Speaking at the AFR Property Summit on Monday, Reserve Bank of Australia (RBA) assistant governor Jonathan Kearns explained that the 225 basis points (bps) of rate hikes would lower real housing prices by around 15 per cent over a two-year period.
According to Mr Kearns theory, the rise in interest rates is beneficial to prospective home owners, because, while lowering house prices, this 225-bp increase will also reduce borrowers’ maximum loan size by around 20 per cent.
“Estimates suggest the net effect is that mortgage payments for new buyers would be higher for about two years as a result of higher interest rates. But after that, the declines in housing prices and mortgage size begin to dominate,” Mr Kearns said.
This, he said, suggests that “because higher interest rates reduce housing prices and so mortgage sizes, mortgage payments for new borrowers could ultimately be lower than if interest rates had not increased”.
Moreover, Mr Kearns flagged that “housing prices in the most expensive areas are the most sensitive to interest rate changes”.
“Overall, this indicates that an increase in interest rates narrows the distribution of housing wealth since more expensive properties experience a larger fall in prices,” Mr Kearns noted.
The RBA has recently been criticised for lifting rates by as much as 2.25 per cent over five consecutive months, despite earlier assuring the populace that rates would remain at the historical low of 0.1 per cent until 2024.
Just last week, RBA governor Philip Lowe admitted that the bank intends to continue to lift rates until it is confident that higher inflation will not become entrenched.
Speaking at the House of Representatives Standing Committee on Economics on Friday, Dr Lowe said the board will consider both a 25 and a 50-bp hike at its next meeting in October.
Questioned about the bank’s central forecast for the overall impact interest rates expected on housing prices, Dr Lowe said that while the RBA doesn’t forecast housing prices, he, personally, has a ballpark idea.
“They went up 25 per cent over the past two years. It would not surprise me — and this is not forecasting — if they came down by a cumulative 10 per cent.”
Commercial property to feel the impact
But the impact of interest rates on housing prices extends to commercial property too.
Mr Kearns explained that the reduction in investors’ risk appetite, which typically follows an increase in interest rates, usually results in tightened financial conditions. This then, results in a higher risk premium and so puts additional downward pressure on commercial property valuations.
“Alternatively, if, for example, commercial property was seen as a hedge against inflation, then an increase in interest rates because of higher inflation could reduce risk spreads and so result in less downward pressure than otherwise on commercial property prices from higher interest rates,” he added.
“All up, simple estimates suggest the fall in commercial property prices in response to higher interest rates appears to be slower, and slightly smaller in magnitude, than for residential property — although this could reflect the greater difficulty in measuring timely commercial property prices.”
Ultimately, Mr Kearns noted that “not only can declining property prices have implications for economic activity, but also for financial stability”.
While those financial stability risks appear to be contained, Mr Kearns assured that the RBA “will continue to carefully monitor the evolution of these risks, including in the Financial Stability Review to be released in early October”.
