Higher interest rates cool demand, but rents and new-build costs continue to climb
The Reserve Bank of Australia’s latest cash rate increase has underscored concern that inflation is proving harder to tame, with housing now the dominant driver of price growth and a key complication for monetary policy.
Headline CPI climbed to 3.8% in the year to December, while trimmed mean inflation also moved higher, taking inflation further away from the RBA’s 2%–3% target band.
According to Nerida Conisbee (pictured top), chief economist at real estate firm Ray White, the central bank’s response reflects its assessment that more policy restraint is needed to contain price pressures.
Housing-related costs have become the largest single contributor to inflation, rising by about 5.5% over the past year and outpacing the overall CPI. This group includes rents, the price of newly built dwellings and household energy charges.
Strong rental growth and elevated construction costs continue, with both linked to a shortage of homes and a thin pipeline of new projects. Conisbee argued that these issues are not easily addressed through higher interest rates.
“Higher rates do little to address the underlying drivers of housing inflation,” Conisbee said. “They do not reduce planning delays, ease regulatory costs or expand the construction workforce. Nor do they lower the substantial tax burden embedded in the cost of building a new home, including GST and state-based levies that add materially to final prices.
“Instead, higher rates lift financing costs, reduce development feasibility and further discourage new supply. In a market already characterised by chronic undersupply, this risks entrenching housing inflation rather than bringing it under control.”
Lessons from recent history
Following the start of a tightening cycle in May 2022, new investor lending fell sharply, dropping 28% within a year. At the same time, rental inflation sped up. By May 2024, national rents were 18.3% higher, with some markets such as Perth recording increases close to 30%.
Conisbee noted that much of the pressure came from strong population gains, including both overseas migration and interstate moves towards regions with stronger labour markets. While higher rates limited investor activity and reduced the flow of new rental stock, they did not alter the demand generated by employment growth. The result was fewer available rental properties and a steep rise in rents.
Government spending is also playing a role in higher housing costs, particularly through large-scale infrastructure programs. Major public works are competing directly with residential building for trades, materials and equipment, absorbing capacity from an already stretched construction sector.
This competition has been pushing up wages and other input costs, increasing the expense of delivering new housing and slowing the rate at which projects can be completed. In turn, this adds further upward pressure to housing components of CPI.
These dynamics leave the RBA in a difficult position.
Government intervention pushing demand higher
Monetary policy can cool parts of the economy still showing resilience, but one of the most important sources of inflation – the cost of housing – is shaped largely by supply constraints and government policy settings rather than borrowing costs alone. Tightening can help keep inflation expectations anchored, yet it does little to expand housing supply or ease structural bottlenecks.
Where higher rates have had a clearer impact is on the pace of house price growth after a period of strong gains. Conisbee stressed, however, that this is not the RBA’s primary objective. The central bank’s mandate focuses on inflation rather than asset prices, so slower price appreciation is best seen as a by-product of tighter policy rather than evidence that housing-driven inflation has been resolved.
At the same time, policy measures aimed at boosting home ownership are adding demand into a market already short on stock.
Conisbee pointed to first-home buyer schemes that allow purchases with deposits as low as 5%, which expand the pool of eligible buyers without delivering extra dwellings. While such programs can improve access for some households, they also intensify competition in segments of the market where supply is most constrained.
“House prices, particularly at the more affordable end of the markets are going to keep rising, even as interest rates rise,” Conisbee concluded.
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