Heavily indebted Australian households and governments are being urged to build greater financial resilience against a global economy facing fresh uncertainties following the rise of Donald Trump, the Reserve Bank of Australia and International Monetary Fund have suggested.
Days of mounting turmoil on global bond markets have sent yields sky-rocketing, stoking a financial market rout that threatens to ultimately test the ability of Australian borrowers to weather a surge in the global cost of money.
In a major speech in Melbourne on Tuesday night, Reserve Bank governor Philip Lowe hinted that he was unlikely to grant households further official interest rate relief lest it generate even more borrowing – even if the economy could use more consumer spending.
"It is unlikely to be in the public interest, given current projections for the economy, to encourage a noticeable rise in household indebtedness, even if doing so might encourage slightly faster consumption growth in the short term," Dr Lowe said.
While Australians could "take some comfort" that the country still has the ability to fend off future shocks – including a flexible currency and remaining federal budget firepower, and a high household savings rate – he warned that "strengthening these buffers makes sense in the uncertain world in which we live."
The warning came just hours after the IMF suggested that a sudden outbreak of Trump-style protectionism that may slam global trade is among the biggest risks facing Australia's heavily-indebted economy in a crisis.
The fund's economists, who have been in the country over recent weeks, challenged Canberra to do more to lift productive infrastructure investment, saying the Reserve Bank no longer has much interest rate ammunition to stave off any sudden downturn.
Bond market investors have been savaged over the past week on speculation a Trump presidency will deliver a boom in debt-financed infrastructure investment and tax cuts, ultimately breaking the global low disinflation affliction that has ground advanced economies down since the 2008 global financial crisis.
Yields have spiked to their highest levels since January around the globe, with Australia's 10-year treasury benchmark trading above 2.7 per cent for the first time in almost a year, though the sell-off slowed on Tuesday.
Cash rate
Bets are also moving against further Reserve Bank interest rate cuts, with the probability of another reduction in the cash rate over the next 10 months narrowing on Tuesday to no more than 12 per cent compared to as much as 28 per cent on Monday. In the US, the jump in bond yields has sparked a repricing of Federal Reserve rate hike expectations, with the probability of a December increase rising to 95 per cent from 83 per cent at the start of the week.
"In a nutshell we think the bond market moves are valid, as a Trump presidency will deliver more growth-friendly policies than has been the case for a long time," said Tamar Hamlyn at Ardea Investment management, a global fixed income fund that specialises in inflation linked securities. "More growth also means more demand for capital, so it is natural for bond yields to rise even if debt levels were to remain steady," he said.
Already there are signs that the "Trump effect" is beginning to squeeze local borrowers. Firstmac, the nation's biggest non-bank lender, and nine other smaller lenders are discreetly tightening the rates on some of their fixed rate products by up to 45 basis points in a move expected to be followed by others, according to lenders and market analysts.
Dr Lowe, speaking at the Committee for Economic Development of Australia's annual dinner in Melbourne, cautioned that high and rising levels of household debt means "we need to watch things carefully."
"It is important that we avoid a build-up of financial imbalances in household balance sheets," he said.
While he said it was difficult to know what level of debt is sustainable as it depends on income growth, lending standards and asset prices, it "surely must be the case that the higher is the debt, the greater is the risk."
Reserve Bank estimates presented by Dr Lowe show that while household debt has reached a staggering 186 per cent of annual household disposable income, the picture isn't as bad once household cash and deposits are counted, even though households with debt typically aren't the same ones with large deposits.
Savings culture
Claiming that consumers are not using their "houses like ATMs" as they did in the decade to the mid-2000s, Dr Lowe said one manifestation of a higher savings culture was that the aggregate balance in mortgage offset accounts and redraw facilities has reached the equivalent of 17 per cent of total outstanding housing loans.
Dr Lowe said this represents a buffer worth 2.5 years of scheduled repayments at current interest rates, and that surveys by the Reserve Bank suggest households in all income brackets are ahead on their mortgages.
On Canberra's budget woes, Dr Lowe said it was important that public finances be placed "on a sustainable track."
"This requires a better balance to be established, over time, between recurrent spending and revenue," he said.
"It is worth pointing out that this does not preclude government spending on infrastructure, where this is backed by a strong business case.
"Such spending can provide support for the economy and can help generate the productive assets that a prosperous economy needs. Done well, infrastructure spending is not inconsistent with establishing a better balance between recurrent spending and revenue. "
Dr Lowe said there has been no shortage of shocks that could have derailed Australia's economy in recent decades, including the Asian crisis, the US tech boom bust and the GFC, as well as the once-in-a-century commodity price boom.
"The point is that we have been able to ride out these and other shocks without too much difficulty.
"In part this is because of the flexibility of our exchange rate, monetary policy and the labour market. We have also avoided the build-up of large financial imbalances. But this resilience is also because when the shocks hit we have had buffers to absorb them."
He finished his speech with an appeal for people to look to the future "with some optimism".
"Australians can continue to enjoy a level of prosperity enjoyed by relatively few people around the world. We have a strong set of fundamentals and a demonstrated ability to adjust to a changing world.
"We should also take some comfort that our system retains buffers against future shocks. Strengthening these buffers makes sense in the uncertain world in which we live."
