How rising interest rates could push real estate prices down in 2022

There are two very conflicting opinions about what will happen to home prices in 2022, but this chart doesn’t bode well for anyone paying a mortgage.

The huge showdown for 2022 will be interest rates. The market is pricing in three rate hikes, the RBA says there will be none. Who’s right?

The tension is very important here, because if interest rates rise this year, the expected fall in house prices could come earlier than expected.

If you have or would like to own a home, the future of interest rates is very important to you. Rising interest rates make it more expensive to take out a mortgage. In addition, higher rates will reduce the amount people can borrow to buy a home, which could drive home prices down.

If you believe the market, interest rates will rise at least three times in 2022. Check out this next chart.

Each blue bar represents a month, from January 2022 to May 2023. The height of the blue bar is what the market “expects” the official interest rate to be at that time. In June 2022, the market expects an official interest rate of 0.22 percent. In December, it expects 0.83 percent. That is a significant increase in just 11 months.

When the financial news talks about the market’s price increases over time, they refer to this chart.

Now you might look at this chart and think the expectations look weird. The RBA typically raises interest rates by 0.25 percent chunks. Why does the chart show numbers like 0.22 percent instead of more plausible numbers like 0.25 percent?

The reason is that it is not a true “prediction” made by one person. It is simply the result of several people buying and selling financial assets called “futures”.

At the top is “implicit yield curve”. That’s important to remember. This chart was created by looking at the price of certain financial assets and calculating from those prices what the market is suggesting about the future of official interest rates. It is constantly changing as the price of those assets changes.

The story we get when we look at market prices is especially interesting at the moment because it’s so very different from the official story. While the market expects at least three rate hikes in 2022, those responsible for interest rates expect none.

RBA Governor Philip Lowe has repeatedly said he does not expect to raise interest rates in 2022 because he does not expect inflation to rise. In December he gave an important speech in which he emphasized this point again.

“The Reserve Bank Board will not raise the spot rate until actual inflation is sustainably within the 2-3 percent target range,” he said.

“We are still quite far from that point. In our central scenario, the condition for an increase in the cash rate will not be met next year. It will probably take some time before that condition is met and the board is willing to be patient.”

The market clearly does not believe that it will be patient, or does not believe that inflation will remain low.

Home prices are currently projected to fall in 2023, when the RBA has hinted that official interest rates may finally rise. But if the interest rate rises sooner, the house price may also fall sooner.

What would the RBA do as the market expects, and raise rates in 2022? The answer is high inflation. As the following chart shows, inflation is rising in the US and Europe. Is Australia on the same track?

The latest data for Australia shows that inflation has risen by 3 percent in the past 12 months. Some things got a lot more expensive, like gasoline, while others, like clothes, footwear, and phone bills, got cheaper.

Inflation of three percent is higher than we are used to, but certainly not as high as in America or the US, and probably not high enough to cause the RBA to panic and raise interest rates.

But the supply chain problems that have caused price increases persist and it is possible that inflation will spread to other categories.

Inflation data only comes out four times a year, with the next release on January 25, covering the period from October to December 2021. If that shows continued price increases, rest assured the market will price in even more inflation increases into 2022 , and there will be even more disbelief about the RBA’s official line of not raising interest rates this year.

So was inflation high in October, November and December last year? If the answer is yes, then the chance of interest rate hikes in 2022 will increase and the future of house prices will become much more shaky.

Jason Murphy is an economist | @jasemurphy. He is the author of the book Incentivology.

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