The two-way relationship between inflation and the property market

Property is often talked about like it's a massive, faceless market. In reality, it's an industry that takes place on a very personal, local level with one seller and one eventual buyer transacting. 

Even so, understanding how macro factors flow through to micro markets and vice versa can be key to reading buyer and seller behaviours and the market ahead. 

So how do global-scale events end up influencing sales results in your local neighbourhood? And how can those individual sales combine to push inflation higher?

How did we reach this high-inflation, rising-rate environment? 

First, it's important to grasp the wider context of why we've found ourselves in this rapidly rising interest rate environment. 

Between knock-on effects of the pandemic and the war in Ukraine, there has been a lot of inflationary pressure that's pushed the price of goods and services higher over the past 18 months.

As of the March quarter, Australia's annual inflation sat at 7 per cent — well above the RBA's target range of 2 to 3 per cent but finally lowered from the December 2022 peak of 7.8 per cent. 

Increasing interest rates is one of the RBA's only tools to get inflation under control and slow the economy, and it's a blunt tool that can be painful for businesses and households. It makes things particularly challenging for borrowers, whether they have a mortgage or they're buyers looking for a loan. 

We now find ourselves in the midst of the most rapid rate hiking cycle in 40 years, and that's had a major impact on the wider property market. The relationship between inflation and property is a two-way street, though, and recent price increases may change the RBA's plan of action.

How the property market influences inflation

Inflation is ultimately a measure of change in the Consumer Price Index (CPI). This covers a broad range of goods and services, and some elements of the property market are included. 

While established homes and land purchases don't fall into that basket, new builds do. If newly built dwellings are going up in price, that contributes to higher inflation. 

Renovations, maintenance, utilities and other similar services also contribute to the CPI. With trades and materials in such short supply, the increased cost of doing any kind of work on property adds upward pressure on inflation. 

Another major contributor is the rental market. Rents have been surging across the country as vacancy rates have plummeted, and that feeds directly into Australia's CPI. 

There's little relief in sight for the rental crisis as overseas migration skyrockets and supply continues to dwindle, so the rental market is likely to continue contributing to the wider inflation problem. 

If the cost of rents, new builds, trades and materials keep rising, that will contribute to the RBA's overall picture of the economy and may necessitate pushing interest rates higher still. 

How inflation influences the property market

The most direct way inflation impacts property is through rising interest rates and the financial pressures experienced by homeowners with a mortgage and potential buyers looking to borrow. 

On the homeowner side, ballooning home loan repayments can lead to mortgage stress and, in worst cases, forced sales. 

The 'fixed rate cliff', which refers to the hundreds of thousands of ultra-low fixed rate borrowers set to be hit with far higher variable rate repayments throughout 2023, has a number of economists concerned about an influx of distressed sales hitting the market and driving property priced down. 

Potential buyers — particularly first home buyers — have also been hit hard by interest rate hikes as their borrowing capacities have been reduced by nearly 30 per cent on average. 

That substantial reduction in borrowing power has played a key role in the wider property price declines seen throughout 2022. 

Interest rates are closely linked with the trajectory of property prices. Typically when rates go up, prices take a hit, while rate cuts often stimulate growth. 

The current dynamic, where prices have started rebounding in many markets despite still-rising rates, is unusual and speaks to the extent of the ongoing listings shortage.

Where will interest rates go next? 

The RBA's process of trying to bring inflation back down to the 2 to 3 per cent range has been a very challenging one. 

If they raise rates too high they risk slowing the economy to the point of recession. If they don't hike aggressively enough, inflation may become sticky and create longer-term negative impacts. 

After pausing in April, Westpac for one believes that the May and June rate hikes signal the intention for further increases to a 4.60 per cent peak by August 2023. 

Whether or not that happens, CoreLogic expects that nudging the cash rate above the 4 per cent threshold will "take some steam out of the housing market." 

Once the full effects of the latest rate hikes flow through to homeowners, there may be an increase in distressed sales, potentially shifting the balance between buyers and sellers. 

CoreLogic noted, however, that "the housing market has defied expectations" this year. As overseas migration continues to ramp up and supply remains low, it remains to be seen whether a new round of price dips is coming or if the market will keep rallying in spite of rising rates.