Interest rates could return to normal next year, but here's what you should know in the meantime

With interests rates continuing to rise this year, many home owners are wondering if they will ever experience a reprieve.

The Reserve Bank announced its 10th consecutive interest rate rise in March – a decision that has been met with a wave of confusion and backlash.

Continued uncertainty looms for those with a variable interest rate, and many homeowners are now considering their options: sell, or wait it out.

We spoke to The University of Queensland's Senior Lecturer in Finance at the UQ Business School, Dr Lin Mi, about what she thinks will happen next, and what the latest research is telling us about property prices.

Why are interest rates continuing to rise?

The main purpose of the continual rise in interest rates is to curb inflation, which was still very high at 7.4 percent in January this year. To get an idea about how high the current inflation is, the Reserve Bank of Australia's target inflation rate range is 2–3 percent.

This inflation rate is at a peak level over the last 30 years. To pull down inflation, the RBA has to increase the cash rate, which leads to higher savings interest rates and loan rates. Higher savings and loan interest rates would discourage people from spending and consequently bring down prices and inflation.

The continual rise in interest rates is caused by COVID-19. During COVID, the RBA reduced the cash rate to 0.1 percent, so it was very cheap to borrow money and spend (also, the savings interest rates were too low, so people preferred spending). The higher demand for goods and services pushed up their prices, leading to high inflation. 

*Editor's note: The cash rate is a rate set by the RBA, which determines the interest that banks and lenders have to pay on the money that they borrow. As they do business, banks transfer money between each other, and the cash rate is the interest paid on this money. When the RBA raises the cash rate, it costs more for banks to transfer money between themselves. Banks and lenders typically pass these costs onto consumers in the form of rate rises. This means people who borrow money from that institution will be charged more interest.

There seems to be debate about whether this continual rise is necessary. Do you believe it is?

I believe it is necessary. Inflation lags all the other key indicators of economic growth (such as building approvals, consumer spending and unemployment rate), which means that the effect of increases in interest rates will not be seen immediately, but after a few quarters. That is the reason why at the end of 2022, after 8 rises in cash rate in a row, the consumer price index was still high at 7.8 percent in December 2022.

Moreover, as the US has been increasing its interest rates, which makes the USD more attractive (people prefer the USD to the AUD as they can save USD and get higher interests). If the USD is more attractive, then the AUD would deprecate against the USD, which would make all the imported goods even more expensive, pushing up the prices further in Australia.

When do you expect to see interest rates stabilise?

I expect interest rates to stabilise around the end of 2024. The current inflation – not only in Australia but also in the US and Europe – is still way too high, so I expect the RBA to increase the cash rate a few more times this year.

However, a high interest rate would not be sustainable as it places a heavy burden on households (e.g., they have to make greater loan repayments). The high interest rate also means that companies’ borrowing costs increase a lot. The one way for companies to reduce costs is layoffs, which would cause a higher unemployment rate. When more people are unemployed, they would not be able to make the loan repayments, so the economy would enter into a ‘toxic’ state. Therefore, after the rate rises this year, I expect the RBA to cut the cash rate in 2024 and the interest rates stabilise around the end of 2024.

When do you expect the property market in capital cities to stabilise?

The property market usually lags interest rate changes for at least half a year, so if interest rates would stabilise around the end of 2024, its effect on the property market would be seen around the mid of 2025 (of course, this expectation assumes that there is no other shock to the property market in the meantime such as a change in capital gain taxes or immigration policy).

For people looking to sell or buy property, would it be wise to wait for interest rates to stabilise, or sell now to ensure they still get top dollar for their current place?

For investors, it depends on when they bought the property and the purchase price. If they bought the property long time ago, say, in 1990 when the price was low, then selling now may not be a bad idea as there is already enough capital gain. However, if they just bought it last year at a high price, then it would not be sensible to sell now, because if they don’t sell, it may just be a paper loss; but if they do sell now, it would be a real loss.

It also depends on the property itself. The general market prices are dropping, but for individual properties, the price change varies. Some prices of good properties (we use the term peaches) may not drop much whereas the bad ones (we use the term lemons) may have a significant decrease in price.

If an investor already holds a ‘lemon’ house for a long time and warrants a sufficient capital gain, then it may be worthwhile to consider selling it now as its price may drop further (the ‘peach’ house prices may be quite resilient).

Should buyers now be keeping their interest rates variable? Or is it still wise to lock in an interest rate for the foreseeable future?

For me, I would prefer to keep interest rates variable, for two reasons.

First, variable rates are lower than fixed rates. Assume that the variable rate is 5 percent and the fixed rate is 5.75 percent (these numbers are made up for ease of understanding). For fixed rates to be preferred, variable rate must rise by greater than 0.75 percent and maintain at that level for at least around one or two years.

Second, and more importantly, the current high interest rates are not sustainable. High loan rates (i.e., high loan repayments) together with high inflation (i.e., high living costs) put a heavy burden on buyers, so it is unlikely for interest rates to continue rising for a long time, at least historically we haven’t observed such a pattern.  

How much of an impact do you expect the Olympics to have on Brisbane's property market?

Great question. We have done some research on this topic. In semester 1 2022, I supervised a group of 5 Bachelor of Advanced Finance and Economics (BAFE Honours) students (BAFE students are high-achieving students with entry requirement of OP1) on an industry project, collaborated with Fluent Property as the industry supervisor.

The project’s title is “The effect of the Olympics on Brisbane's real estate prices”. Using sophisticated econometric models, forecasts of key indicators of property market (e.g., population growth, employment, infrastructure expenditure, housing additions and vacancy rates) and scenario analysis, we find evidence supporting our expectation that hosting the Olympics would positively contribute to house price growth in the lead up to the event.

The underlying reason is due to increases in employment and infrastructure development in the lead up to the Olympics, which would increase the demand for housing and exert upward pressure on market prices.

However, due to the limitation that some forecasts (e.g., additional jobs created are at the state level rather than city level, infrastructure expenditure was forecasted by a percentage of the Brisbane City Council’s revenue (which was forecasted by a historical constant), it is difficult to estimate the magnitude of the price increases.

Dr Lin Mi is a Senior Lecturer in Finance at the UQ Business School. Lin's research interests include corporate finance and real estate finance. Her work has been published in well-regarded international journals including Journal of Banking and Finance, Economic Modelling, International Review of Finance, Pacific-Basin Finance Journal, and Accounting and Finance.
Contact:
l.mi@business.uq.edu.au
+61 7 334 68038

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