Financial stability & its potential bearing on eventual RBA rate cuts
The RBA is alert to the possibility that eventual rate cuts might spur risky borrowing by already-heavily-indebted households.
This week’s board minutes reported that the special topic at the late September RBA board meeting was the staff’s semi-annual assessment of financial stability risks.
This involved pointing out the usual risks to Australia’s financial stability, such as low risk premia reflecting market expectations for a global soft landing that may not be realised against a backdrop of rising public-sector debt and a lack of fiscal discipline, as well as longstanding concerns about the Chinese financial system.
Interestingly, the board concluded its assessment with a “[discussion of] the potential for financial sector vulnerabilities to build if easier financial conditions were to lead higher risk borrowers to take on excessive debt and/or lenders to compete more aggressively by lowering lending standards”.
Put simply, this is an acknowledgement of the threat to financial stability when households already have a lot of debt and banks and borrowers might both take more risks when the board eventually cuts interest rates, which could happen in response to either unexpectedly good news on inflation and/or a sharp rise in unemployment.
Ordinarily, economic concerns take precedence over financial stability when the RBA sets interest rates, but the board noted “the RBA review’s recommendation that decisions about monetary and macroprudential policy should be coordinated in such a situation”.
It remains to be seen whether the RBA would, in practice, place more weight on financial stability given to date it has placed most emphasis on retaining the COVID-era gains in the labour market, but it could conceivably constrain the size of an eventual easing cycle.
All these issues are brought home by the following charts which contrast how Australia has deviated from the largest advanced economies.
Firstly, unlike the US and euro area, monetary policy is not particularly tight in Australia when judged by comparing the real policy rate – defined as the policy rate less the central bank’s forecast of year-ahead underlying inflation – with the central bank’s estimate of the neutral real rate.
Secondly, high mortgage rates have not stopped Australia’s household debt from continuing to grow at a solid rate, unlike the weak growth seen in the US and negligible growth in the euro area.
Thirdly, household leverage has reached a new record high in Australia, with total liabilities now slightly more than two times annual income. This contrasts with households reducing already much lower gearing ratios in the US and euro area, where, excluding the COVID-episode extremes, US leverage is now the lowest since the late 1990s and euro area leverage is the lowest since the mid 2000s.
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Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy, contributing to the investment decisions of the firm. Kieran has long experience as a macroeconomist in both the private and public sectors. He has worked most recently as Chief Markets Economist for National Australia Bank and was previously Chief Economist, Australia and New Zealand, for Barclays Bank and ABN Amro Bank/RBS. Kieran also worked as Principal Adviser on the macroeconomy and budget policy in the Commonwealth Treasury and Director of Forecasting.
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Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy,...
Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy,...
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