It wasn’t long ago that the media was filled with talk of a 40-year high in inflation, soaring interest rates vs. inflation, a potential property market crash, and our economy falling into an inevitable recession.
Not to mention Russia’s war with Ukraine and the Middle East crisis causing a spike in energy prices and fuelling supply chain issues.
Thankfully, Australia’s inflation peaked in December 2022 at a heady 7.8% and is slowly coming down, albeit with some bumps along the way.
But as it’s unlikely to fall into the Reserve Bank of Australia (RBA)’s preferred range of 2-3% until 2025 it’s worth understanding a bit more about it.
Note: We know that the COVID-19 pandemic saw our government overspend to keep our economy afloat—a stimulus that was quickly reversed—but it set the scene for a strong inflation rate and a cost of living surge as soon as we exited the lockdown period of 2020-21.
In this blog, I’ll explain what causes inflation, discuss whether inflation is good or bad, and what it means for house prices.
But before I do, let me start with one very clear message:
Tips: Always look at the big picture.
When we’re faced with economic problems (or any problem), there are two ways to view things:
- The up-close perspective: Looking at inflation, interest rates, debt, consumer spending, joblessness, and so forth.
- The broader big picture perspective: Looking at long-term trends and historical patterns.
It’s easy to get tunnel vision during periods of high stress, so I always suggest taking a step back so you can take a broader view.
Tips: Remember, our property market and the economy move in cycles and there have always been periods of high growth and low growth.
As the platitude goes:
History doesn’t repeat. It rhymes.
So to start… let’s go back…
Australian inflation rate history
By looking at Australia’s CPI (the Consumer Price Index measure of inflation) over the past 70 years, we can see that Australia has experienced long periods of high inflation, disinflation, and, until recently, long periods of low and stable inflation.
The CPI reflects the impact on the Australian economy of global influences, such as oil price shocks, as well as domestic effects, such as policies that impact the labour market and wage growth.
Annual CPI movement
And while the CPI hovered around the RBA’s target range of 2-3% for some time the chart below shows how Australia’s CPI surged between March 2021 and its 8.4% peak in December 2022.
The latest ABS stats show the quarterly inflation rate is now down to 3.8% (although this is an increase from the 3.6% seen in the March quarter.
While that is a significant improvement from the last few years, it is still higher than the 2-3% target range that RBA wants to see.
It appears that, despite the RBA’s efforts to dampen inflation levels, we’re going to have significantly higher inflation for quite some time, in part due to overseas influences such as the price of oil.
In fact, the RBA has now revised its prediction on headline inflation, stating that there should be a gradual easing with the 3% inflation goal being further off in the future around late 2025.
The RBA’s goal of reducing consumption to curb inflation is a complex issue.
Australians are known for their high consumption habits, particularly the older generation who have accumulated substantial savings.
And the current high-interest-rate environment only amplifies this trend, as it increases the value of their savings.
On the other hand, rising interest rates have a disproportionate impact on low-income and young Australians, who often have negative savings due to recent home purchases.
Despite this, the gradual wealth transfer from older Australians to younger generations is keeping consumption levels high.
Inflation vs house prices in 2024
So what happened to Australia’s house prices during the inflation surge?
Dwelling values in Australia fell during 2022, but not really due to inflation, but because of rising interest rates.
As of today, property prices in Sydney, Brisbane, Adelaide, Perth and some regional areas have regained (or even exceeded) all the value lost during the short sharp downturn of 2022.
Summary of housing values since the onset of COVID in March 2020 and relative to peak levels:
| Onset of Covid to October 2024(%) |
$ | Δ from peak to October 2024 | Series peak to date | |
| Sydney | 29.1% | $269,048 | -0.1 | 24-Sep |
| Melbourne | 9.9% | $69,913 | -5.1% | 22-Mar |
| Brisbane | 66.9% | $354,112 | <at peak> | <at peak> |
| Adelaide | 70.8% | $335,194 | <at peak> | <at peak> |
| Perth | 76.0% | $347,564 | <at peak> | <at peak> |
| Hobart | 27.7% | $141,285 | -11.9% | 22-Mar |
| Darwin | 23.4% | $93,309 | -7.5% | 14-May |
| Canberra | 30.8% | $200,108 | -6.5% | 22-May |
| Regional NSW | 49.3% | $243,562 | -2.8% | 22-May |
| Regional VIC | 30.6% | $131,755 | -8.5% | 22-May |
| Regional QLD | 67.2% | $272,419 | <at peak> | <at peak> |
| Regional SA | 67.9% | $178,128 | <at peak> | <at peak> |
| Regional WA | 72.1% | $225,677 | <at peak> | <at peak> |
| Regional TAS | 46.1% | $162,298 | -3.9% | 22-May |
| Combined capitals | 34.4% | $229,066 | <at peak> | <at peak> |
| Combined regional | 54.1% | $225,917 | <at peak> | <at peak> |
| National | 38.6% | $225,360 | <at peak> | <at peak> |
Source: CoreLogic
Note: Onset of COVID calculated from March 2020.
