Bank of America Merrill Lynch chief economist Saul Eslake reckons that RBA rate cuts won’t work unless the government and the RBA can rebuild confidence – both at consumer and business levels.
But that’s not going to stop the RBA from cutting rates again given, since that’s the only tool it has in its kit – apart from outright sale of Aussie dollars to drive its value down, which the RBA seems unwilling and unlikely to do.
While economic growth may still struggle at a ‘below trend rate’, the RBA’s rate cuts are likely to drive up property prices and with them, the level of household debt in Australia, Eslake says.
Eslake is forecasting a 6-7% growth in dwelling prices, which is “entirely based on leverage.”
This means that:
The debt to income ratio for households will likely continue to rise. This is from an already record high of 152.8% as of September. Indeed on the majority of measures and metrics Australiaâ€™s household debt level is already high compared to our own history and other developed nations.
To put this level of debt into perspective, last week credit rating agency Standard and Poors warned the government, via the Wall Street Journal, that its AAA rating would be at risk if the level of debt approaches 30% of GDP. Australian household debt is currently above 125% of GDP.
Eslake says “The household sector holds more debt than the non-financial business sector and all levels of government combined. And as a proportion of GDP more than any other comparable developed economy.” He says that the high level of debt “may create problems for the household sector once interest rates do inevitably rise as the debt servicing ratio rises relatively sharply.”
Indeed, Eslake argues that Australian dwellings are overvalued on a longer term basis if we assume a normalisation of rates in the future. By year’s end, assuming further RBA cuts, this ‘overvaluation’ will be around 12.5%.
The worrying thing about Eslake’s argument is that:
- RBA rate cuts won’t get the economy moving enough to get back to trend
- RBA rate cuts will add further upward pressure to drive dwelling prices
- RBA rate cuts will drive household debt higher than already incredibly high levels
- RBA policy implies a risk to macroeconomic stability
The upshot according to Eslake is that when rates do normalise in the future this “implies some damaging economic consequences if we assume the wealth effect works as prices decline as is being done (by the RBA) as they are rising.”
It’s a bleak picture of an economy with only one lever of growth and it feels a lot like the United States before the sub-prime debt problems, which caused the GFC.
That is, the RBA policy is implicitly borrowing growth from the future to plug a hole in the present. But in doing so the Australian economy is becoming dangerously overburdened with household debt.