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House prices soar as inflation dives: What you need to know

Interest rate hikes are reining in inflation but having little effect on house prices.

Composite image of 'Sold' sign in front of a house, and a woman smiling in a supermarket to represent inflation falling
House prices are up 5 per cent from their February trough, while inflation has almost halved in just seven months. (Source: Getty)

Two key components of the Australian economy are inflation and house prices, and the most up-to-date news on both is clear – inflation is continuing its free-fall and house prices are continuing their run higher.

Annual inflation peaked at 8.4 per cent in December 2022. In July 2023, it eased back to 4.9 per cent - a chunky fall of 3.5 percentage points in just seven months. Slower economic growth, an absence of excessive wage increases, stable to lower commodity prices and the early signs of a turn in the unemployment rate are all factors behind this trend.

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Inflation is now on track to return to the Reserve Bank’s (RBA) target band of 2-3 per cent during 2024, which is welcome news for consumers being buffeted by cost-of-living pressures and falling real wages. Low inflation is the critical element in any recovery in real wages.

Low inflation will also feed into an easing of cost pressures for many businesses and take the pressure off them to increase selling prices to maintain their margins – a virtuous cycle in the lower-inflation scenario.

The deceleration in the inflation rate, in concert with the broader economic trends, is almost certain to be enough to see the RBA hold interest rates steady for several more months. It has already done enough in terms of the 400 basis points of interest rate hikes since May 2022, much of which is still to materially impact cash flows and economic activity.

It has hinted as much in recent commentary.

That news on the likely peak in interest rates is being reflected in financial markets, where the yield on a three-year government bond, for example, is trading at 3.7 per cent, materially below the official cash rate - 4.1 per cent.

This pricing suggests that, over the medium term, investors are expecting interest rate cuts to be delivered by the RBA, but not yet.

House price rebound continues

The other big news relates to house prices which, according to Corelogic, rose a further 0.8 per cent in August to be 5 per cent higher than the low point in February 2023. Indeed, house prices have risen for six consecutive months, having registered a relatively moderate peak-to-trough drop of 9.1 per cent from early 2022 to early 2023.

Prices have risen despite some earlier fear-mongering that the interest-rate-hiking cycle would see falls of 20 or even 30 per cent before they found a base.

Such poor analysis put too much emphasis on interest rate changes and overlooked the dominant drivers of house prices: demand from population growth and other demographics, supply, which is determined by new dwelling construction, and the cost of building, which covers the materials and labour needed to erect a dwelling.

These latter points have dominated any short-run negative effects of interest rates.

Population growth is rapid, with immigration and international students returning to Australia after the COVID pandemic. New dwelling construction has slumped to its lowest level in a decade, being impacted by a sharp increase in building costs and a tightening in lending rules from banks and other financial institutions.

The outlook for house prices remains positive, although the rate of increase could slow as the surge in immigration eases and building cost pressures ease. It will take some time for there to be a meaningful lift in new dwelling supply because that requires a lift in building approvals to translate into completed dwellings that people can move into.

After rising by around 8-10 per cent in 2023, nationwide house price growth is likely to ease to around 5 per cent in 2024, even if the RBA does in fact deliver a small number of interest rate cuts as inflation falls.

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