MNI POLICY: RBA Ponders How To Respond To Rental Inflation

The Reserve Bank of Australia is debating how to deal with rental costs, which are heavily weighted in consumer price inflation and are set to continue to rise strongly over the next year, but are relatively insensitive to interest rates, MNI understands.

One view at the RBA, which left the cash rate on hold at 3.6% on April 4 as it monitors whether more hikes are needed, is that tighter policy will depress inflation in other sectors, pulling average CPI down irrespective of the housing market. But rental inflation should remain strong for some time as the supply of new houses continues to lag demand.

Rent inflation of 1% a quarter is baked into the market for at least the next year as the housing market rearranges, according to Paul Ryan, senior economist at REA Group and a former housing market specialist at the RBA. (see chart below) While rent is heavily weighted in March quarter consumer price index data due April 26, its correlation with interest rates is potentially weak, he said.

“The housing market will provide huge baseline inflation that will continue to feed through to CPI for some time,” Ryan told MNI. How much importance the RBA places on rent, overall CPI and its decision on further interest-rate increases was unknown, he said. “If we consider demand conditions now are impacting rents going forward over the next year, how does the RBA consider that in its assessment of its goal? Is demand greater than the productive capacity of the economy? The RBA does not want to dampen demand further.”

RBA VIEW

In a report published Monday, the RBA noted rent increases were more common and larger on average – particularly for the 2-3% of properties each month that change tenants. A preference for smaller households, larger houses following the pandemic and net population outflows more recently had driven the trend, bringing availability down to record lows and pushing rents higher (see chart below).

Ryan said the ongoing strength of the rental market will continue to push CPI higher for longer, testing the RBA’s dovish resolve. “The RBA knows inflation is falling, but it also knows rent will be one of the most persistent components of inflation,” he added. “But that’s the reason we have both headline trimmed mean and weighted median measures – there are always volatile factors that are affecting inflation.”

The tight labour market with unemployment at 3.5% will likely play a more prominent role in the RBA’s future decisions, Ryan added. “There's a reason why the RBA has prices, wages and labour as part of the same team – they are all super intertwined.”

Investors only anticipate a small chance of a hike at the RBA’s next meeting on May 2, with futures implying a peak in the cash rate below 3.8% by September before it drifts lower.

LABOUR STRENGTH

Sean Langcake, head of macroeconomic forecasting at BIS Oxford Economics and former RBA economist, told MNI inflation driven by the labour and rental market will be persistent and not “bounce around too much”.

Inflation expectations have not been ingrained yet, but the RBA is making a trade off between the tight labour market and concerns around price hikes, which incurrs a risk, he said. MNI reported last week the RBA would deem its monetary policy successful if inflation returns to its 2-3% target by mid-2025 and the unemployment rate holds between 4-4.5% (see: MNI POLICY: RBA Eyes Mid-25 Target Return, Unemployment 4-4.5%).

“There is little in the data just yet that suggests long-term expectations have drifted up,” Langcake noted. “Fighting inflation is about maintaining purchasing power. The RBA knows it has to maintain its credibility to keep expectations anchored, so there is more that needs to be done to tamp down inflation.”