Falling house prices are the point, not the problem

Falling property prices may be easing speculative excess, but with inflation still above target, a housing downturn alone is unlikely to convince the RBA to cut rates.

By Professor Vito Mollica, Deputy Dean (Research and Innovation), Macquarie University
| | Finance | 2 min read
Melbourne terrace house
Property price falls nationally are still largely concentrated on the more expensive market segments. (Image source: Lisa Parry)

Australia’s housing market has turned. After several years in which the dominant question was how much further prices could rise, attention has shifted to how far they might fall and whether falling prices will eventually force the Reserve Bank of Australia (RBA) to cut interest rates.

That last assumption deserves more scrutiny than it is getting.

Housing matters enormously to Australian households and to the economy. But the RBA does not have a house price target, and its job is not to protect the value of the country’s largest asset class, despite its significance. Its mandate is price stability and full employment, with inflation targeted at 2–3 per cent. On the first of those, the problem is not yet solved.

Weaker housing demand is one of the main channels through which restrictive monetary policy slows an economy.

Cotality’s national Home Value Index fell 0.7 per cent in July, its largest single-month decline since December 2022, and the weakness is no longer confined to Sydney and Melbourne – mid-sized capitals that had held up have moved into negative territory.

The falls are concentrated at the top. Upper-quartile values fell 3.2 per cent nationally over the three months to July, while the lower price tier gained 0.3 per cent, a pattern consistent with credit constraints landing hardest on the largest loans.

Research at Macquarie Business School points to something further.

The MQBS Housing Fever Index, developed by Professor Shuping Shi with support from an Australian Research Council Discovery Project, estimates how far prices have departed from what fundamentals can justify.

It strips out the contribution of rents, real interest rates and supply, and treats what remains as speculative. Its latest readings show that component easing: the national index fell in the June quarter, its first quarterly decline since late 2024, after five consecutive increases.

The markets where speculative pressure had built most – Sydney, Melbourne and Canberra – all moved lower. The smaller capitals have not turned yet.

So, this is not merely slower price growth. Some of the speculative heat has begun to dissipate.

The RBA at its 11 August meeting left the cash rate at 4.35 per cent, after three increases this year, and explicitly acknowledged that “momentum in the housing market has shifted, with housing prices falling in some capital cities and new housing loans declining noticeably”.

That sentence has been read in some quarters as the beginning of a pivot. It reads better alongside what the central bank said about inflation. Headline inflation remains too high, trimmed mean inflation is still elevated, and it does not expect inflation back near the midpoint of its target until late 2027. It has left open the possibility of a further increase if upside risks materialise.

Inflation expectations are the second reason for caution. The MQBS Business Outlook Scenarios Survey, led by Associate Professor Ben Wang, tracks around 500 financial decision-makers across small, medium and large firms. Its latest results put median long-run inflation expectations – over the next five to ten years – close to 4 per cent.

That should attract attention.

If businesses making investment, wage and pricing decisions believe inflation will remain higher than target, this does not bode well for interest rates.

House prices not driving the RBA agenda

There is one condition under which the picture changes quickly.

The RBA does respond to housing when financial stability is at stake and arrears rise sharply, lenders retrench, and a correction threatens the banking system rather than merely household balance sheets. Declining new lending and falling values are not, by themselves, that. Discomfort is not dysfunction.

Australia has spent two decades absorbing an implicit rule: serious weakness in housing would eventually be met by cheaper money. The current inflation environment tests it. The RBA can tolerate falling prices while inflation is too high and the financial system is sound.

That suggests the numbers that matter now are not next month’s house price index, they are the quarterly trimmed mean, the unemployment rate and mortgage arrears.

Until the first of those is convincingly beaten, falling house prices alone are unlikely to deliver rate relief.

Article Q&A

Will falling house prices force the RBA to cut interest rates?

Not necessarily. The RBA does not target house prices; its focus is inflation and employment. Unless falling property values contribute to a broader deterioration in financial stability or economic conditions, weaker housing prices alone may not trigger rate cuts.

Why is the RBA concerned about inflation despite falling property prices?

Inflation remains above the RBA’s 2–3 per cent target, while trimmed mean inflation is still elevated. The central bank does not expect inflation to return near the midpoint of its target until late 2027, meaning it may need to keep monetary policy restrictive even as housing values decline.

What economic indicators matter more than property prices for future interest rate cuts?

Investors should watch underlying inflation, particularly the quarterly trimmed mean, as well as unemployment and mortgage arrears. A sustained improvement in inflation would provide a stronger case for rate relief than falling house prices on their own.

interest rates, prices, RBA, mortgage stress, housing, employment, inflation, Professor Vito Mollica, Macquarie University, capital cities, credit, lending, Professor Shuping Shi, Associate Professor Ben Wang, MQBS Housing Fever Index, Macquarie Business School

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