic. (Although that’s not as much as the increase in mortgage repayments. Repayments go up 38% on a 25-year loan when rates rise from 2% to 5%.)

In each of these cases, the buyer must sit on the sidelines or lower their expectations. 

Looking ahead

The market is not necessarily restored to balance the moment when rate rises stop. It may take longer for prices to fall to the point where demand recovers enough to meet supply. Timing is less important than the size of the price fall being enough to tempt buyers back to the market.

Note also that a bigger price fall will be needed if there are other pressures on repayment budgets, such as rising unemployment and continued falling real wages. If the RBA can somehow crush price rises without making unemployment worse, the housing market will recover after a smaller fall.

The major banks tip a total house price fall in the high teens, about 18% top to bottom. They expect the bottom to be later this year.

But when prices start rising again, sellers will be keen to move too so they can make their replacement purchase before prices rise too far. Any rise in prices should bring activity back to the market, but of course that doesn’t guarantee price rises.

A long period of stasis is actually possible in housing markets, as anyone who owned a house in the 1990s will be able to attest.

Sign up to read this article
Read news from 100’s of titles, curated specifically for you.
Already a member? Sign in here
Related Stories
Top stories on inkl right now
One subscription that gives you access to news from hundreds of sites
Already a member? Sign in here
Our Picks
Fourteen days free
Download the app
One app. One membership.
100+ trusted global sources.