Mon Mar 16

Despite denials, there are signs the RBA does consider house prices in setting rates

Written by: Martin Duck, Post-Doctoral Research Associate, University of Sydney

As households are squeezed by the cost-of-living crisis, central bank governors such as Jerome Powell ^[1] in the United States and Michele Bullock ^[2] in Australia are coming under repeated fire from politicians, pundits and households.

Before each interest rate decision, there is debate about what the Reserve Bank of Australia (RBA) should do and predictions as to what it will do. Afterwards, the gap between these generates heated commentary.

This is uniquely Australian: a high concentration of variable-rate mortgages ^[3] exposes Australian households to interest rate changes more than in other advanced economies.

Interest rate decisions affect the economy in several ways, including business borrowing costs, the value of the Australian dollar and inflation expectations. But they also have an almost immediate effect on households’ cash flows ^[4].

Ahead of Tuesday’s Reserve Bank interest rate decision, the debate has reignited ^[5].

Housing complicates the picture

One of the RBA’s core tasks is to limit price rises in consumer goods and services – fuel, groceries, power bills and so on. But the bank has repeatedly stressed ^[6] it does not target house prices when deciding on whether to change rates.

Our recent research ^[7] shows that house prices and household debt, having increased dramatically over recent decades ^[8], complicate the RBA’s decisions.

In addition to inflation and employment, the RBA is responsible for ensuring the stability of the financial system ^[9]. High house prices and household debt can lead to financial instability ^[10] risks.

What former RBA insiders say

Interviews we conducted with five former RBA economists ^[11] showed that housing does indeed influence their interest rate decisions. A review of RBA documents shows although the bank often publicly denies targeting the housing market ^[12], it uses households’ mortgage payments to control inflation ^[13] and slow the economy.

One former RBA economist said housing “paralyses them, and it causes them to make mistakes”.

According to this economist, between 2015 and 2019, the RBA held interest rates higher than its own modelling suggested it should. During this period, the RBA undershot its inflation target ^[14] because it was worried that lower interest rates would increase house prices and cause financial instability.

In 2017, then-Governor Philip Lowe said ^[15] the RBA would like faster economic growth and lower unemployment. But achieving this with lower interest rates “would encourage people to borrow more” and probably “put more upward pressure on housing prices”. Lowe didn’t consider either of those things to be “in the national interest”.

When asked about this period, the same ex-RBA economist interviewed said:

there were policy mistakes that were made specifically because they were looking at the housing market too much.

They said the RBA’s modelling suggested it should cut interest rates, and that its decision not to cut went against its own research.

a property auction in Homebush, in Sydney

High levels of household debt pose a risk to financial stability. Dan Himbrechts/AAP

Another former RBA economist said this period was dominated by internal debates at the bank about whether it should focus on inflation or the risk of financial instability caused by high house prices and large mortgages.

They said that although there was “a strong case” for lower interest rates, the RBA decided to hold them steady because it was worried about its financial stability objectives.

Scrutiny over house prices

At a Senate hearing late last year ^[16], RBA Governor Michele Bullock faced scrutiny over rapidly rising house prices and inflation.

When asked about the role the Reserve Bank played in fuelling higher house prices, Bullock admitted that “part of the way monetary policy works is through the housing market”. But she did “not accept that the Reserve Bank is responsible” for house prices.

When pressed on the role played by property “speculators” and tax settings like the capital gains tax discount, Bullock replied:

Government runs government policies on housing. The policy that I’ve got control over is the interest rate.

Slower growth in house prices would make it easier for the RBA to set interest rates. Removing tax breaks for investors that increase housing demand ^[17], house prices ^[18], and household debt would help.

In Senate hearings about reforming the capital gains tax discount, former RBA governor Bernie Fraser said the tax breaks should be scrapped ^[19].

Rate increases hit differently

Interest rates will remain political because of their uneven effects.

Interest rate rises increase the burden of repayments for younger, more heavily mortgaged households ^[20] while boosting the savings and investments of older, wealthier households ^[21].

Despite denials, there are signs the RBA does consider house prices in setting rates

Mortgage repayments rose after the RBA’s hike in interest rates in February. Susie Dodds/AAP Image

Interest rate cuts increase house prices ^[22] and lock people out of the market.

Throughout 2024 and early 2025, as interest rates were rising, Australians who rent or make mortgage payments had softer growth in household spending ^[23] than those who own their property outright.

During the recent rise in inflation, spending diverged between age groups ^[24]. Those aged 18-39 reduced their spending on essentials and discretionary categories while those aged over 60 increased their spending.

Recent homebuyers are spending twice as much of their income ^[25] on mortgage payments than new homebuyers were five years ago, when the official cash rate was near zero.

Another hike in interest rates is expected, either on Tuesday or in May.

Our research shows that the RBA – constrained by high house prices, large mortgage payments and global events ^[26] – is unlikely to avoid the public or the government’s ire any time soon.