Higher for longer? The new cash rate paradigm – RBA’s April decision

The interest rate outlook has changed remarkably in a short space of time.

It was less than two weeks ago that financial markets and many economists were forecasting a rate cut as early as September.

With the release of higher-than-expected inflation figures for the March quarter, a new ‘higher for longer’ mantra has emerged.

Recall the RBA took a slightly dovish tilt at their March 19 meeting, noting inflation continues to moderate in line with their forecasts and inflation momentum was easing.

This newly adopted neutral stance didn’t last long, with the RBA taking a more cautionary tone at their May meeting as the inflation trajectory rose above the forecast path alongside tighter than expected labour market conditions, and only tentative evidence of a productivity improvement across the labour market.

Although there has been significant progress in reducing inflation, with the annual headline rate dropping from 7.8% at the end of 2022 to 3.6% over the 12 months to March 2024, the ‘last mile’ of getting inflation back to the target range of 2-3% is shaping up to be a challenge, especially in the ‘stickier’ areas of service and non-discretionary inflation like health and child care, insurance, housing and education; all areas where lower levels of consumer spending doesn’t make much difference in lowering price growth.

The pullback from consumer spending is clear in other areas of the economy and inflation outcomes.

Discretionary inflation rose by only half a per cent in the March quarter compared with a 1.3% jump in non-discretionary inflation.

Less consumption is flowing through to softer economic outcomes more broadly, with economic activity declining on a per capita basis over the final three quarters of 2023 (a trend that has probably persisted into 2024), retail spending has been virtually flat over the past six months and consumer sentiment remains close to recessionary lows.

Despite high interest rates and ongoing cost of living pressures, housing prices have continued to rise, moving through a 15th straight month of growth in April.

Although conditions are diverse across the cities and regions, at a national level home values are up 8.7% over the past 12 months adding approximately $62,400 to the median dwelling value.

The upward pressure on housing prices may seem surprising at face value, given the high cost of debt, stretched affordability and low sentiment, but housing remains in short supply while demonstrated demand is continuing to track higher than a year ago and above the decade average for this time of the year.

The May RBA meeting marks the two-year anniversary of the rate hiking cycle

It’s a timely reminder that interest rates are only one factor that influences housing prices and activity.

Since interest rates started to rise two years ago, national dwelling values are ‘only’ up 2.8%.

In contrast, the prior two years (ie April 2020 to April 2022) saw national home values surge 31.7% higher!

The early phase of rate hikes sent housing values into a short but sharp downturn, with CoreLogic’s national index dropping 7.5% in the space of nine months.

However, a shortage of housing stock alongside tight rental conditions, record levels of migration and above-average volumes of purchasing activity saw the market move back into an upswing from February last year.

Since then the national HVI has recovered to new record highs, but also housing conditions have diversified.

The performance of housing markets where prices are lower and demand side pressures remain strong, including Perth, Adelaide and Brisbane, have diverged with values continuing to rise rapidly.

More expensive markets (Sydney and Melbourne) and those that show a better balance between supply and demand (Hobart, ACT and Darwin) are recording softer conditions.

Although the pace of growth in dwelling values, at last at a macro level, has slowed since the middle of last year, the outlook for values generally remains positive until the supply/demand dynamic rebalances.

Considering the trend in the earliest phase of new housing supply, dwelling approvals, remains well below average, a material supply response seems some way off.

Other hurdles to delivering a supply response include tight margin pressures for builders following a surge in input costs through the pandemic, skilled labour and trade shortages, rising labour costs and high funding costs.

About Tim Lawless Tim heads up the Core Logic RP Data research and analytics team, analysing real estate markets, demographics and economic trends across Australia. Visit www.corelogic.com.au