Financial Review quarterly survey of economists: consumption growth at risk

Financial Review quarterly survey of economists: consumption growth at risk


Growth as a risk

Consumption growth has been highlighted as a risk in the context of low household income growth by the Reserve Bank, which warned in the November statement on monetary policy that declines in housing and equity prices will weigh on household wealth. For that reason it welcomedthe pick-up in wages growthin the September quarter, which was the most in three years.

“The main triggers for turning household debt into a problem are higher unemployment and higher mortgage rates. So much depends on the skills of policymakers in keeping growth on track and inflation in target,” said Michael Blythe, Commonwealth Bank’s chief economist. “The risks come from the combination of high debt levels at a time of very weak growth in household income.”

But well-intentioned policy might have unintended consequences, Mr Blythe warned.

“The risks are accentuated, I think, by actions taken to improve financial stability. For example, the regulators have discouraged interest-only lending. As borrowers convert from [interest only] to principal and interest, they find their repayments lift by 30 to 40 per cent. With weak income growth, the outcome is less available funds for consumers to spend.

“So we have translated a financial stability risk into a macro-economic risk,” he said.

The next statement on monetary policy is due in February, where economists expect that official growth forecasts will be downgraded.

“It’s difficult to say how much debt is too much for households, but historical experience probably suggests that debt-to-income ratios in excess of 150 per cent are consistent with more vulnerability in the household sector/broader economy,” said JPMorgan’s Sally Auld. “Regulators are attempting to engineer a gentle deleveraging of the household sector in order to manage the risk, but progress on this has been slow.”

The household debt-to-income ratio appears to have stabilised at elevated levels of about 189 per cent, she said.

“More time (and stable economic conditions) will be required to bring this ratio to less risky levels,” Ms Auld concluded.

For debt levels to be sustainable, households need at least to be able to service their loans from income without borrowing to meet interest payments, QIC’s Matthew Peter said. “With debt accruing at a rate of more than 4 per cent on interest payments alone and growth in household disposable income of less than 3 per cent, households’ savings rates must be rising, not falling, for debt levels to be on a sustainable path.”

That means debt levels are rising too rapidly and at an unsustainable rate, Dr Peter said. “If income growth fails to pick up over 2019, interest rates will have to fall or savings rates will have to rise if household debt is to come under control,” he warned.

Dovish signal

Dr Debelle’s December speech was inferred as a dovish signal from the Reserve Bank, because he also discussed that interest rates could be cut if economic conditions deteriorated, and other policy measures deployed beyond there. Only three economists think the Reserve Bank will reduce rates in 2019: Stephen Koukoulas from Market Economics, Stephen Anthony from Industry Super Australia, and Shane Oliver from AMP Capital.

Thedeputy governor also said the Reserve Bank was in “uncharted territory”, because it had not seen anywhere in the world such a fall in house prices in two capital cities at the same time that unemployment was going down and growth was reasonable.CoreLogic figures released on Wednesdayshowed Sydney property prices have now reached a correction peak-to-trough, falling 11.1 per cent.

“That speech was totally misinterpreted,” TD Securities’ Annette Beacher said. “He was referring to what has been done, and what could be done again, not [offering] a blueprint for 2019.”

Ms Beacher sees two “completely separate” risks at play: the balance sheet kind, which have been lowered as a consequence of the reduction in interest-only lending – “the fact that lower house prices is collateral damage should be welcomed” – and macro risk, where households can’t cope with higher interest rates.

“This risk isn’t being managed at all. Talk of a rate cut just encourages more borrowing, there are no policies to address record owner-occupier debt levels,” she said.

Macquarie’s Ric Deverell said it was not that useful in reality to settle on an aggregate household debt-to-income figure that was “too high”.

“Other countries and their banking systems have run into problems with household debt ratios at vastly different levels prior to the issues emerging,” he recalled. “Some reduction in the aggregate household debt-to-income ratio, however, would be a good thing.”

Debt distribution

HSBC’s Paul Bloxham said it was the distribution of debt that mattered, not the aggregate level. “Different households can handle different amounts of debt. The key is having a financial system that ensures that households do not take on more leverage than they should.”

In an imprecise sense, when households are borrowing significantly to purchase multiple investment properties, and using equity release to finance luxury purchases, “they have too much debt”, according to Industry Super’s Mr Anthony. “Back [in 2016] we said this was all unproductive and will end in tears. You can see now the tears are beginning to flow. Meanwhile, SMEs still can’t [borrow] a zac from a major Australian bank.”

He disputes that the risks are being appropriately managed.

Graham Harman from Russell Investments believes that to manage leverage risk, anything over 100 per cent is too much in household debt-to-income terms.

“In my view, if the thing you’re invested in is returning more than the cost of the debt, then you can never have too much debt, or pay it off too slowly. And if the thing you’re invested in is returning less than the cost of the debt, then you can never have too little debt, or pay it off fast enough,” he said.

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