House prices sink even further as rate cuts squeeze Aussies

Latest figures show a massive decline in house prices – and it’s not the end as forecasts show they could drop to a terrifying level.

ANALYSIS

Australian house price results for January have been released, with broadbased declines recorded across the nation.

CoreLogic reported that national dwelling values have fallen 8.9 per cent from their peak, with the combined capital cities down 9.6 per cent and the combined regions down 7.4 per cent.

PropTrack reported a smaller 4.5 per cent decline in national dwelling values from their peak, with the combined capital cities down 5.5 per cent and the combined regions down only 2.5 per cent.

The primary driver of the decline in Australian dwelling values is obviously the aggressive interest rate hikes from the Reserve Bank of Australia (RBA), which have lifted the official cash rate (OCR) by 3.0 per cent from their pre-tightening level in April 2022.

The OCR is currently tracking at its highest level since November 2012, whereas the average discount variable mortgage rate is tracking at its highest level since April 2012.

This represents the fastest increase in interest rates in Australia’s history and has already seen variable monthly mortgage repayments soar 41 per cent above their pre-tightening level.

A typical borrower with a $500,000 variable rate mortgage is now paying around $900 extra in monthly mortgage repayments following the RBA’s rate hikes.

The higher cost of borrowing has dramatically reduced borrowing capacity and buyer demand.

According to Finder, the amount of pre-tax income required to service a $500,000 mortgage has risen from around $121,000 in April 2022 to $181,000 as at December.

Thus, borrowing capacity has been reduced by around one-third following the RBA’s aggressive rate hikes.

Lower borrowing capacity equals lower house prices. The equation is that simple. And the more the RBA tightens, the further house prices will fall.

RBA to deliver further rate hikes

Economists and markets universally expect the RBA to lift the OCR another 0.25 per cent at Tuesday’s monetary policy meeting.

From there opinion is divided, with the lower end of forecasts (CBA and AMP) expecting no further rate hikes while at the upper end (Deutsche Bank and Goldman Sachs) anticipate three further 0.25 per cent rate hikes over the next six months.

Whatever the case, the average discount variable mortgage rate will inevitably rise to 6.70 per cent next week with further increases possible. In turn, borrowing capacity will shrink further, pulling house prices lower.

House prices to continue falling

Consensus forecasts expect a peak-to-trough decline in Australian dwelling values of between 15 per cent and 20 per cent, with values expected to bottom sometime this year.

How far house prices ultimately fall will hinge on two key factors.

First, the aggressiveness of the RBA’s rate hikes. If the RBA stops hiking the OCR after next week’s meeting, then prices will stabilise sooner and a peak-to-trough decline closer to 15 per cent is likely.

But if the RBA follows Deutsche Bank’s and Goldman Sachs’ forecast, and lifts the OCR to 4.1 per cent, then house prices nationally will likely fall by more than 20 per cent.

Second, nearly one-in-four mortgages (by value) will this year switch from ultra-cheap fixed rates originated at around 2 per cent to rates that are more than double these levels.

Accordingly, there is the risk that the severe financial strain caused by the fixed rate mortgage reset drives a wave of distressed house sales, pulling prices even lower.

Whether significant distressed sales occur will also depend on the strength of the Australian labour market, and whether there is a sharp increase in unemployment.

Expect house prices to begin rebounding late this year

After going too hard on interest rate hikes, alongside the fixed rate mortgage reset, I expect the Australian economy to weaken considerably over the first half of 2023. This will prompt the RBA to commence a rate cutting cycle in the September quarter in a bid to stave off recession.

In turn, these rate cuts will lift borrowing capacity and set the foundation for a house price rebound late this year.

Leith van Onselen is co-founder of MacroBusiness.com.au and Chief Economist at the MB Fund and MB Super. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.

Originally published as House prices sink even further as rate cuts squeeze Aussies