10 consecutive cash rate hikes by the central bank within a year is something that is not seen often nowadays. It reflects the Reserve Bank’s determination to bring down the inflation caused by the Russian-Ukraine war and Western sanctions. As predicted by standard economic theory, the increase in cash rates would dimmish the total present value of the wealth of households, thus constraining demand for owning residential property, resulting in a decline in property prices.
We often hear from the news that the full impacts of these rate hikes are yet to be felt by the households, but how much is there left? Will the residential property prices in major capital cities in Australia keep declining or bounce back?
I have used a VARX model that contains 3 endogenous variables on residential property index, nominal GDP, and cash rate with exogenous control on supply and COVID impact, which traces out the residential property movements based on historical data from ABS and RBA in 3 scenarios as to when the COVID impact on residential property prices will diminish by the end of 2021, mid. Of 2022 and the end of 2022.
The second graph takes into account the interest shocks as RBA aggressively raises rates to keep inflation expectations in check. The estimates of the effect of 1 standard deviation of the cash rate change on the growth rate of house prices from the orthogonalized impulse function are added back to the forecasts in the first graph to produce the effect of the recent 10 consecutive rate hikes on property price movements from Sep. Quarter in 2021 through to the end of 2023.
The black dot shows the actual price level observed at the moment according to CoreLogic indexes since ABS has stopped publishing the residential property price index from 2022 onwards. The dot lies right in the middle of the central forecast and the lower bound at the end of 2022, which implies that the recent interest rate hikes are probably the main driver behind the property price movements.
The time of writing this article is in Mar. of 2023. Looking into the future is always surrounded by uncertainty as shown by the widening gap of the upper and lower bounds of the blue and yellow lines respectively. But, as the model has passed tests of structural breaks, unit root, and parameter stability, implying the future forecast error distribution is highly likely to be consistent with its past. Therefore, with a 95% confidence band, the statistical forecasting provides an intuitive sketch of the impact of 10 consecutive rate hikes on the average residential property price movements across all capital cities in Australia while holding all else constant.
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