The Reserve Bank of Australia raised the cash rate by 25 basis points to 3.1% at its December meeting, the highest level in a decade. 

With inflation expected to peak around 8% in the December quarter, RBA governor Philip Lowe said further tightening is expected in 2023.

But with Australian households among the most indebted in the developed world, Lazard Asset Management portfolio manager Philipp Hofflin outlines the vulnerabilities facing the housing market.

Transcript

Dr. Philipp Hofflin: In Australia, we have per dollar of income for a household twice the household price and twice the debt than they have in the United States. And in addition, as you'd be aware, in the United States, mortgages are lent on a 15 to 25-year fixed basis. So, they never change. While in Australia, of course, pretty much all of our debt is floating rate, that is, it's standard variable or converts to standard variable. So, Australia is much more interest rate sensitive.

Now, we've had 300 basis points pretty much of tightening. Let's see what happens this afternoon. But on the numbers, it looks as if that will reduce the borrowing ability of the marginal buyer by about 24%. And it will no doubt mean that our house prices while they have started to fall, they will probably continue to fall as those increases slowly actually come through. And it is a vulnerability in the sense that when you have very expensive markets, and our housing market no doubt is expensive, and you have a fair bit of debt behind it, that the adjustment process can get out of control, right? The market starts to fall because people lose faith in the asset class, they want to de-gear, they want to sell. And then, you are in a very difficult position because it's then very hard to reverse that. So, I think the RBA will be very aware of that. I'm sure they're looking at these numbers very carefully.

An interesting, sort of, lead indicator is New Zealand for us. It's what we call the Kiwi in the coalmine, because they're sort of six to nine months ahead of us in the interest rate cycle. And as you know, the RBNZ has now raised rates to 4.25%. They're saying they'll go to over 5%. So, in some areas, such as Wellington, prices are already down 20% or a little bit more. So, I think, if problems start to emerge, we will see it in New Zealand first. And I think given that they do have wage increases that are running too high, it seems quite likely that New Zealand will have a recession even if in Australia, I think, perhaps the jury, as I said earlier, is still out.