Australia Defies Hawkish Talk as Lowe Frets Over Household Debt

  • Global backdrop and investment picture are signs of optimism
  • But wage weakness and record debt leave consumption at risk

RBA Holds Key Rate at 1.5%

Australia’s central bank failed to join global counterparts in talking up policy tightening, with Governor Philip Lowe instead reiterating concerns that record household debt and weak wage growth leave consumption vulnerable.

While speculation gathered in currency markets that the Reserve Bank of Australia would follow the Bank of England and Bank of Canada in taking a hawkish turn, the last thing Lowe would have wanted is to trigger a currency surge. The RBA is traditionally comfortable with failing to meet market expectations and it did so in its shortest statement since October, at 493 words.

Lowe did show some optimism: business conditions have improved and capacity utilization has increased; and business investment has picked up in areas of Australia unaffected by mining. In addition, resource-orientated regions are almost through the multi-year unwinding of investment, he said. 

But it was the RBA chief’s references to household debt, which has climbed to a new record, that were most noticeable.

  • “Consumption growth remains subdued, reflecting slow growth in real wages and high levels of household debt”
  • “Growth in housing debt has outpaced the slow growth in household incomes” and recent lending curbs from the bank regulator “should help address the risks associated with high and rising levels of household indebtedness”

Read More: RBA Holds Key Rate to See If Hiring Burst Augurs Wage Rises

Lowe again pointed to the mixed nature of the nation’s labor market -- a key indicator. While the last three monthly reports have shown strong hiring gains and unemployment has dropped to 5.5 percent from 5.9 percent, under-employment remains high. There’s still plenty of slack in the labor market and this is the epicenter of any turnaround on wages -- which are increasing at the slowest pace on record.

The central bank said wage growth is likely to remain low for a while yet. Core inflation remains below the central bank’s 2 percent to 3 percent target and is only forecast to “increase gradually” as the economy strengthens. As an aside, the RBA dropped its reference to an economic growth forecast of 3 percent and said the recent slowing in gross domestic product partly reflected temporary factors, like weather, but not all of it.

“The RBA has explicitly chosen not to adopt a more hawkish tone,” said Sally Auld, head of fixed-income and currency strategy for Australia at JPMorgan Chase & Co. “Ultimately, a more hawkish central bank requires the distribution of risks around both growth and inflation to have improved, such that the current setting of financial conditions is no longer appropriate. Our sense is that this is not yet the case in Australia.”

Keeping interest rates relatively low remains important -- not just to cushion the transition away from mining investment, but to try to stimulate businesses to borrow and invest, and in turn, hire. Lowe again warned an appreciating currency would complicate the economy’s adjustment -- which is why any observers who were expecting a hawkish turn had put hope above experience.

The Aussie dollar dropped more than half a U.S. cent to 76.18 cents at 4:45 p.m. after the RBA failed to adopt a hawkish stance. Three-year government bond yields fell 6 basis points to 1.96 percent, their biggest decline since March.

Property Prices

The housing market has shown some signs of cooling -- following the introduction of lending curbs in response to a doubling of property prices in Sydney and Melbourne -- but that will, like faster wage growth, take time to take hold.

The bigger picture of a simultaneous, broad-based pick-up in the global economy is very much front of mind for the central bank. Increasing international demand may mean greater strength in commodity prices that underpin Australian exports. 

Yet it’s the consumption picture that’s important. Households who are saving less as they need every dollar to service debt and meet other cost of living expenses suggest that any unexpected shock to the economy could see spending fall fast. Since consumption accounts for more than half of GDP, that would be a big problem indeed.

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