There weren’t many punters betting on a rate cut on Melbourne Cup Day, with financial markets allocating only a 5% chance the RBA would reduce the cash rate by twenty-five basis points.
It was only a few months ago when some forecasters were still expecting a November cut, but the data simply hasn’t been compelling enough to bring rates down just yet.
At the very least, the decision to hold interest rates at 4.35% should provide a further boost to household confidence, along with clear signs that inflation is moving in the right direction and the next move is likely to be down, albeit with some uncertainty around the timing of cuts. A further rise in sentiment is a positive for housing, but we aren’t likely to see stronger housing outcomes until borrowing capacities improve and barriers to mortgage serviceability assessments are reduced.
Inflation is reducing but still too high for a cut.
Headline inflation has reduced to 2.8%, the first time annual CPI has been under the 3% upper limit of the RBA’s target range since the Mach quarter of 2021.
However, the RBA has been clear that it will look through headline inflation outcomes, where the lower reading is partially due to the mechanical effect of federal and state government energy rebates and, to a lesser extent, Commonwealth Rental Assistance.
The RBA is looking for inflation to stage a “sustainable” return to the target range.
The RBA’s preferred measure of core inflation, the trimmed mean, has trended lower since a peak of 6.8% in the final quarter of 2022. But at 3.5%, it’s safe to say underlying inflation is on the right path but hasn’t quite reached its destination yet.
The housing component of inflation, which holds the largest weighting in the CPI calculation at 21.7%, has been doing some heavy lifting, reducing from a high of 10.7% in Q4 2022 to 2.8% in Q3 this year. Again, energy rebates have been a significant factor here, with the annual change in the price of utilities (which includes energy costs) dropping 7.6% over the year.
But we are also seeing growth in the price of new dwelling purchases reduce significantly, down from a peak of 20.7% in Q3 2022 to 4.8% in Q3 2024. New dwelling purchases have the second largest weight of any sub-component of the CPI at 8.1% (after private motoring costs at 11.1%), so the reduced growth rate in new building costs has a significant flow through to CPI.
The pace of growth in CPI rents is also coming down, reducing from a recent high of 7.8% annual growth in the first quarter of 2024 to 6.7% in Q3 2024, the lowest annual change since mid-2023.
While the slowdown is partly a result of increased Commonwealth Rental Assistance, it is also a reflection of changing supply and demand dynamics in the rental market.
CoreLogic’s combined capitals rental index has been virtually unchanged since June. It’s clear that rental conditions are levelling out, foreshadowing a likely further reduction in CPI rents over the coming quarters.
And then there are labour markets, where conditions are holding tight and jobs growth is above average. While strong labour markets are a good thing for Australians, with only 4.1% of the labour force being unemployed, the RBA is looking for labour markets to loosen. A rise in unemployment implies less upward pressure on wages which would support inflation moving sustainably within the target range.
The RBA has forecast the unemployment rate to reach 4.3% by December before rising to 4.4% by mid-next year. Similar to the path of inflation, the trajectory is heading in the right direction, with unemployment rising from a low of 3.5% in mid-2023, briefly reaching 4.2% in July before slipping back to 4.1% in August and September.
Households are weathering the storm of high interest rates and high cost of living pressures by pulling back hard on their discretionary spending, which can be seen in relatively weak retail spending outcomes. Also, household savings accrued through the pandemic have largely been drawn down. The combination of high interest rates, cost of living pressure and less savings has seen mortgage arrears return to around pre-pandemic levels.
It’s clear the flow of economic data will be central to understanding where the cash rates moves from here. Almost certainly, the next move is down, but the timing of a rate cut remains uncertain.
If we continue to see inflation moderate and labour markets gradually loosen, as is expected, we should see interest rates coming down through the first quarter of next year. This timing is the consensus view among economists, however financial markets are not fully pricing in a rate cut until June next year.
For housing markets, a rate cut would clearly be a net positive.
Lower interest rates imply inflation has been tamed, with both factors supporting a boost in consumer sentiment (which has already been trending higher from a low base). Higher sentiment and housing activity have historically shown a strong correlation.
Lower interest rates will also provide a boost to borrowing capacity which should support better access to housing, however affordability challenges which are broad-based across the Australian housing market are likely to persist, keeping a lid on any material rebound in home sales.
While lower interest rates will help to improve serviceability and boost sentiment, a tightening in credit regulations is another potential risk if household debt levels rise as interest rates come down, a trend regulators are likely to be attuned to.
Meet Tim Lawless
Executive, Research Director, Asia-Pacific
Tim is executive research director of CoreLogic’s Asia–Pacific research division, managing a team of economic and data specialists across Australia and New Zealand. He brings more than 20 years’ experience to the role, providing deep insights and analysis on national housing trends.
Full profile