An update on inflation – key take outs for the housing market

Key takeaways

CPI results for the December quarter show a decline in inflation from 5.4% to 4.1%, marking the fourth consecutive quarter of decline.

This decline is attributed to softer demand in the economy, reflected in areas like retail trade and job vacancies.

Falling inflation strengthens the case for interest rates remaining unchanged in the near term and potentially decreasing later in the year. Lower interest rates could stimulate housing demand, which has been constrained by high-interest costs and borrowing limits.

Rental inflation is showing signs of easing, which could alleviate some cost-of-living pressures for tenants.

The moderation in inflation and the expectation of future rate cuts could lead to improvements in consumer sentiment.

Lower cost-of-living pressures and anticipated rate cuts may contribute to a more optimistic outlook for households and support economic recovery.

CPI results for the December quarter showed inflation has fallen once again, from 5.4% in September to 4.1%.

This marks the fourth consecutive quarter where inflation has declined on an annual basis, and the December result is below the 4.5% forecast made by the RBA last November.

Falling inflation reflects softer demand in the economy, with weakness showing up in retail trade, a slight fall in job vacancies and a gradual rise in unemployment from lows in late 2022.

But the good news about falling inflation is in its implications for monetary policy.

The more inflation comes in under expectations, the firmer the case for interest rates remaining on hold next week, and coming down later this year.

A reduction in interest rates is likely to boost housing demand.

As seen in the rental market, the fundamental demand for housing is very strong, but demand for home purchases has been influenced by high-interest costs and limited borrowing capacity.

The RBA would probably not consider more exuberance in the housing market an ideal scenario if interest rates come down.

However, established dwelling purchases do not feed directly into inflation measures, and other macroprudential tools can still be used to ensure housing lending remains prudent.

Housing measures in the CPI

Housing makes up around 22% of the CPI basket that is used to calculate inflation over time (in fact housing has the largest weighting of all components within the CPI calculation).

The biggest sub-components of the housing measure are the change in the cost of newly constructed dwellings and major renovations by owner-occupiers, and the change in rents paid to landlords.

For the purchase of new homes, the CPI measure eased to 5.1%, down from 5.2% in the previous quarter and a peak of 20.7% in the year to September 2022.

While the rate of increase is easing, residential construction remains a substantial contributor to inflation overall and was the most significant contributor to inflation in the quarter overall.

High labour and material costs continue to put pressure on the price of new homes.

Annual growth in the rent component of CPI was 7.3% in the December quarter.

The annual change in the rent component of CPI has reduced from 7.6% in the September quarter, marking the first signs of rent inflation easing in two-and-a-half years.

Historically, growth in the CoreLogic rent value index has been a leading indicator for the rent component of CPI.

Given that CoreLogic rent value growth peaked in early 2023, it is not surprising to see early signs of easing in the growth of rent paid, but at 7.3%, annual growth is still well above the pre-COVID decade average of 2.3%.

One thing to note about CPI measures is that they capture the change in goods and services across the combined capital cities market.

CoreLogic rent values for the combined regional market of Australia have seen a marked decline in annual growth that far outweighs what has been seen in the capitals, down to 4.3% in 2023 (from a peak of 13.4% in the year to August 2021).

What’s the takeaway?

Inflation is still well above the RBA target range of 2-3%, but it is moving in the right direction, and it is falling faster than anticipated.

The economic pain Australian households are feeling is working to unwind inflation, and firm up the case for interest rates to start falling sometime this year.

Housing contributes a lot to high inflation through rent paid and the cost of new dwellings, but even these indicators are moving in the right direction.

The rate of increase in rents paid is finally slowing, suggesting some hope for tenants that the rental market could turn a corner in 2024, which is also indicated by CoreLogic rent measures.

Easing cost of living pressures should help to support an improvement in consumer sentiment, which has been holding in deeply pessimistic territory since mid-2022.

High cost of living pressures and high-interest rates have been the key factors holding sentiment close to recessionary lows.

It's likely the lower-than-forecast inflation outcome for the December quarter, alongside a growing expectation of rate cuts later this year will help to lift consumer attitudes.

If that is the case, we should expect housing activity to follow suit later this year.

About Eliza Owen Eliza is head Of Residential Research Australia for Corelogic and a respected property market commentator. Eliza holds a first class honours degree in economics from the University of Sydney