MNI POLICY: House Price Strength Thwarts RBA Models

The recent strength of the Australian housing market has unexpectedly reduced the drag on household consumption factored into Reserve Bank of Australia models, catching the RBA off-guard and potentially raising the chance rates could move higher if strong house-price growth persists, MNI understands.

If rising house prices add to a stronger consumption outlook than expected, this will mean the balance between supply and demand has not shifted in line with the Reserve's view, adding upward pressure on rates. Other factors, such as productivity and firm pricing decisions, will also feature in the RBA's next decision on July 4, MNI understands.

HOUSE PRICE FOCUS

The RBA board pointed to house prices following its decision on Tuesday to lift the cash rate 25bp to 4.1%), while Governor Philip Lowe featured the issue in his follow up presentation. “The headwind for household spending from falling housing prices looks to be coming to an end and could be replaced with a tailwind from increasing housing prices,” he noted.

CoreLogic’s national Home Value Index showed a 1.2% rise in May, the third consecutive increase and the strongest growth since November 2021. The data showed house prices had likely found a floor in February, increasing 0.6% in March and 0.5% in April.

"The turnaround in the housing market has been so quick and in the midst of these interest rate increases has been surprising," said Paul Ryan, senior economist at REA Group and a former housing market specialist at the RBA. “[The RBA] will want to understand the drivers of that and part of that will be discussing the demand and supply conditions in the market, which are easily seen in the rental market with rents increasing sharply everywhere."

While the RBA does not consider house-price fluctuations part of its mandate, it will take note of market strength to gauge consumption health, according to Jonathan Kearns, former head of the RBA’s financial stability department and now chief economist at Challenger. “We have learned in recent years that the housing market has a big impact on household consumption,” Kearns noted. “People feel wealthier as their house [price] goes up and an increase in prices tends to correlate with an increase in turnover. When people buy or sell a house they spend money to do that, such as the fees involved or through renovation costs. Consumption is very sensitive to the housing market.”

AGGRESSIVE STANCE

Kearns noted the tone of the RBA and Lowe’s communication had shifted to a more aggressive stance aimed at curtailing future inflation expectations. “Financial markets were very bullish prior to May and they had expected rates to have peaked by now, but that was never feasible as rates need to be higher for longer to curtail inflation,” he said. “That’s what we’re seeing now – the RBA has caught up to that and I think financial markets are likely still too far behind where the Reserve is going.”

The overnight index swap market, which has systematically underestimated further rate rises, has now priced in a peak rate of 4.5% by November. Recent data also suggests a strong case for a rate increase in July, with GDP per hours worked – a measure of productivity – recording one of its sharpest y/y falls on record, down 4.6% in the March quarter, according to the Australian Bureau of Statistics (see table below).

Ryan noted the RBA’s latest statements showed the Bank’s view on wages growth had evolved to productivity and unit labour costs. “It's a subtle difference, but the RBA is really looking at services inflation and how labour costs are feeding into that and how that might contribute to the price-wage cycle.”

FUTURE HIKE?

Kearns noted the RBA could choose to pause in July and update forecasts, before lifting in August. “There’s a fair chance that inflation is persistent, but there's a fair chance that Australia and some other countries go into recession due to the correlation of recessions across countries for a range of reasons,” he added.

Ryan noted there was no doubt the RBA would hike again. “I think we're just talking about the timing and the data flow,” he argued.