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Rising Interest Rates: The Whole Story

October 24, 2022



Rising Interest Rates: The Whole Story

October 24, 2022


Why delaying a purchase decision could be a bad strategy for some

The media loves a “bad” news story. With the twin threats of rising inflation and higher interest rates, the media has had a field day relating these issues to a decline in dwelling prices. These negative inputs are causing distress for our clients and a typical reaction is to do nothing. That can be a combination of burying your head in the sand or believing that it is prudent to play the waiting game. This could be a poor strategy for a client.

In this article we want to explore some of the pitfalls around viewing the consensus opinion as fact and some of the opportunities that can emerge during this cycle.

The bottom line here is that in the end no-one knows, so don’t rely solely on experts or media: do your own research.

Phillip Lowe, the Governor of the RBA, suggests that Australia should brace for a period of higher inflation that the RBA will seek to mitigate via cash rate rises. The RBA has a charter that requires it to establish policy settings to contribute to, among other things, full employment and uses a target inflation in the 2-3% range through the economic cycle to achieve those policy outcomes. With inflation in Australia nudging high single digits the RBA has responded with a series of 50 basis point rises in the cash rate. The wording of the minutes of the RBA meeting indicate that these rises will persist in the medium term.

Is the RBA right? Is inflation out of control? Have they been wrong before?

Let’s see. As recently as last year the Governor suggested that it would be unlikely that interest rates would rise until 2024. So, let’s put this into perspective. The Governor of the RBA with the best economic inputs that were available did not foresee what is playing out now. He has apologised but that hardly benefits those borrowers that used his forecast when making credit decisions in 2021.

Howard Marks, Chairman of Oaktree, and considered one of the world’s best investors made the following observation: All forecasters are wrong. Markets are too complex and interrelated for any forecaster or model to distil all the relevant information into a single series such as an interest rate prediction.

So, the first thing to say is, don’t believe the doom and gloom. The so-called experts are often wrong, and you should not rely soley on their predictions.

Now let’s spend some time looking at the Australian housing market. It is very important to be informed by history and to consider the current and future fundamentals of the housing market. Yes, one of the fundamentals of the housing market is the cost of debt, but that is but one of the inputs that will ultimately drive housing prices.

History suggests that in the aggregate Australian housing has been a blue-chip investment that has defied many gloomy scenarios. After the rout that afflicted the US housing market in 2008 many gloomy forecasts emerged. Professor Steve Keen in 2008, for example, predicted that house prices in Australia would fall 40%. Prices, again in the aggregate, fell approximately 5.5% overall and have subsequently risen over 40% since.

With all the current doom and gloom scenarios house prices have fallen just 2.9% at the aggregate national level but sit well above levels of a year ago.

My point is that forecasters are often wrong and that historically the housing market in Australia has been robust.

What of the market conditions today.

As I said it’s important to consider the cost of finance when evaluating the market but there are very many other factors you need to consider, and you should make sure your clients are considering these factors as well.  On the supply side, what does the availability of existing and new housing stock look like? What do the demand drivers look like: new home buyers and demand from immigration? What does the employment market look like?

Let’s look at these factors.

Firstly, there is clearly a lack of existing stock and shortage of new stock. This will underpin housing prices.

Secondly, there is still significant untapped demand from new home buyers. Added to this is that coming out of COVID the government is announcing significant increases to immigration numbers as these had stalled during the pandemic. This will be (and has been) a significant underpinning of housing prices in Australia.

Lastly, employment. There has not been a stronger employment market in Australia for over 20 years.  Effectively in Australia we are at full employment. Anecdotally an employer will say that their greatest current challenge is attracting and maintaining their workforce. Many economists will argue that the greater determinant in demand for housing is not based on cost of finance but whether a mortgage can be serviced via stable employment.

All these factors should be considered by your clients when considering a purchase. Yes, cost of money is an issue and a client’s ability to afford that cost are important factors, but if housing prices rise then waiting to purchase can be an opportunity cost for your clients. So, when your clients say: I’m waiting for the market to bottom out or I’m going to sit back for a while make sure that they understand and consider the potential consequences of that position.

It’s also very important to understand the micro (or client) impacts of higher interest rates and potentially lower housing prices. Again, the picture is not as simple as it seems. By playing the wait game, the combination of higher rates and increased Household Expenditure Measure (HEM) benchmarks will have an impact on the amount a customer may qualify to borrow. Research suggests that borrowing capacity levels have reduced by nearly 30% since May 2022 cash rate increase, thus for many resulting in that once achievable purchase, now out of reach despite a lower purchase price!

Let’s look at a typical case of this at work. A prospective home buyer in the market for a $1m property, having saved a 20% deposit plus costs and qualified for a $800,000 mortgage. She forecasts that given market conditions the property price will fall 5% to $950,000 in the coming months, providing a great saving. However, this could be detrimental when you take into account the twin effects of interest rates and HEM as this customer’s borrowing capacity could reduce significantly, and, no longer have sufficient deposit to bridge the gap between the new purchase price and loan she qualifies for.  The once achievable purchase is now out of reach!  Sometimes it can be prudent to wait but other times it is not. You need to be on top of the changing lending landscape to ensure your clients are not adversely impacting themselves by playing the waiting game. In conclusion I want to provide you with the key talking points for your clients.

  1. Forecasters are often wrong. Do not rely on them solely: do your own research. What is the local property market doing?  Where is employment, inflation, rates going?
  2. The Australian housing market has been historically robust, and the long-term outlook remains so.
  3. As lenders adjust their lending criteria, waiting to buy may have an impact on borrowing capacity.

A position to simply wait this period out may not be a sensible approach for a client.  It is important that you have these discussions with them.


Adrian Fisher

Adrian Fisher
Head of Distribution and Product


The above information is a brief summary only and does not take into account your personal needs and is not a substitute for independent professional advice. We strongly recommend that you speak to your accountant as they will be able to provide you the most suitable advice for your individual circumstance and to ensure that you are also always receiving the most up to date information.