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09 Aug 2022

The outlook for property in an inflationary environment

By Matt Wood, Head of Mortgage Distribution for Citi Branded Wealth Inflation has accelerated and it's vital for buyers and those seeking to build to understand its impact on the housing market

Fuel and food prices have taken centre place in the news cycle, focusing on the impacts of rising inflation and interest rates on families. It is a cause for concern, but the real litmus test of how that battle first plays out is in the property market.

While falling house prices in the key Sydney and Melbourne markets have been the prime focus, it is the construction side that has taken the brunt of the pain. Multiple building companies have collapsed as the downside of fixed price contracts has become evident in a rising price environment. The key components of house construction, timber and steel have risen rapidly this year, compounded by supply chain shortages that arose during lockdowns imposed globally during the worst years of the COVID-19 pandemic.

Steel products jumped 42.1 per cent in the 12 months to March this year, according to ABS data, but other costs also rose, with timber up 20.6 per cent, electrical equipment 13.9 per cent, ceramic products 12.6 per cent and cement products 7.1 per cent.

The combination of supply side constraints, high new housing demand, labor shortages and higher transport costs have hit an industry hard in a time that 12 months ago looked robust. Core Logic's research director, Tim Lawless, expects it will taker another 12-18 months to work through the issues.

For existing housing, the tale of two cities as housing prices fell in Melbourne and Sydney this year on the back of interest rates rises has spread, with more expensive areas in Brisbane, Canberra and Hobart now starting to record price falls, according to Corelogic data.

The property research group found 41.9 per cent of unit and house sales it analysed in the June quarter fell in value, compared to 23.6 per cent in the previous quarter. Overall, national dwelling values declined 0.2 per cent in the June quarter, with house values in Sydney down 3 per cent.

What is happening in Australia is not an isolated phenomenon 

There is a clear and present danger of a synchronized global recession, but it is by no means certain. Consensus market forecasts are already indicating the United States, Euro area and United Kingdom will slip into recession over the next 12 to 18 months, but it is not expected to be a deep recession and overall, the global economy will continue to expand, albeit at a clipped pace.

NAB economists are forecasting global economic growth this year of 3.2 per cent, falling to 2.9 per cent next year and 3 per cent in 2024. That compares to the long- term average of 3.4 per cent, so certainly growth is below trend.

The risks to a deeper downturn are in plain sight. The East European conflict is impacting energy and agricultural markets heavily. We have seen the effect at the petrol pump, but it is even more of a burden to developing nations. If that conflict was to escalate, it would have further implications to global growth.

China's ongoing eradication policy response to COVID-19 has impacted its manufacturing and agriculture production, further exacerbating shortfalls in the global supply chain. We can see these impacts in the cost and supply of goods, from cars, white goods and vegetables to timber and steel for constructing houses.

Both these issues carry great uncertainty to their resolution, but the other big variable is an orchestrated event. Major central banks, including Australia’s Reserve Bank of Australia are raising interest rates at a rapid pace to try and stem an outbreak of inflation. The US Federal Reserve has made it clear it will do whatever it takes to avoid stagflation – a situation where economic growth flatlines and unemployment and inflation remain at elevated levels – and is prepared to take the US into a deeper recession to avoid it if required.

It should be remembered that the consensus view is we will skate through this period of turbulence without sinking into global recession, but the risks are real and skewed to the downside.

What does this mean for Australia?

NAB economists see economic growth this year to be on trend for Australia at 2.3 per cent, before moderating to 1.8 per cent in the two subsequent years. That lower growth is a planned event by the RBA, as it wants higher interest rates to stop people spending so much and adding to inflationary pressures. Currently money markets expect inflation to peak around 7 per cent towards the end of year and start to ease mid next year.

Unemployment is currently at 3 per cent, its lowest level in 50 years but it is expected to rise slightly through 2024 as lower growth combined with increased immigration takes some of the pressure off the current severe skills shortage being experienced across many industries, particularly construction, hospitality and healthcare.

Like the US, Australia has to walk a fine line between crimping consumer demand and applying the brakes too harshly, plunging the country into recession. The RBA is being transparent on its expectations, to provide markets with confidence on what lies ahead. It sees inflation continuing to rise through the remainder of the year but views the low unemployment rate as an indicator of the resilience of the local economy, according to its July board meeting minutes.

At a business level investment spending intentions remain above trend for non-mining companies, and government spending also remains elevated, driven by higher than expected revenue. Nevertheless, the RBA board said overall economic activity had eased a little, driven by rising inflation, higher interest rates and lower housing price growth.

How will inflation affect property?

Inflation is taking the steam out of Australia’s decade long property boom by prompting the RBA to raise interest rates quicker, earlier and further than expected. By necessity commercial banks have had to raise mortgage rates. The main tool used by the RBA to curb inflation is a hike in its target interest rate, which influences rates for lending throughout the financial system, including home loan rates.

Banks will also increase mortgage rates when inflation is high, in order to ensure they receive an adequate real return from the interest payments from loans. Rising mortgage rates are a key factor behind any slowdown in the property market, as they increase the cost of borrowing to buy houses and the ability of buyers to obtain finance.

The new home start dilemma 

Further increases in interest rates could lead to a sharp decline in new home builds by pricing out potential homebuyers from mortgages, leading to contraction in a key source demand for property. In turn, that would reduce supply for an already tight rental market.

For this reason, it’s critical for property buyers to keep a close eye on both inflation in the general economy, and related adjustments to interest rates by the RBA. It is also a period where the help of a trusted advisor like a mortgage broker could help ensure you get the desired outcome from property purchases. 


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