This article delves into the latest inflation figures and their potential consequences for the Australian housing market. With inflation on the rise, will the RBA be forced to increase interest rates? Learn about the economic indicators, central bank policies, and what it means for you as a mortgage holder or renter.
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Now, if you were hoping for interest rates to be cut in 2024, you're probably in for a nasty surprise.
In this article, I want to talk to you about the latest inflation data that dropped two weeks ago and why it could have major implications for you as a mortgage holder or if you're currently renting—it might be about to get worse.
If you're interested in what my thoughts are, definitely keep reading.
There has been ongoing speculation for the better part of the last two years around inflation, when it is going to calm down, and whether we're probably at the end where we can now start seeing interest rates cut.
We've already got talks of the United States trying to cut rates in the back end of 2024.
We've also got some countries starting to implement cuts now, and that is probably a sign of things to come here in Australia.
We saw the exact same thing play out when interest rates started hiking. Some went out of the gate really fast.
Some central banks increased rates in a shorter period of time with higher interest rate hikes, and then there's others like Australia, which started implementing rate hikes of about 25 basis points. Whereas, the Federal Reserve Board was pretty much doing 50 basis points all the way through.
Now, why is that important?
Why do we need to know it now when we're looking at Australia?
The reality is that global central banks pretty much dictate what happens around the world.
Now, everything is not linear, and everything does not move at the exact same time, so keep that in mind as we go through this article. Just like any other asset class, when you're looking at the prices, if you stay in the short term and look at the data day to day, you're going to find there's so much volatility.
If you're making long-term decisions based on short-term metrics, you're going to get wrecked.
So let's look at a couple of things regarding:
“A higher than expected inflation number has dramatically raised the risk The Reserve Bank will be forced to hike interest rates again to get consumer prices under control,” ABC Australia reported.
“The Australian Bureau of Statistics' measure of consumer prices for May showed a rise in annual headline inflation from 3.6% back to 4%,” the report added.
Now, we know the Reserve Bank of Australia has a target between 2% and 3%.
The report also revealed that Asia-Pacific Economist for Indeed, Callen Pickering, said the data would “give the RBA a lot to think about at their next meeting,” which will take place in early August.
So if you're reading this, we're probably in the third week of July, which means we still have about 3 weeks before the next RBA meeting.
In that time, we're going to be able to capture a lot more data.
Now….
If we were to zoom out and look at the monthly Consumer Price Index indicator, we can pretty much see that the RBA is looking to get inflation between 2% and 3%.
We haven't been at these levels since 2021, and early 2022.
Since then, we saw the headline move in excess of 8%.
Now, what's important is you see the blue line and you see the red line.
This is the one that we want to focus on.
Why?
Because you can always have months where certain things are abnormal. What you want to do is not just base decisions on abnormal activity; you want to smooth out that data so it gives you a real accurate reading over a long period of time.
It's the same as if you were to go into any property market and saw one specific metric that was completely out of whack. You would pretty much disregard that and then take all of the other baskets of indicators and get a weighted average.
That's what we're doing here.
Now, what we can see is that although the headline goes up and down every single month, the CPI excluding these volatile items has a clearer trend.
What you'll see is that we've pretty much been on a downtrend since early 2023. Now that's about 18 months of being on a decline.
What we've seen over the last 6 months is that it's starting to smooth out, which means that inflation is being stickier than normal.
Now although this looks really bad on the front end, it actually could be a good thing, because what we want is to see this actual weighted average level out. So it's just going in between the bands of maybe just above 2% and 3%, and then enter 2% and 3% occasionally, to then just be maintaining itself.
What you don't want is to see extreme volatility and what you see is we were at headline inflation at minus 0.2% in early 2020 (obviously due to the lockdowns).
However, only about 2 years later, it was sitting at 8%.
That's what we want to compress. That is when we get an economy that's growing and sustainable, and that's when you don't have the central bank and the government stepping in with really volatile policies to try and fix something.
It's like the rubber band effect, right?
When you start pulling one way too hard, and it flings back the other way, it then causes a lot of damage, and that's what we're starting to see here.
When interest rates dropped so dramatically due to the lockdowns, we saw inflation come after that. Then the RBA increased interest rates so dramatically that now we're starting to see inflation go down.
However, this is very pivotal as to what moves the RBA makes next, and why it's important to not just say: Oh well, inflation is higher than the target band of 2% to 3%. That means rate rises are back on.
I'm sure at this point, you've probably heard every news outlet come out and say, "Well, inflation's high, that means interest rates are going up."
I think it does nothing more than scare people like you and me.
But the reality is that you can't just look at inflation and say: That's what we're going to base our decisions on.
What you need to look at is the wider economy.
Why?
