(Bloomberg) -- Australia’s record household debt was a key factor in the Reserve Bank’s cautious approach to tightening, and now housing is an important consideration in the RBA becoming an outlier in the easing cycle and keeping interest rates on hold this week.

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Housing costs, including rents, constitute roughly a fifth of Australia’s consumer basket and are the biggest driver of inflation after services. That helps explain Governor Michele Bullock’s hawkish rhetoric and why economists see the RBA holding the cash rate at a 12-year high of 4.35% on Tuesday — and keeping it there until at least February.

As the Federal Reserve kicked off its easing campaign last week, the RBA’s message had been clear: it’s “premature” to consider rate cuts. Underlying inflation in Australia is running at 3.9% — well above the 2-3% target — and the RBA expects it will only return to the band in late 2025.

“The Australian circumstance is perhaps no coincidence given that the RBA has been less aggressive than the Fed in raising the policy rate to tackle inflation,” said Stephen Miller, an investment strategist at GSFM. “The flip side is that it might need to exercise a little more patience when it comes to cutting.”

Many economists, including Westpac Banking Corp. and Goldman Sachs Group Inc., expect the RBA will undertake a shallow easing cycle when it finally starts cutting, reflecting its cash rate peaking 1 percentage point below the Fed’s.

From the outset, the RBA has been concerned about how much tightening Australians could absorb given they are among the most indebted in the developed world. But it’s the supply side that has turned out to be the main problem as a surge in post-pandemic immigration and soaring residential construction costs triggered a housing squeeze. That sent rents soaring, adding to inflation, and kept property prices rising in a period of restrictive policy.

Mortgage lending, excluding-refinancing, rose 3.9% in July from a month earlier, while home loans to investors jumped 5.4% to be up 35.4% from a year earlier, according to government data. The level of investor lending, at A$11.7 billion ($7.97 billion), is close to a January 2022 peak.

The strong demand for housing has come as build times for new projects have blown out since the pandemic by around 20% from approval to completion, while costs have risen by around 40%, according to Masters Builders CEO Denita Wawn.

“The government’s priority should be growing the building and construction workforce,” Wawn said, calling for a boost in the number of skilled migrants. “Domestically, we cannot fill this gap.”

Residential construction has the second-largest economic multiplier of all 114 industries that make up Australia’s economy, according to a government report. Underlining the sector’s importance, each A$1 million of residential construction output supports nine jobs across the economy.

The worker and materials crunch has meant that housing starts over the past 12 months have run at 165,000 – well below the 250,000 needed just to keep up with demand, according to Diana Mousina, deputy chief economist at AMP Ltd.

Soaring input costs and a nationwide shortage of housing drove annual rental inflation to 7.3% in the June quarter, while home prices are at record highs in Sydney. The danger is that any rate cut will further fuel the property market.

Still, some economists reckon the RBA won’t wait for a cooling in housing before embarking on rate cuts.

What Bloomberg Economics Says...

“The RBA would like to see housing costs come down but it won’t necessarily wait for it before starting rate cuts. Employment and domestic demand conditions are more crucial.”

— James McIntyre, economist

The RBA’s rate hikes have slowed economic growth markedly, largely due to weak consumption while strong population gains and higher government spending have kept Australia out of recession. The labor market, meanwhile, remains surprisingly resilient with the unemployment rate holding at 4.2% in August.

Oxford Economics reckons Australia hasn’t really experienced this combination of anemic GDP growth and very low unemployment in its recent history. Economist Sean Langcake pointed to weak productivity and a monetary-fiscal “policy mismatch” among factors making for a slow disinflation cycle. He expects rate cuts to only begin in the second quarter of next year.

Gareth Aird at Commonwealth Bank of Australia, the nation’s largest lender, says the outlook for housing inflation is “slowly improving,” as price pressures for both construction inputs and rents begin to cool.

“A firmer disinflationary pulse than the RBA expects in the third quarter of 2024 is a necessary ingredient to see the RBA commence an easing cycle this calendar year,” said Aird. “But the evolution of the unemployment rate will also play a big role when the central bank joins its global peers in cutting rates.”

Third-quarter inflation is due on Oct. 30.

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