Are interest rates and home prices actually linked?

I’m reticent to write about Australian home prices, for several reasons. Firstly, people are irrationally tied to home prices, especially their own home. Secondly, the Australian media is obsessed with Australian home prices. Thirdly, it’s the hottest of political hot potatoes. Fourthly…..actually, I could do this all day, so I’ll stop.

If all I did was listen to or read the media, I’d swear home prices and interest rates are inextricably linked, and the low interest rates of 2008 to 2022 explain everything you need to know about current Australian home prices. And that we need to lower interest rates to make housing more affordable.

What bunkum!! 

That’s a lazy media who want an instant answer, and for that answer to get lots of clicks or views. To be fair, interested parties then jump in and support this fallacy. For example, the CEO of Bendigo and Adelaide Bank recently said that financial inequality will continue to broaden in Australia, driven by home prices, until interest rates start to fall.

It's just not true. Let me show you.

Looking back, housing markets in big cities all over the world were fundamentally changed by COVID. The work-from-home culture that was born, as well as the moves people made into-and-out-of big cities all over the world, have entirely changed the data series. And of course, interest rates fell through the floor after March 2020 and home prices in desirable places all over the world have increased sharply since then, supposedly because of irresponsibly low interest rates – at least that’s what the media tells us time-and-time-and-time again. Depending on the source, I also keep hearing that this was another classic example of the boomers screwing the millennials because boomers in Government shelled out loads of cash through COVID to benefit asset owners, who are mainly boomers, at the expense of younger generations who not only watched assets they don’t yet own soar in value, but they will have to pay the debt off at some point (spoiler alert, they won’t – nations have to service debt, of course, but not necessarily pay it off).

Except for one annoying little thing about that post-COVID housing market narrative that was so clean and so neat (you know, the one about interest rates down, asset prices up, boomers good, millennials bad….that one) – the post-COVID market includes 2022 and 2023 when the RBA cash rate went from 0.1% in March 2022 to 4.35% in November 2023, the sharpest and most elongated interest rate hiking cycle in Australian history (maybe 1994 is in the ballpark).

Forget post-COVID, too much weird stuff is in the data. Let’s go pre-COVID, and 50 years back. Look at this chart.

There’s a broad flattening of prices in the early-to-mid 1980s. Many people point to the hard-and-fast ratcheting-up of interest rates as the world grappled with high inflation. And the impacts in Australia were compounded by an extended drought so that farmers were getting lower yields but paying higher prices for everything, interest rates included.

See?, they said. Interest rates and home prices are directly correlated.

Small problem – home prices also flattened in the early-to-mid 1990s due to “the recession we had to have” and 17% interest rates, but then interest rates fell from 17% to 7%. Where was the correlation then? Look at this interest rate chart below and compare it to the home price chart.

Using these charts as the basis, there is almost zero relationship between housing prices and interest rates over 50 years.

Housing is always about supply. Always.

Demand is going to do whatever it does but the real determinant of home prices is the supply of dwellings. To be very clear, the following two sentences are not a comment about immigration, they are a comment solely about maths. Here goes - Australia allowed over 105,460 in-bound migrants just during February 2024. It doesn’t matter what else happened, there simply isn’t enough housing supply to meet that amount of demand.

Housing is always about supply. Always.

Setting COVID aside, the chart immediately below is immigration over the last 50 years.

The two flat periods in housing prices that I’ve already noted above have no relationship to interest rates but you know what they’re directly related to? The fall-off in immigration you can see in the above chart during the same periods.

The reason Australian home prices have risen steadily and consistently is almost entirely a function of the number of available dwellings versus the population seeking those dwellings. And a big part of it is the world going global. That’s when rich and mobile and ambitious people all over the world started buying homes in nice places to live, and it turns out we have lots of those in Australia.

Again, if you’re ever unsure, remember:

Housing is always about supply. Always.

If someone is harping about affordability or the “housing crisis”, and they’re not actively talking about actually expanding supply, or worse - they're talking about curbing the ability to build homes - they’re simply not in touch with reality. It’s not about rent caps or freezes, or “greedy developers”, or social housing.

Or lower interest rates.

Housing is always about supply. Always.

Good luck out there.