Because a lot of these problems that we have when it comes to the Consumer Price Index, which include things like rent, could be alleviated by lower interest rates.
What I mean by this is people aren't willing or unable to take on loans to go and build new homes because it's simply unaffordable. So if your income isn't there to allow you a borrowing capacity to go and construct a home, you're saying: Well, I can't construct a home. I'm going to go rent.
If that's another person entering the rental pool, that means rents go up and it means there's less supply on the market.
If you have less supply, demand goes higher, which means prices go higher and that price goes into the CPI and we go around in this lovely merry-go-round until we say: Hey, it might be a problem now.
This is where we are right now, because you've got the economy actually in a retail recession.
A per capita recession is already playing out, which is effectively saying that we're not actually growing. The economy, while it looks like everyone out there is at the shops and shopping, what you need to look at is:
On my end, I've noticed that 6 months ago, there were a lot more people walking around with shopping bags and going into the actual stores, walking out with bags.
Whereas now, we've got a lot more people just walking around and window shopping. Now, this is the concern. If inflation is starting to level out, it's important we don't have a rash decision made by the RBA.
Now, some people might sit in the camp and say, "Oh well, I would love interest rates to go higher because property prices will crash."
Then there's others that hold property who might go, "Well, I want interest rates to get cut so my property asset value can go higher."
I believe there's an opportunity in either of those markets. So although I hold a lot of debt, I would love to take on a lot more debt if interest rates were lower, but I also would love to buy a lot more assets that are undervalued, given interest rates are higher, which means most people can't enter the market.
So I'm pretty much in the middle here. If interest rates go up, I'll survive and I'll continue doing what I need to.
If the interest rates are cut, then you better believe that prices will go higher, and it pretty much means I need to adjust what my financial plans are, but my passive income goes up.
Now, not everyone is in that scenario and that's why you need to prepare during these times of “mass distractions.”
Now, to showcase how bad the situation is, apart from inflation being a little bit higher than expected, I’ll show you this graph:
This is household disposable income, and this is broken down as per capita, annual percentage change.
What we can see is that we (Australia) have been pretty much on the downtrend since the start of 2020, and this is a real cause for concern because all of the other countries around the world are pretty much going the opposite way with a V-shaped recovery post-2022.
So what does that mean?
It means that a lot more people here in Australia have a lot less to play with when it comes to disposable income.
Now, this is National Real Retail Turnover, and this is done by Deloitte's economics team.
What you can see is that we had a moment where we went negative in 2020 (again due to the lockdowns).
We saw another moment in late 2021, and we found ourselves not just here blipping through for a moment, we've actually been here for a while and I'm going to estimate based on this it's pretty much been for about a year at this point.
And although the forecasts look like they’re going to improve and we want to be optimistic, the reality is: if interest rates stay where they are right now, the retail money will bleed out.
This is what happens when you have interest rates go up: it's more expensive for retail to go and purchase something.
If sales drop, then it will force unemployment to go higher. This will cause further pressure on retail spending, and it would fall even further, because again if you don't have a job, you're probably not buying Chanel handbags.
As I mentioned, one of the biggest attributes towards higher inflation is: rental growth.
We've seen rental growth out of this world.
Rental demand has increased as home ownership has declined, because people can't get a loan out there with interest rates being so high.
Now yes, for the few of you that say: Hey! Interest rates aren't that high. Interest rates were so much higher before. We will probably just come back to normal terms.
Yes, you're right. If you looked at long-term averages, you'd be correct.
However, a lot of people that have become homeowners in the last 10 years have never seen those days.
In fact, if you've bought a house in the last 5 years, the average interest rate is much much lower than where we are right now.
So it's all relative. If you've bought a property and it was 30 years ago, and interest rates were at 15%, it is not as applicable right now, because house prices were also like 10% of what they are worth now.
Now, let me show you another graph:
What this effectively means is as the cash rate goes up (which in this case is down because it's inverted), we actually see dwelling approvals fall and that's happened every single time.
So until we see the rate cuts actually occur, we're probably not going to see more dwelling approvals come into the picture.
Now, the final point I'll make here is if the approval comes through, it'll most likely take about 12 months to build those homes. If it's a unit block, it's probably going to take two to three years until that actual supply comes onto the market.
As long as interest rates stay at these levels or even increase, you will not see the top of this market.
If you're waiting to see when this market's going to crash, you're probably early because we still have that last bit of the cycle to run up. This will only occur when liquidity comes into this market, and this will come in the form of interest rates being cut—at this point, we will see approvals increase. After that, we will see supply increase, and that is when the top of the market occurs.
This will be the precursor for when you can time your exit if you decide to sell property and not witness some sort of property crash.
I hope you guys have learned so much from me in this article.
I’ll catch you in the next one.
Thank you!
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