Reserve Bank interest rate moves limited by high debt, rising house prices

Fears of inflating housing bubbles in Sydney and Melbourne are stopping the Reserve Bank from cutting interest rates to boost the economy, the central bank governor conceded today.

The stark admission by Reserve Bank governor Phillip Lowe about the RBA's dilemma comes as soaring house prices in the eastern states have Australians carrying "more debt than they ever have before".

Dr Lowe delivered the reality check at the Australia Canada Economic Leadership Forum, where he said low interest rates made it attractive for borrowers in both countries to invest in real estate, making further rate cuts an undesirable option.

"We are trying to balance multiple objectives at the moment," he said in response to questions after the speech.

"We'd like the economy to grow a bit more quickly and we'd like the unemployment rate to come down a bit more quickly than is currently forecast.

"But if we were to try and achieve that through monetary policy it would encourage people to borrow more money and it probably would put more upward pressure on housing prices and, at the moment, I don't think either of those two things are really in the national interest."

For the moment, it looks like the Reserve Bank feels content — or locked in — to leaving official interest rates on hold at a record low 1.5 per cent.

However, Dr Lowe expressed optimism that this level of rates was low enough to spark business investment and stronger economic growth, and therefore there would be no need to lower rates further.

"I think there are signs that things are improving in the economy — we've seen it in a whole range of business indicators in the last couple of months," he said.

"So the hope is that the current setting of monetary policy will generate stronger growth and we can avoid a further upward pressure on housing prices."

Rate rises should be 'welcome'

Globally, the US economic recovery and Donald Trump's stimulus plans have put interest rates on an upward trajectory for the first time since the financial crisis.

Given that Australia's banks borrow hundreds of billions of dollars from overseas, these rate increases are already filtering through to higher costs and independent rate rises on certain loans, such as fixed-rate mortgages and investment lending.

Dr Lowe, however, painted these rate increases in a positive light.

"We should welcome a gradual rise of interest rates in the world, because it would mean that the acute appetite to save would be diminishing but, more importantly, that the return to underlying capital formation [business investment] is higher and businesses are prepared to use the world's saving to increase capital formation and [promote] stronger growth," he said.

Record household debt limits scope for rate rises

However, in his speech, Dr Lowe acknowledged the risk that high household debt levels posed to the Australian economy.

Speaking in Sydney this morning, he said some households were carrying "more debt than they have before", while slower income growth was putting pressure on their ability to service loans.

Reserve Bank figures show the Australian household debt-to-income ratio is at a record 187 per cent, mostly due to mortgage debt.

If interest rates were to rise, Dr Lowe warned that many consumers might have to severely curtail their spending to keep up their repayments.

"It is possible that continuing rises in indebtedness, partly as a result of low interest rates, increase the fragility of household balance sheets," Dr Lowe warned.

"At some point in the future, households, having decided that they have borrowed too much, might cut back consumption sharply."

But he said both central banks were "watching carefully" for signs of stress in the interaction between consumption, saving and borrowing.

"It is one of the key uncertainties around our central scenario for the Australian economy," Dr Lowe said.

"It is difficult to quantify this risk but it is one that is difficult to ignore."

Dr Lowe's comment came amid concerns about dangerous potential real estate bubbles in Sydney, Melbourne and Brisbane, fuelled by record low interest rates.

Last week, the Commonwealth Bank announced an out-of-cycle rate rise for investor loans to keep within guidelines from the Australian Prudential Regulation Authority.

Dr Lowe is expected to face more scrutiny on the outlook for interest rates and the broader economy when he faces the House of Representatives Economics Committee on Friday.

Follow Peter Ryan on Twitter @peter_f_ryan and on his Main Street blog and Michael Janda on Twitter @mike_janda.