How rising rents could put downward pressure on interest rates: Karen Maley

Viewers of the Channel Nine renovation series, The Block, recently got a first-hand experience of just how treacherous Sydney’s property market can be.

In the series finale, only one of the four renovated units – located in the suburb of Vaucluse in Sydney’s eastern suburbs – managed to achieve an auction price above the $1 million it cost to purchase and renovate the unit. The cheapest unit was passed at a mere $865,000.

Still, if Reserve Bank boss, Glenn Stevens had been watching, he probably would have been very encouraged by the auction results. The country’s central bank is determined to keep inflationary pressures under control as the country goes through a once-in-a century mining boom. Since October last year, the Reserve Bank has raised the official cash rate from 3% to 4.75%.

The increase in official interest rates is already being felt in the housing market. The property market has tightened and clearance rates at auctions around the country are slipping. And, as some of the contestants on The Block discovered, property prices are now coming under a bit of pressure.

But, home buyers and home owners aren’t the only ones to feel the effects of tighter monetary policy. Australia’s renters are also about to be hard hit.

Tim Toohey, Goldman Sachs chief economist points out that the interest rate rises we’ve seen so far have produced a decline in housing approvals. As a result, the supply of housing is about to get tighter.

At the same time, Toohey argues that the demand for rental housing is about to rise. Toohey – who predicts that the Reserve Bank will raise interest rates again in March, May and August next year – argues that housing affordability is about to come close to reaching all-time lows over the next 12 months. At that stage, he says, housing will become as unaffordable as it was in 1989, and in 2008.

As a result, he says, a lot of people will decide that they’d rather keep on renting, rather than taking out a large and expensive mortgage.

The trouble for renters is that there’s going to be more demand for rental accommodation at the same time as a decline in building approvals means that fewer homes and apartments are being built. As a result, rents are likely to come under pressure.

At present, rents are rising at a 4.3% annual rate. Toohey estimates that increased pressure in the rental market will likely cause rents to start increasing at an annual rate of 7 to 8%.

Toohey points out that about one-third of Australian households rent their houses. Many – although certainly not all – of these people are in lower income brackets.

Even though incomes in Australia are growing quite strongly at present, lower income renters are about to be hit with a sharp increase in their rental costs. At the same time, the cost of utilities, such as gas, electricity and water, are also rising very steeply. Lower income earners are about to find that their rental and utility costs consume a greater and greater portion of their weekly pay cheques.

What’s more, Toohey notes that higher rental costs are going to have an impact on the country’s inflation rate.

Rental costs are one of the largest single items in the basket of goods that are used to calculate the consumer price index, accounting for 5.6% of the total basket.

So big rental increases will show up in the form of a higher CPI inflation rate, which will in turn increase pressure for future interest rate rises. And that will mean further bad news, for both home buyers and renters.

This article first appeared on Business Spectator.