Inflation set to level out in 2023 - but more interest rate pain likely

Australian mortgage holders should prepare themselves for more pain this year, with experts predicting another interest rate rise when the RBA meets next month.

The Big Four banks expect the RBA to raise the cash rate by at least another 25 basis points, which would mark the ninth consecutive rise since May last year, and the highest peak since 1990 at 3.35 percent.

The Reserve Bank has been raising the cash rate in a bid to combat rising inflation, which currently sits at 7.8 percent, the highest level since 1990. The Australian Bureau of Statistics points to more expensive domestic holidays, international travel and higher energy prices as some of the key drivers.

While some have expressed concern that further interest rate rises could be enough to push Australia into a recession, head of research at CoreLogic, Eliza Owen, says there’s not too much cause for alarm just yet.

In the CoreLogic Property Pulse Report released this week, she points out that the RBA predicted inflation would peak at 8 percent this year and that the signs of a coming decline in the rate of inflation are already there.

“Underlying core inflation (the RBA’s preferred reading on inflation), which is measured by trimming excessively volatile components of CPI, actually fell in the quarter, from 1.9 percent in September to 1.7 percent,” she said in the report.

“Annual core inflation is still a long way from the 2 to 3 percent target range set by the RBA, at 6.9%. However, December marked the first fall in quarterly core inflation since March 2021, following eight consecutive interest rate rises from May 2022.”

The result, she said, is that inflation may have already peaked.

“Inflation across the combined OECD slowed to 1.8 percent in the September 2022 quarter, after peaking at 2.1 percent through June,” she said. “Forecasts from the OECD also suggest a fall in inflation through 2023 across most major economies, as global economic demand starts to slow.”

This includes Australia’s major trading partners such as China, Germany, Japan and the US.

In better news for those looking to renovate or build this year, the report also says that housing metrics indicate the rate of growth in new build costs is slowing.

“December CPI figures showed housing costs were still up a substantial 1.9% in the quarter, but this was down from a 3.2% lift in the three months to September,” Ms Owen said.

The Reserve Bank had little choice but to raise interest rates again this week.

Inflation was already proving stubborn before the latest Middle East instability added further pressure to energy prices and supply chains.

Housing inflation alone has averaged six per cent over the past year, remaining one of the single biggest contributors to CPI.

But while the focus remains on rates, the deeper problem is structural and far more dangerous.

Australia is not building enough homes, and the conditions required to fix that are deteriorating simultaneously.

Construction costs remain elevated. Builders are increasingly unwilling to absorb contract risk. Labour shortages persist.

Capital is becoming more expensive. And as borrowing capacity weakens and sentiment softens, fewer projects are becoming financially viable.

The result is a self-reinforcing cycle.

The RBA raises rates to fight inflation. Higher rates reduce development feasibility. Fewer projects start. Housing supply tightens further. Rents rise. Inflation persists. The RBA raises rates again.

The only long-term solution is supply, yet Australia remains nowhere near the National Housing Accord target of 240,000 new dwellings a year.

Completion continues to lag approvals, meaning many projects approved on paper are simply never making it out of the ground.

That gap matters enormously because housing is not just another sector of the economy.

Around two-thirds of Australian household wealth is tied to property, while the sector underpins millions of jobs and related industries. Weakness here quickly spreads beyond real estate.

We are already seeing signs of stress. Auction clearance rates in Sydney and Melbourne have softened, borrowing capacity has declined, and parts of the market are experiencing price corrections as confidence weakens.

At the same time, policymakers continue to debate tax measures such as changes to negative gearing and capital gains tax discounts, despite fears that such reforms could drive private capital out of the rental market at precisely the moment when supply is most constrained.

This is the paradox at the centre of Australia’s housing crisis.

Demand for property remains extraordinarily high, yet the economic conditions required to actually build new housing are worsening.

The Reserve Bank cannot solve that problem alone.

Monetary policy cannot accelerate planning approvals, reduce construction costs or create more tradies. It can only raise the cost of money until something eventually breaks.

And increasingly, that “something” looks like the development pipeline itself.

Paul Miron is the Co-Founder & Fund Manager of Msquared Capital.

Inflation set to level out in 2023 – but more interest rate pain likely

Mortgage holders should brace themselves for another hip pocket hit when the RBA meets next month

Rising rates, construction inflation and shrinking investor confidence are pushing Australia deeper into a dangerous housing spiral that monetary policy alone cannot fix.