PHILIP LOWE: The spike in household debt has left Australia vulnerable

Reserve Bank of Australia Governor Philip Lowe at a parliamentary economics committee hearing in September 2016. Photo: Peter Parks / AFP / Getty Images.

Reserve Bank of Australia (RBA) Governor Philip Lowe today said the surge in Australia’s household debt has reduced the economy’s resilience to future shocks.

In a speech to the Economic Society of Australia in Queensland, Lowe said Australian banks were relatively well safe-guarded from financial stability risks in the event of a house-price correction.

However, given the recent uptick in household debt — from already elevated levels — Lowe noted the economy was more susceptible to reduced household spending:

Lowe acknowledged that low interest rates had played some role in the recent price action, which has seen both house prices and the level of household debt jump higher. At the same time, he said other key factors have also played a role.

Specifically, he highlighted a noticeable drop in the growth of household income over the last four years. That lower level of income, combined with higher household debt provides lends weight to the RBA’s concerns about reduced levels of consumer spending in the economy:

“In terms of resilience, my overall assessment is that the recent increase in household debt relative to our incomes has made the economy less resilient to future shocks,” Lowe said.

Regardless, Lowe made it clear that in terms of financial stability concerns, the RBA does not buy into doomsday scenarios about a potential housing market collapse.

“The Australian banks are resilient and they are soundly capitalised. A significant correction in the property market would, no doubt, affect their profitability. But the stress tests that have been done under APRA’s eye confirm that the banks are resilient to large movements in the price of residential property,” Lowe said.

He said that in terms of mortgage-related stress, the RBA’s data “indicates that around two-thirds of housing borrowers are at least one month ahead of their scheduled repayments and half of borrowers are six months or more ahead”.

Lowe said that Australian housing differs to the US market in the lead-up to the sub-prime crisis in terms of the distribution of debt. He said that in the US, many loans were approved for lower-income borrowers while in Australia that wasn’t the case.

“If we look across the income distribution, it is clear that the rise in the debt-to-income ratio has been most pronounced for higher-income households,” Lowe said.

Despite that, Lowe said the higher the level of household debt, the more sensitive individual households will be to declining house prices or incomes, or both.

“If this result were to translate to the aggregate level, it would mean that higher levels of debt increase the sensitivity of future consumer spending to certain shocks,” Lowe said.

Lowe also noted a key difference in consumer behavior as house prices have roared ahead of incomes.

“In earlier periods of rising housing prices, the household sector was withdrawing equity from their housing to finance spending. Today, households are much less inclined to do this.”

That reduced level of debt for consumption purposes is evident even in the current environment of low interest rates, which means that discretionary spending in the economy would be particularly sensitive to any rate rises in the future.

In light of the risks facing the economy from reduced consumption, Lowe commended the recent macro-prudential (MacroPru) measures undertaken by APRA to control spiraling mortgage debt.

He said that in the current environment, “the resilience of our economy would be enhanced by an extended period in which housing prices and debt outstanding increased no faster than our incomes”.

That might be easier said that done, but in addition to MacroPru Lowe was still hopeful that underlying supply and demand imbalances could be rectified.

He said that continued building construction and transport infrastructure improvements would both alleviate supply side concerns, and warned that at some point in the future interest rates would rise.

Lower interest rates “have helped support employment and demand through a significant adjustment in the Australian economy”, Lowe said.

“We should not, though, expect interest rates always to be this low.”

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