Yes, the Reserve Bank is worried about high levels of debt, high housing prices, but more importantly, Governor Philip Lowe reckons a greater concern for the bank that if the proverbial hits the fan, a new risk could be triggered and that is the damage a downturn does to consumer confidence and spending.
He says while a sharp fall in house prices would hit Australian banks’ profits, they would not cause them to collapse because they have strong levels of capital.
In fact what he said in his much awaited speech in Brisbane yesterday on “Household Debt, housing Prices And Resilience” was that the more dangerous impact would be on the level of consumer demand which could trigger a much larger problem.
In fact the speech represented the new criteria a Philip Lowe-led central bank will now assess when considering the level of interest rates.
He revealed that the Reserve Bank will start factoring in the impact of future rate rises on consumer demand, given the high level of debt.
Usually the central bank watches inflation and employment very closely and then other factors such as the level of demand, wages, the trade account, housing etc.
Now the level of consumer confidence and activity has bene promoted up the pecking order for the central bank when it considers interest rates.
Inflation and employment remain vital, but consumer demand and the level of household has joined them.
Dr Lowe says the bank now believes that the higher levels of household debt means future rate rises will have a much bigger impact on consumer activity than in the past.
“The recent increase in household debt relative to our incomes has made the economy less resilient to future shocks," he told a Brisbane business economists lunch.
Dr Lowe said that it was now commonly accepted that house prices and debt levels mattered in the debate about financial stability.
"What people typically have in mind is that a severe correction in property prices when balance sheets are highly leveraged could make for instability in the banking system, damaging the economy," he said.
"There is, however, likely to be an asymmetry here. When the interest rate cycle turns and rates begin to rise, the higher debt levels are likely to make spending more responsive to interest rates than was the case in the past. This is something that we will need to take into account.”
But Dr Lowe said this was not in fact the focus of the RBA as it considered risks to the economy from housing debt if the property market turned south.
He said Australian banks (Really the Big Four) were “resilient and soundly capitalised” meaning they would suffer a drop in profitability but would not collapse.
"Instead, the issue we have focused on is the possibility of future sharp cuts in household spending because of stretched balance sheets," he said.
"Given the high levels of debt and housing prices, relative to incomes, it is likely that some households respond to a future shock to income or housing prices by deciding that they have borrowed too much.
"This could prompt a sharp contraction in their spending, as they try to get their balance sheets back into better shape. An otherwise manageable downturn could be turned into something more serious.
So the financial stability question is: to what extent does the higher level of household debt make us less resilient to future shocks?”, he asked.
Dr Lowe said that was a difficult question to answer given house prices and the accompanying debt were both at record levels.
But he pointed out that while they had done so in the past, Australian households now appeared less likely to use the equity in their homes to put more money into housing.
"Households are much less inclined to do this. Many of us feel that we have enough debt and don’t want to increase consumption using borrowed money,” Dr Lowe said.
"Many also worry about the impact of higher housing prices on the future cost of housing for their children.
"This change in attitude is also affecting how spending responds to lower interest rates. With less appetite to incur more debt for current consumption, this part of the monetary transmission mechanism looks to be weaker than it once was,” he added.
In his speech, Dr Lowe warned Australians shouldn’t expect official rates to remain at their current record low levels forever. But he also made it very clear he was not signalling a rate rise in the near term.
