RBA rate cuts fuelled Australia's housing price boom

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  • Australian home prices are regarded as being among the most expensive in the world according to a variety of metrics.
  • Researchers at the RBA suggest lower interest rates largely explain why home prices boomed earlier this decade.
  • Population growth was also deemed to be a factor, although not as large.
  • Financial markets and an increasing number of economists believe the RBA will cut Australia’s cash rate again this year.

Australian home prices are regarded as being among the most expensive in the world according to a variety of metrics, having soared since the GFC.

Much of the growth has been concentrated in Sydney and Melbourne — the largest and most expensive capital city housing markets in the country — where median prices near-doubled in less than a decade.

It’s meant that many younger Australians have been effectively locked out from these markets

According to new modelling from researchers at the Reserve Bank of Australia (RBA), rather than supply and demand for housing, falling interest rates has been the chief catalyst behind the recent surge in prices.

“We build an empirical model of the Australian housing market that quantifies interrelationships between construction, vacancies, rents and prices,” said Trent Saunders and Peter Tulip, researchers at the RBA, in a note released today.

“We find that low interest rates — partly reflecting lower world long-term rates — explain much of the rapid growth in housing prices and construction over the past few years.”

This chart from the RBA shows what its housing model suggests would have occurred should Australia’s cash rate not have fallen from 4.75% back in late 2010 to 1.5% today.

RBA

The model results are presented in blue with actual outcomes shown in maroon.

Without the reduction in interest rates, the model suggests Australia’s dwelling price to income ratio would have been substantially lower than where it is today.

The housing building boom seen in recent years would also not have been anywhere near as big, reflecting that higher prices and lower borrowing costs prompted a supply response from developers.

“The model estimates that the reduction in real interest rates (actual interest rates, less inflation) accounts for most of the subsequent boom in dwelling prices and a large part of the boom in dwelling investment,” said researchers Trent Saunders and Peter Tulip.

“The increase in housing supply boosts the vacancy rate and reduces rents.

“However, these effects are offset by the effect of higher income, with neither the vacancy rate nor rents being much changed on net.”

Outside of interest rates, the model suggests that faster population growth, primarily reflecting strong growth in immigration, has also contributed to a a higher dwelling price to income ratio than what would otherwise been the case, although not to the same degree as the reduction in interest rates.

Only growth in real rental costs, those less than inflation, would have been substantially slower over the past few years, according to the model. Lower interest rates, not stronger demand from faster population growth, were largely behind the latest run-up in prices.

The scenarios presented are hypothetical in nature, aiming to assess what would have happened should interest rates remain steady.

Interest rates were cut for a reason over this period: the global economy was sluggish, Australian unemployment was elevated and inflation remained entrenched below the RBA’s target, a scenario that saw the RBA take action to help reverse those trends, at least from a domestic perspective.

While Australia’s unemployment rate has fallen to the lowest level since 2011, Australia’s economy slowed sharply in the second half of last year. Inflation also remains below the RBA’s target by some margin, helping to explain why an increasing number of economists, and those in financial markets, believe the RBA will have to cut Australia’s cash rate again this year.

Should the RBA reduce interest rates again — something that will likely be determined by what happens in Australia’s jobs market in the period ahead — it’s likely there’ll be plenty of speculation that home prices may start to lift again.

While the RBA analysis suggests that’s a risk, with the introduction of tougher lending standards towards household expenses and outstanding debt held by individual borrowers, whether a further cut in the cash rate will see prices lift by any meaningful degree is highly uncertain, at least in the near-to-medium term.

Like the outlook for the cash rate, it’s likely that job market conditions will play a key role in determining what will happen next for prices.

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