How the housing market impacts inflation
THE highest annual inflation rate in almost 32 years was recorded in June, ABS figures show.
And according to the RBA and Treasury, annual inflation is expected to peak at over seven per cent.
This will mean there will be a tightening of household budgets, a reduction in savings and likely lower housing demand.
It also means more investors will look for areas where they can get a better rental return.
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In Mackay, many investors from Brisbane, Sydney, Melbourne, Tasmania and Adelaide are exiting their markets and redirecting their investments into the Mackay and Whitsunday market which has a much more attractive average yield of over six per cent.
So while housing demand is implicated by inflation it is housing itself that influences inflation.
Let’s look at how the housing market impacts inflation.
What is included and excluded in inflation
The Consumer Price Index (CPI) tracks the costs of goods and services consumed by households and inflation measures the change in the CPI.
The purchase of established dwellings and land is not factored into inflation because established dwellings are traded within the household sector and land is considered an asset, not a consumption good.
However, the purchase of new dwellings by owner-occupier households (minus land value) is factored into inflation calculations.
And while mortgage interest costs are excluded from inflation, property-related expenses such as rent values, rates and charges, property repairs, maintenance and renovations, are included.
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How housing influences inflation
The biggest weight of CPI goods and services is the housing component. Housing costs are a relatively large expenditure and as a result, inflation is influenced by utility costs, new dwellings and changes in rent.
In June, the second largest increase in CPI components was the annual change in total housing (nine per cent according to ABS data).
Meanwhile, conditions in the housing construction sector were highlighted by the 20.3% annual increase in new dwelling costs for the June quarter and values in rent also increased annually by 1.6 per cent contributing to higher inflation.
How inflation impacts housing
Inflation impacts housing but whether that impact is good or bad depends on what is driving inflation.
Inflation can erode the value of debt which can be a good thing for mortgage holders but this year, income growth has been slow and price rises have been steep in areas such as fuel, housing and food making it hard to cut back on spending.
Until wage growth picks up substantially, households have to deal with rising costs of living and high debt levels.
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Inflation also erodes the real value of housing. In this current climate, rising inflation has impacted the housing market through subsequent increases in the cash rate.
Using the cash rate setting, the RBA aims to influence inflation and is now lifting the cash rate at a fast pace because as interest rates rise and economic activity slows, inflation may be reduced.
This affects housing because borrowing money to purchase becomes less desirable and in turn, this slows purchases and prices in the housing market.
As a result, the relationship between home values and interest rates means when considering the housing market outlook, inflation is the key indicator to watch.
Benjamin Molineux
Principal and licensee
Baileux Real Estate
