With the Reserve Bank of Australia (RBA) continuing to raise interest rates, house prices in Australia are likely to decrease. But what does this mean for those seeking to purchase their first home?

Recent Reuters poll predicts Australian house prices to decrease another 9% this year. However, analysts forecast a small growth of 2.5% for 2024.

Expectations for a Modest Australia House Price Correction

Though house prices have been trending higher for some time now, they remain far from reaching their peak. With average house prices rising 20-30% annually for two years, many believe this run cannot go on indefinitely and that its end is near.

One major reason for this is rising interest rates. The Reserve Bank of Australia (RBA) began raising rates in May last year, and now markets anticipate they will rise even further next year.

With the RBA raising rates so rapidly, this has caused mortgage stress and elevated the potential risk of borrowers falling into negative equity. This has contributed to an overall weakening in economic sentiment as well as reduced consumer spending.

In response to this rising risk, banks have intervened and begun offering various ways for homeowners to protect themselves. These include refinancing, loan modifications and a new home equity loan.

These measures aim to reduce the burden on borrowers to borrow more than they can afford. Furthermore, they offer a safety net for people who must sell their homes due to changes in employment or family circumstances.

But there are still widespread worries about rising living costs, particularly for those attempting to purchase their first home. This issue is especially acute in places with high unemployment rates.

Many will find it increasingly difficult to purchase a home. This puts an immense strain on the mortgage markets and may lead to lower home prices in the long run.

According to a report released by the Commonwealth Bank (CBA), Australian house prices will decrease by 10 per cent over the next few years, leaving home owners no longer able to enjoy the high level of wealth they have achieved in recent years.

The CBA anticipates the RBA is starting to tighten its cycle and this will push house prices lower. They forecast an increase in cash rate from its record low of 0.1% this year to 1.25 by the third quarter of 2023.

Rising Rate Expectations

With rising interest rates and an improving economy, low unemployment should keep property prices in Australia from declining as sharply as some anticipate. Indeed, economists predict that home prices will remain stable throughout the year.

Particularly in Sydney and Melbourne, where house prices had already begun to slow before the Reserve Bank raised official interest rates in May. There is concern that this move could further stifle demand.

Matthew Hassan, a Westpac economist, believes that rising rates will reduce the borrowing power of many potential buyers. This is good news for sellers but bad news for purchasers.

He emphasizes that these increases will make it increasingly difficult for many prospective homebuyers to secure mortgages, particularly first-time buyers. This will decrease the number of new homeowners and also impact supply of existing homes, leading to decreased house prices.

The Fed has hinted that it may continue raising its key interest rate through 2023, but only after seeing sustained positive economic data. Thus, markets anticipate that the Reserve Bank's last hike will occur in March.

Meanwhile, an improving unemployment and wage outlook could potentially put pressure on the housing market. However, given that unemployment remains below December 2020 lows and wage growth is forecast to remain strong, a significant decline in property values is unlikely.

Property values experienced a remarkable surge recently, which is unlikely to be replicated again. As such, our property market will become much more fragmented - houses, apartments, townhouses and villa units will be spread out more across the country.

Rising Inflation

Inflation is a cause for concern to the Reserve Bank of Australia (RBA), not only because it can raise mortgage rates. Furthermore, rising house prices create a wealth effect that encourages people to spend more money. Ultimately, this could lead to higher inflation over time.

Tracking inflation expectations is possible through various means. One is conducting surveys of consumers and businesses, or economists' forecasts. Another method involves monitoring up-to-date references to price changes in the media - these references can be analyzed by MarketPsych which has developed a time series scoring system for thousands of reliable news and business-related social media sites.

Researchers found that when recent references to price increases or decreases are available, they provide more precise inflation forecasts than what experts typically predict each month. This makes sense, since the market is highly dynamic and changes rapidly.

In the past, economic forecasters have been caught off-guard by rapid inflation. As a result, they often made inaccurate projections for the future.

Thankfully, many economic forecasters have developed strategies for avoiding this outcome by monitoring inflation expectations. For instance, the University of Michigan Survey Research Center and the Federal Reserve Bank of New York both conduct similar monthly surveys that ask respondents how they anticipate prices will change over the next year or five to ten years.

Information gathered can then be utilized to make more precise forecasts for the future. Inflation is a concern because it drives up costs for everyone from everyday consumers to global enterprises.

Inflation is caused by an excess of money supply. Monetary policy's role is to supply just enough money to ensure price stability, since too much expansion in our money supply can obscure important price signals that keep our economy running efficiently. This task is essential for maintaining price stability.

For instance, if prices of items such as food and energy increase rapidly, it can have devastating effects on businesses that sell them. This could result in decreased profit margins and greater employee turnover.

Rising Unemployment

Australia boasts a strong economy with unemployment near record lows and job opportunities galore for everyone. That explains why Australian home buyers tend to stay current on their mortgage payments even when they must pay more interest than the value of their property.

However, the RBA must keep an eye on house prices as they are such a critical aspect of our economic system. This is because house prices are usually the first sector affected by any changes in interest rates.

In response to the Reserve Bank of Australia's eight hikes in 2022, Australian house prices have plunged at an unprecedented rate - 8.4% since May. CoreLogic's latest research revealed that the value of Australian homes has dropped approximately $64,820 per household.

The national decline was much less severe than Sydney, where property values plunged -13.3% in just the third quarter alone - even though prices had already started to fall prior to the rate hiking cycle starting.

It appears that much of the decline in house prices was caused by RBA rate hikes and consequent reductions in borrowing capacity. This poses a problem for both prospective home buyers and property developers alike, since it reduces their capacity to generate cash from sales.

Another key factor contributing to the ongoing decline of Australian house prices is an increasing ratio of mortgage debt to income. This has become an issue recently, particularly as more households rely on debt for housing costs.

Recent RBA statistics demonstrate that Australians owe an impressive 188.5% of their household incomes on housing loans, and this ratio is expected to continue rising over the coming years.

Therefore, if the economy starts to sputter in the future, this could have an adverse effect on Australia's house prices. This is because people may end up having less money for spending if they must pay more interest on their mortgages.

Rising rates make it harder for individuals to service their existing debt, potentially leading them to default on their mortgages. Fortunately, this is not a major concern in Australia's banking system since our mortgages remain relatively secure.