Published 15 September 2021
What is inflation?
Inflation is the general increase in the level of prices of goods and services that households buy, it is used to understand the rate of change of the costs of something over a period of time.
In Australia the inflation rate is calculated by the Australian Bureau of Statistics (ABS) using the Consumer Price Index (CPI) of thousands of items across a range of categories. The ABS uses the CPI to calculate the change in price across all these items and aggregates them to calculate the inflation rate.
Australia’s target inflation rate is 2-3%, on average, over time. This target is considered a suitable rate as it does not materially distort economic decisions in the community and helps to allow Australia in achieving price stability in its economic growth.
The inflation rate is calculated each quarter and as of Q2 2021 is at its highest reading since 2008 of 3.8%.1
How can inflation impact housing prices?
Australia’s housing market plays a vital role in how the inflation rate is calculated, accounting for 22.3% of the total weight of the CPI. It’s important to understand this when looking at how both inflation and the housing market work together and impact each other.
The inflation rate can impact housing prices through its relationship to interest rates. In Australia, the inflation rate and the cash rate are strongly correlated as the inflation rate has an influence on the RBA’s decision to adjust the cash rate. The RBA may increase or decrease the cash rate as a means of meeting the inflation target. The cash rate is then used as a major factor for lenders in determining the interest rate for home loans.
Some considerations when understanding how inflation impacts housing prices can be seen by looking at the intent of the cash rate decisions. For example, if the RBA lowers the cash rate, this can be a means to stimulate the economy. With a low cash rate, interest rates are likely to lower, making buying homes become more affordable and property prices tend to increase. This is similar to what we are currently experiencing in Australia as the cash rate and interest rates are at record lows and many of the country's major property markets are experiencing booms.