Why soaring property prices could dampen future interest rate cuts

Stock investors may have sunk into a collective stupor, mesmerised by Donald Trump's recent sleight of hand on tariffs.

But central bankers including our own Michele Bullock are treading more warily.

This time next week, the Reserve Bank of Australia will hand down its decision on interest rates and you'd be a brave punter to bet against a 0.25 of a percentage point cut.

Until a fortnight ago, there were pretty good odds on a double cut, after America's incredible own-goal in declaring a trade war against everyone — a tactic likely to backfire on US consumers.

This time last month, there was an upheaval on stock and bond markets that hinted at something far more sinister, perhaps a re-run of the 2008 global financial crisis.

In that climate, there were valid arguments the RBA needed to reassure Australian households.

But the US president was forced to retreat, temporarily at least, which helped calm market fears of a global recession.

Those forces, however, haven't disappeared. They were merely delayed by 90 days and almost one third of that period has elapsed.

High-stakes talks between China and the US have now also yielded a 90-day pause and a 115 per cent tariff reduction, leaving uncertainty about where the goalposts will be moved next.

When the newly-reconstituted RBA board meets, starting next Monday, it undoubtedly will focus on global instability and the impact here.

But another equally-powerful domestic force will be front and centre of the debate — real estate.

Against all odds, given the economic cyclone that ripped through Australian household budgets as interest rates were jacked more than a dozen times in the past few years, property prices again are punching through record levels.

Inflation may be declining and global growth may be under a cloud. But feeding rate cuts into an already hot property market is likely to spark another buying frenzy and even higher prices.

That could throw doubt on the RBA's ability to provide the number of cuts pencilled in for this year.

More people, no more houses

It's not rocket science. Everyone needs a roof over their heads.

So, when you increase the population by one of the biggest margins in the developed world just as a crisis envelopes the construction industry that sends builders broke and new construction collapses, the end result is inevitable.

On the demand side, our population has grown at levels far above most other OECD countries. In 2023, Australia's population grew 2.4 per cent, outdone only by Canada, Iceland and Ireland.

But when it comes to housing supply, not only have we failed to keep pace with the increase in people needing a place to live, we've gone backwards.

Building approvals figures released last week showed that in March, around 15,000 new dwellings were given the tick to start.

That's about 50 per cent below the stimulus-driven post-COVID boom four years ago, and about the same number approved 15 years earlier in March 2010.

Affordable housing to remain a dream

Housing was a red-hot issue at the recent federal election, and almost every recent state election as well.

In short, there's not enough of it and what is available is outrageously expensive.

While the government's policies were better than the Coalition's, any policy that boosts demand — even if only for first home buyers — runs the risk of steamrolling the supply initiatives.

For those initiatives — such as the first home buyer's Help To Buy scheme and an expanded Home Guarantee Scheme — to work without boosting demand, they would need to be coupled with a winding back of tax incentives to investors.

Politically, that's a no-go zone. At least for now.

It takes a long time to build houses and even longer to put up apartment blocks, making it almost impossible for supply to keep up with demand, particularly if we are going to continue immigration at current levels.

That makes the dream of affordable housing just that, a dream.

It also explains why real estate kept on rising in the face of so many interest rate hikes — demand for housing completely swamped supply.

If the four rate cuts pencilled into many economists' forecasts come to fruition, that trend will only continue.

National Australia Bank chief executive Andrew Irvine last week told The Business that he expected price rises to continue and that rate cuts would help propel them.

"And the big driver of that is the lack of housing stock in the country, and when you have supply that's constrained and you have newcomers coming to our shores and young people who want to enter the market, that drives up demand."

Rate cuts, he said, would "increase the spending power of buyers if we get to see that type [four cuts] of reduction."

Why the RBA is wary of rocketing real estate

When it comes to housing affordability, a few factors come into play,

First, there's the price. Most of the argument and analysis of affordability focuses only on that factor.

But there are others as well.

The second main factor is the cost of servicing a loan.

If interest rates fall, that cost falls and so, technically, housing becomes more affordable.

Right now, housing has never been less affordable. Prices are at record levels and, after official rates jumped from 0.1 per cent to 4.35 per cent, the repayments on variable rate housing loans skyrocketed.

Cutting interest rates makes housing more affordable in theory.

What happens in practice, is that buyers extend themselves to the maximum amount they can borrow, thereby sending prices higher which swallows up any benefit.

The extent to which Australians have hocked themselves in the quest to own a home has worried the RBA in the past and there is every reason it will be a major concern at next week's meeting, given its rate cutting cycle is just getting underway.

The reason is that over-indebted households can pose a risk to the financial system and the economy, especially during periods of global uncertainty, such as now.

With political fixes off the agenda, there are ways the RBA can limit, and perhaps even lower, house prices.

Between 2014 and 2018, the Australian Prudential Regulation Authority (APRA) took the wind out of the real estate market by imposing restrictions on investors.

It first limited investor mortgages and then later wound back interest-only mortgages.

Investor loans slumped and first home buyers jumped at the chance to get a foot in the market.

The absence of investors saw property prices ease in most capitals with falls of around 10 per cent in some major cities.

It's possible the RBA and APRA could do that again if the rate cuts send real estate into orbit.

Ultimately, though, the quest for affordable housing rests with two primary factors — the rate at which the population is growing and increasing the supply of dwellings.

Unless those two areas are addressed, the undercurrent of discontent will become a political boiling point in the very near future.