Housing market in correction mode as rate hikes kick in

Australia’s housing downturn is underway, with expectations for aggressive and accelerated rate increases from the Reserve Bank likely to keep prices under pressure over the next two years. 

The RBA this month kicked off the tightening cycle in response to a surprisingly strong surge in inflation. While much of this is due to offshore factors that can be expected to ease over time, the high starting point for inflation and the tight domestic labour market mean the bank needs to move more quickly on rates.

Our recently revised forecasts have the cash rate rising to a peak of 2.25 per cent by May 2023 and holding at this level through 2024. This, in turn, is expected to see an earlier and sharper correction for dwelling prices. We see them falling 2 per cent over 2022, a further 8 per cent in 2023, and 1 per cent in 2024.

Market conditions have already turned: sales are down sharply from last year's extreme highs, buyer sentiment is plumbing new cycle lows and house price expectations are being pared back quickly. With risk aversion already elevated, any loss of confidence around the jobs market would be a further headwind. 

Still, some parts of the country are more vulnerable than others. The boom in New South Wales and Victoria is well and truly over, with both markets cooling sharply. Queensland and South Australia remain more resilient, with price growth only just starting to slow and coming from a strong starting point in both.

In terms of mortgage pain, we forecast the debt servicing ratio - the proportion of income required to meet repayments for households with an owner occupier loan - to hit its highest levels since 2007/08, when the RBA tightened aggressively to rein in high demand-driven inflation during the mining boom.

Buyer affordability - the proportion of average income needed to finance the purchase of a median-priced home - is also expected to test highs not seen since 2007/08. Our forecast peak-to-trough market decline of 14 per cent sees affordability improve somewhat by late 2024 but high interest rates will remain a significant hurdle.

For the full report, visit Westpac IQ