Property prices could drop 20 per cent in Australia if interest rates rise

House prices could tumble thanks to a key factor in Australia’s economy which is improving faster than anyone expected.

It’s becoming increasingly likely that interest rates will increase earlier than expected and this could see house prices drop by up to 20 per cent for every 1 per cent increase.

Experts believe it is becoming more likely the Reserve Bank of Australia (RBA) will be forced to increase interest rates earlier than expected due to rising inflation.

ANZ senior economist Felicity Emmett said last week’s inflation report had prompted a rethink of Australia’s outlook over the next year or so.

“It was very different to nearly everyone’s expectation,” she told news.com.au.

She said it was initially thought that supply bottlenecks due to the pandemic would only see a temporary rise on the prices of goods but there also seems to be the beginnings of a pick-up in wages.

“Labor shortages will possibly see through to higher wages,” she said.

“And that’s a lot more of a permanent feature.”

Any increase in wages could also lift inflation, which measures the cost of living and how expensive it is for people to buy certain goods and services.

This already seems to be happening, much to experts’ surprise.

The RBA had not been expected to lift interest rates until inflation was within a target band of 2-3 per cent.

It previously predicted this would happen in mid-2023, sparking a potential rate rise in 2024.

However, the September quarter showed inflation was already in this range – at 2.1 per cent.

“We are already inside the target band,” Ms Emmett said.

This has led many experts to believe the RBA will lift interest rates earlier than 2024.

Ms Emmett said it was possible that an interest rate rise of just 1 per cent, could see house prices fall by 20 per cent, with RBA modelling showing prices could drop by as much as 30 per cent.

House prices could drop by 20 per cent in Australia if interest rates rise. Picture: Dylan Coker/NCA NewsWire

However, Ms Emmett said she expected the RBA would dampen down talk of a rate rise at its meeting tomorrow.

“It’s very unlikely (the rate rise will happen soon),” she told news.com.au.

“They really want to see inflation around 2.5 per cent for a number of quarters before they are confident inflation is sustainably in their target band … before it starts increasing the cash rate. At this stage it seems unlikely to happen before 2023.”

Even once the RBA does start lifting rates, Ms Emmett believes this will happen slowly and the RBA will be conscious of the impact on house prices and people’s spending.

“They don’t want to be too early in lifting rates and take away the punch bowl,” she said.

Other experts including AMP Capital chief economist Shane Oliver also believe the price falls will be modest.

“You might see a 5 per cent fall but you won’t see a collapse,” he told news.com.au.

“I think what we’ll see is a cyclical downturn in 2023 – I’m not assuming there will be a crash or anything.”

However, while much of the focus has been on the Reserve Bank’s cash rate, which impacts variable rates, some banks have already increased fixed rates.

This is already impacting new buyers and will limit how much they can afford to spend, making it harder for some to get a mortgage and acting as an immediate dampener on house prices.

“Nearly half of all new loans are fixed rate loans so this will flow through to the housing market more quickly than the mooted increase in the cash rate (from the RBA),” Ms Emmett said.

One other key factor that could impact the property market is the return of international students and other migrants once Australia reopens its border to these overseas arrivals next year.

This will likely boost demand for housing, although Ms Emmett said it’s unclear how much of an impact it will have.

For those who are worried about the impact of potential rate rises, Mr Oliver said they could take action now.

“For people who have locked in (their interest rates) at 2 per cent for the next few years, they should try and get their mortgage down as quickly as possible if they can,” he said.