What’s Really Driving Australia’s House Prices Higher?

Lower inflation, financial deregulation, stronger population growth and housing supply constraints have all shaped Australia’s property market

Australia’s housing market has experienced a dramatic increase in property prices relative to household incomes over the past three decades. Speaking to a Senate Committee examining intergenerational housing inequality, Westpac chief economist Luci Ellis, a former RBA assistant governor, explained that the reasons extend well beyond the recent housing boom.

According to Ellis, a significant part of the long-term increase can be traced to lower inflation and the resulting decline in average nominal interest rates, combined with financial deregulation that occurred during the 1980s and 1990s.

Lower inflation changed borrowing capacity

Australia’s move towards an inflation-targeting framework in the early 1990s helped bring inflation and average nominal interest rates down from the much higher levels experienced in previous decades.

Ellis explained that when interest rates are lower, households can service a larger mortgage for the same repayment as a share of their income. Greater borrowing capacity can then translate into households being able to take on larger loans and accumulate larger deposits relative to their incomes.

Over time, this creates an important connection between borrowing capacity and property prices. As households are able to support larger mortgages, the amount they can potentially spend on housing can increase, contributing to higher prices relative to household incomes.

Ellis therefore described much of the increase in the house price-to-income ratio as a multi-decade consequence of lower inflation and financial deregulation rather than simply a recent development.

Population growth adds to housing demand

More recently, however, the housing affordability discussion has increasingly focused on the balance between demand and supply.

Australia has experienced relatively rapid population growth compared with many other OECD economies, partly reflecting its approach to migration. More people create additional demand for housing, increasing the need to build enough properties to accommodate a growing population.

Ellis said this creates a larger challenge for Australia because housing supply has not always been able to keep pace with the number of people needing homes.

Supply constraints add further pressure

The supply side is another important part of the equation. Constraints on the ability to build enough properties can make it harder for new housing supply to respond quickly when demand increases.

This pressure has been particularly visible in rents in recent years, while limited supply can also contribute to higher house prices. Ellis noted that rental pressures have been more pronounced recently, although they were not as significant a decade ago.

The combination of population growth and constraints on construction therefore creates an ongoing challenge for Australia's housing market.

What it means for investors

For investors, the discussion highlights that Australia's property-price growth has been shaped by structural forces operating over several decades. Lower inflation and financial deregulation increased borrowing capacity, while population growth and constraints on housing supply have added further demand pressure.

The future direction of property prices will therefore depend not only on interest rates, but also on how effectively housing supply responds to population growth and changing demand.

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