So how do the property price changes fit with the rate of inflation?
Do house prices generally fall during inflation, or rise?
Below is an inflation vs house prices chart to explain how the two affect each other.
This chart by Lindeman Reports tracks this gradual fall in loan rates since 1990 and shows that it has been accompanied by a steady rise in Australian median house prices over the same time.
Source: Lindeman Reports
As the report points out, there does appear to be a strong correlation between falling interest rates and rising property prices, but does this mean that the reverse is also true?
As the below graph shows, house prices since 1990 have not fallen as a result of interest rate rises.
Sure, property prices might have increased more quickly if interest rates hadn’t risen but it is important to note that they did not fall.
Source: Lindeman Reports
Why?
As I often say, most property owners, particularly sophisticated investors, are immune to the impact of interest rate rises.
I’ll explain this further below.
Housing prices vs inflation in Australia
This chart by Lindeman Reports tracks this gradual fall in loan rates since 1990 and shows that it has been accompanied by a steady rise in Australian median house prices over the same time.
Source: Lindeman Reports
As the report points out, there does appear to be a strong correlation between falling interest rates and rising property prices, but does this mean that the reverse is also true?
As the below graph shows, house prices since 1990 have not fallen as a result of interest rate rises.
Sure, property prices might have increased more quickly if interest rates hadn’t risen but it is important to note that they did not fall.
Source: Lindeman Reports
Why?
As I often say, most property owners, particularly sophisticated investors, are immune to the impact of interest rate rises.
I’ll explain this further below.
What happens to house prices during inflation?
I know many investors are wondering about inflation-adjusted housing prices in Australia, so I’ll answer some of the common questions I frequently hear.
What is inflation?
Inflation is a persistent substantial rise in the general level of prices related to an increase in the volume of money resulting in the loss of the value of the currency.
In other words, inflation is the result of an imbalance in the supply and demand of money.
It’s a rise in the cost of goods and a devaluation of your money and purchasing power.
There are many different things that might affect the price of certain items in the short term – such as when widespread flooding in 2011 ruined banana crops and sent the price of any remaining bunches up 470% for the season – or the long term – such as supply chain issues caused by the war in Ukraine or the global lockdowns.
But the only thing that affects the price of all goods, consistently, and over a long period of time is the volume of money.
Some inflation is normal, and it is healthy for the economy.
But hyperinflation, or a surge in inflation like we’re experiencing now, is harmful to everyday people, workers, and consumers.
That’s because, as I mentioned above if the cost of living rises considerably more than wages, the standard of living declines.
And no one wants to see the value of their asset, the value of their money, or their purchasing power go down.
What causes inflation?
As I mentioned above, it’s not only possible but common for the cost of certain items to undergo short-term inflation.
Drought, flooding, or even a bumper crop can directly impact the volume of crops, for example, which can influence whether the price of the produce is high or low.
An increase in the cost of oil would make transportation more expensive, while supply chain issues would restrict the volume of supply – each of these also influence the price that the end user will be required to pay.
But on a macro level, inflation is caused by 1 of 2 things: pressure on the supply side of the economy, or on the demand side.
- Cost-push inflation: This is when prices increase due to increases in production costs, such as raw materials and wages.
- Demand-pull inflation: This is when there is strong consumer demand for products or services.
The high rate of inflation Australia experienced over the past 3 years was caused, in part, by factors related to the coronavirus pandemic.
During the peak lockdown years of 2020-21, the government crafted several stimulus measures to prevent a recession and high unemployment by entering a quantitative easing program: reduced interest rates, increased money supply, and more lending.
What resulted was a period of high savings directly followed by a period of high consumer confidence with low unemployment and rising wages… which led to more spending.
The problem is, as life returned to normal, this spending surge caused an uptick in demand for products (and property), which then pushed prices higher and higher, causing excessive inflation.
So, in essence, the government caused inflation, and then it handed over the task of getting it under control to the RBA.
Why did the RBA decide to raise interest rates?
Interest rates are the RBA’s primary tool for controlling Australia’s inflation level.
And, over the last 18 months, 12 interest rate rises had many Aussies worried.
Australia’s “official” interest rate has been on hold at 4.35% since November 2023 after homeowners winced through 13 consecutive rate rises since May 2022.
And the recently appointed RBA governor Michelle Bullock has said that another rate rise could still be on cards, if inflation rises again.
Understandably, many investors and homeowners are worried.
They are asking questions like:
- What do rising interest rates mean?
- How does raising interest rates slow inflation?
- What is the reason for rising interest rates?
- Does raising interest rates really help inflation?
The RBA hoped that by raising mortgage repayments so high that households are cash-strapped, they would be forced to cut back on spending on non-essential items, which will in turn lower demand, and therefore inflation would fall as businesses have to compete for business by lowering prices.
