The housing market in Australia is expected to be impacted as the largest hike in interest rate for twenty years hits household budgets and affect housing demand.
At its monthly board meeting on Tuesday, the Reserve Bank of Australia lifted official interest rates by 50 basis points to 85 basis points or 0.85 percent.
The increase – which was bigger than what many economists had anticipated – represents the largest single monthly increase in the cash rate since February 2000.
The move came after higher fuel and construction prices drove year-on-year inflation to 5.1 percent in the March quarter.
It represents a sharper than expected withdrawal of monetary policy support which was provided by ultra-low rates during COVID.
Whilst the RBA forecast that inflation would return to the bank’s target rate of 2-3 percent per annum next year, it warned that this would rise further in the short term on account of higher prices for electricity, petrol.
With the economy being resilient and household balance sheets being in good shape, the bank said it was now appropriate to wind back the support afforded during the pandemic.
It added that further rate increases are likely in coming months as monetary policy returned to a more normalized condition.
“Today’s increase in interest rates by the Board is a further step in the withdrawal of the extraordinary monetary support that was put in place to help the Australian economy during the pandemic,” the RBA said in its statement.
“The resilience of the economy and the higher inflation mean that this extraordinary support is no longer needed. Given the current inflation pressures in the economy, and the still very low level of interest rates, the Board decided to move by 50 basis points today.
“The Board expects to take further steps in the process of normalising monetary conditions in Australia over the months ahead. The size and timing of future interest rate increases will be guided by the incoming data and the Board’s assessment of the outlook for inflation and the labour market.
“The Board is committed to doing what is necessary to ensure that inflation in Australia returns to target over time.”
The latest increase comes amid growing signs of softening in the housing market.
In May, capital city housing values dropped by 0.3 percent over the month – the first monthly decline in more than three years amid price declines in both Sydney and Melbourne.
Meanwhile, the value of new housing finance commitments fell 6.4 percent during April – albeit with housing finance values remaining above pre-pandemic levels in February 2020 to the tune of 44 percent.
Economists and researchers expect the impact on the housing market to be considerable.
CoreLogic Research Director Tim Lawless says the housing market slowdown in Sydney and Melbourne will gradually spread to other regions.
Stressing that a strong rate of underlying inflation (currently 3.5 percent) means that interest rate increases are likely to continue through the second half of this year and into 2023, Lawless said variable mortgage rates are likely to increase by the same or similar amount to the cash rate increase over the next week.
That will the average variable interest rate for a new owner occupier loan to around 3.16%.
Combined with the 25-basis point increase handed down last month, the cumulative 75 basis point lift in mortgage rates will add approximately $200 per month in additional repayments on a $500,000 mortgage compared with mortgage rates in April.
Lawless says the higher interest rates will not only reduce borrowing capacity but will impact upon mortgage serviceability assessments for prospective buyers by reducing household savings and further tightening balance sheets.
For households, this creates a ‘double whammy’ as the higher cost of debt comes on top of higher costs for food and fuel.
Still, Lawless says economic resilience and tight labour markets will help to ensure that any housing market downturn remains ‘orderly’.
“For housing markets, higher mortgage rates add further downside risk to values, which are already trending lower, such as the case in Sydney and Melbourne, or losing steam in the rate of growth across most other markets …,” Lawless said.
“While we expect the housing downturn evident in Sydney and Melbourne will gradually spread to other regions, the trajectory for this will depend on how fast and how high interest rates move and normalise, along with the performance of the broader Australian economy and labour market.
“A stronger economy, along with the tightest labour market conditions in a generation, should help to ensure the ensuing housing downturn remains orderly.”
Dr Peng Yew Wong, a lecturer in the School of Property, Construction and Project Management at RMIT, broadly agrees.
“The RBA is on a definite pathway embarking a series of “contractionary monetary policies” by increasing official cash rates,” Wong said.
“Putting the inflation pressure aside, the rise in the RBA cash rate will be translated into an increase in home mortgage interest rates. Undoubtedly this will directly impact the home borrowers as they will need to start paying a higher mortgage repayment as a result. Can they afford the higher mortgage payments in the midst of an unprecedented inflation? Borrowing power of homebuyers is simultaneously reduced, so perhaps it is prudent to assume some might not be able to? House prices in Sydney and Melbourne are already on the down trend as a result.”
“We are quite certain that the negative impact on the homebuyers borrowing power will negatively impact the housing market buying activities. The reduced housing market buying activities should translate into reduced house prices.”