Rising rents is driving inflation, leaving Australia with uncertain future

It’s not only renters that are being pummelled by rising rents – and what lies ahead for all of Australia is incredibly concerning.

ANALYSIS

When the Reserve Bank Australia (RBA) pulled the trigger on their 13th interest rate rise of the current cycle on Melbourne Cup Day, the nation’s attention swiftly shifted back to one key question: are there more rate rises to come?

In the statement accompanying the rate rise, RBA Governor Michele Bullock shared the RBA’s raised inflation forecasts with the public. In August, the RBA’s inflation forecasts expected inflation to sit at 3.25 per cent at the end of 2024 and 3.3 per cent at the end of 2025.

In the update forecasts, it is now expected that inflation will be “around 3.5 per cent” at the end of 2024 and “the top end” of the 2-3 per cent target range at the end of 2025.

While it doesn’t sound like much of a change, the RBA’s growing concerns about entrenched inflation were sufficient to warrant the Cup Day rate rise.

It raises an interesting question, after the RBA raised rates by 4.25 per cent, driving the largest relative rise in mortgage rates in Australian history, why does the RBA continue to see high inflation on the horizon?

Inflation go away, come again another day

In several recent media appearances Treasurer Jim Chalmers lauded the impact of the Albanese’s governments various subsidy schemes for their impact on bringing down headline inflation.

“It would have been much worse in childcare without us, It would have been much worse in rent without us,” Chalmer’s recently stated in an interview with Sky News Australia.

“It would have been much worse in electricity as well, outside the services calculation.”

In terms of the headline reading of the consumer price index, Chalmers is correct.

The increase to the Childcare subsidy, the outsized 15 per cent increase in the maximum rate of Commonwealth Rent Assistance and the Energy Bill Relief Fund all helped to suppress the headline CPI figure.

If not for the impact of these various policies, quarterly inflation would have been around 1.7 per cent, instead of 1.2 per cent, the highest reading since the December quarter of last year.

Meanwhile, the annual inflation figure would have been around 5.9 per cent, instead of 5.4 per cent. This would have been a very minor move from the previous reading of 6.0 per cent.

However, while the increase in rent assistance and childcare subsidies has effectively passed those additional costs on to the taxpayer, the Albanese government’s Energy Bill Relief Fund has postponed the impact of electricity price inflation.

Due to differences in how the energy price subsidy was implemented on a state and territory basis, the impact from electricity price inflation will feed in at different times.

In New South Wales and Victoria, the impact will be felt in the Q4 CPI figures. In Queensland and South Australia, the subsidy was spread across four quarters, so the impact won’t be felt in the CPI until the September Quarter of next year.

In Western Australia the impact of the subsidy will feed out of the data in the March quarter of next year.

Baked in inflation

But its not just the lagged effect of subsidy impacted CPI components that is expected to keep inflation uncomfortably high. There is another source of inflation that could plausibly add up to around 1 per centage point to the headline CPI figure, leaving little room for error in the RBA’s fight against inflation.

That outsized driver of inflation is residential housing rents.

As things currently stand, the CPI sees capital city rents up 7.6 per cent in the last 12 months. But if the 15 per cent increase in the maximum rate of Commonwealth Rent Assistance did not occur, the figure would be around 7.8 per cent.

It is here that an important distinction must be made. The ABS measures all rents currently payable, while other data providers such as Domain, SQM and PropTrack measure advertised rents for properties currently up for rent.

This is part of why there is such a large discrepancy between the rental increases seen by many Australian renters and the figure that is put forward by the ABS. However, historically over time the ABS CPI measure of rents eventually catches up with the asking rents seen in the indices of the various private providers.

When overlaid with the various private property data providers, the CPI most strongly tracks the Domain capital city asking rents index when lagged by 18 months.

Recently, Domain figures recorded their highest level of capital city rental growth on record, potentially indicating that the peak of rents in the CPI is still 18 months if the relationship between the two metrics continues to track.

If the full peak of rental price growth seen in the Domain figures were to be seen in the CPI, it would add 0.85 per centage points to the headline annual CPI.

But there are other data sources such as SQM Research that provide an even more concerning picture of what may lay ahead for rents in the CPI. Based on quarterly data, the annual rate of capital city rental price growth peaked at 24.6 per cent in the December quarter of last year.

If that were to fully feed CPI, it would account for 1.41 percentage points of headline inflation, accounting for almost half the top of the RBA’s target range by itself.

Its also worth noting that the reweighting of the CPI is coming up at the end of the year and this could see the weighting applies to rents increased, potentially adding further upward pressure to the aforementioned scenarios.

With so much inflation still to come from residential rents, it is perhaps unsurprising that the RBA has raised their inflation forecasts in the recently released Statement of Monetary Policy. The baked in inflation from the tapering off electricity subsidies and continued strong rental price growth may keep upward pressure on rates for some time to come.

Ultimately, challenging times lay ahead for the average Australian household, as still rising aggregate demand driven by population growth masks the largest fall in inflation adjusted household living standards in at least three decades.

Tarric Brooker is a freelance journalist and social commentator | @AvidCommentator