In other words, the RBA was trying to minimise discretionary spending.
The easiest way to do this is to hike mortgage costs, which will mean the average consumer will have less money in their pocket after forking out more on their monthly mortgage payments.
Think of it like a pay cut, which should help to slow down spending and economic growth and therefore inflation.
Consumer confidence also played a big part – all the negative messages in the media and stories about the potential of property values falling meant that homeowners felt less secure and curbed their spending, once again decreasing economic activity and inflationary pressures.
Of course, raising interest rates only tends to have an effect on the demand side of the inflation equation, not the supply side, and supply constraints from the geo-political problems added to the inflationary pressure Australia experienced in the last few years.
It all comes down to the economic law of supply and demand.
Note: Many economists say that inflation is basically a problem of “too much money chasing too few goods”.
The pandemic, the Russian invasion of Ukraine, and a persistent labour shortage we experienced after our lockdowns all disrupted Australia’s regular commerce.
And since the RBA was unable to create more goods (or services) to meet the demand, its only option was to tackle the “money” part of the equation by crimping supply.
The problem with the RBA’s plan to force consumers to consume less is that it came with a serious risk of slowing the economy down so much that it causes a recession.
And clearly, to some degree it has worked.
After 13 interest rate rises – to 4.35%, the highest level since 2012 – Australia finally began to see a very slow decline in inflation.
The problem is, many are concerned that these interest rate increases have driven Australia to its “weakest rate of economic growth” outside the pandemic since the recession in the early 1990s.
Many were fearful that the RBA has pushed the economy to a knife edge after hiking rates harder and for longer than expected after inflation remained stubbornly high for the first half of 2023.
Thankfully, the threat of a recession has not subsided, but, as I mentioned above, the threat of more interest rate rises to push inflation to an acceptable level, has not.
Does inflation cause house prices to drop?
The answer to this question is, yes and no.
Note: Many commentators feared higher interest rates could cause property prices to drop or, even worse, ignite a property market crash.
They assumed that inflation and higher rates would erode the borrowing power of property buyers and make ownership more expensive for mortgage holders, dampening property values.
But this isn’t what happened in Australia.
As we know, the Australian property market has been underpinned by solid demand (from a growing population fed by immigration) and low supply.
Despite stubbornly high inflation, the value of well-located properties in most Australian states have continually risen.
Case study: house prices vs. inflation
As we know, in the early 2020s, Australia faced a surge in inflation driven by factors such as supply chain disruptions, increased consumer demand post-COVID-19 lockdowns, and rising interest rates aimed at controlling inflation.
In 2021, the property market experienced initial inflationary pressures while it began to recover from the pandemic, with stimulus boosting consumer spending – House prices rose sharply, particularly in major cities like Sydney and Melbourne where prices increased by approximately 20% in 2021 as demand outstripped supply.
In 2022, Inflation reached its highest levels in decades, peaking at around 7% in late 2022 and the RBA began raising interest rates to combat inflation. By late 2022, the cash rate increased from 0.1% to 3.1%. These higher interest rates led to increased mortgage costs, cooling demand. House prices began to stabilise or decline in some areas, with Sydney experiencing a price drop of about 10% by early 2023.
In 2023, as inflation pressures continued but began to ease, the housing market showed signs of recovery. Prices stabilised in many regions, although affordability remained a significant issue. Investors began to re-enter the market, looking for opportunities as prices adjusted. The rental market also tightened, with increased demand leading to rising rents.
By mid-2023, inflation had stabilised, leading to more predictable economic conditions. At this point, analysts began to predict gradual price recovery, with ongoing debates about the impact of future interest rate adjustments and potential government interventions.
This time period tells us that while inflation can lead to short-term declines in house prices due to higher interest rates, the long-term dynamics of demand, supply, and economic recovery play crucial roles in shaping the housing market in Australia.
Investors and homeowners must always remain vigilant to these trends to make informed decisions in a fluctuating economic environment.
So is inflation good for property owners?
Inflation can be both good and bad for property owners and investors depending on their financial and personal situation, their property type, location and level of outstanding debt.
Negatives of inflation for property owners include cash rate rises (increased cost of servicing a mortgage), and larger disparity between rental income and mortgage repayments.
Positives of inflation for property owners include increased rental income (thanks to an increase in rental demand), tight supply puts a floor under prices, and for those with fixed-rate mortgages repayments are lower.
But the key message here is, strategic investors don’t need to worry too much about market phases.
Because it’s just that – a phase.
And we’ll be onto the new phase soon enough.
Instead, you need to concentrate on growing your portfolios and investing in the right type of properties in a way that suits your finance, their strategy, and their long-term goals.
Remember Warren Buffet’s words:
Be fearful when others are greedy and greedy when others are fearful.
Sure, it’s difficult to take action when others around you are talking doom and gloom, but it is during downturns that lifetime wealth is made.
