RBA dilemma: raising interest rates may help the economy but cripple many households.
Australia’s household debt levels are so high that many will be left vulnerable should we see a rise in global interest rates or any other economic downturn.
Australian households are among the world’s most indebted after a $1 trillion splurge on mortgages over the past 10 years.
The Bank of International Settlements (BIS) warned that should global interest rates rise, many Australian households would find themselves in a terrible financial position.
According to the Reserve Bank of Australia (RBA), Australia’ household debt-to-income ratio is at an all-time high of 189 per cent. This figure has risen sharply in recent years after sitting at around 160 per cent for much of the 2000s and 60 per cent in the early 90s.
It is estimated that, of the country’s 3.1 million households, around 670,000 can’t afford to cover their living and interest rate costs, even though borrowing costs are at historically low levels.
The BIS report underlines the risk many households face by accumulated high debt levels during a period of low interest rates.
"Maturing financial cycles and high debt levels raise the risk of potential weakness in consumption and, in some cases, investment," said BIS head of monetary economics Dr Claudio Borio.
"In many economies, the expansion has been consumption-led. The empirical evidence indicates that such expansions are less sustainable. Our analysis suggests that a number of economies where household debt is historically high can be vulnerable, especially should interest rates rise considerably."
The report showed that household debt in Australia, Canada, Sweden and Switzerland, rose by two to three percentage points in 2016.
When interest rates rise – and they will eventually rise – household spending will be reduced considerably, which could weaken GDP growth.
Low interest rates may have helped to fuel a housing boom, but increasing these same rates, although good for anyone living off the interest from savings, will be a disadvantage to the consumer sector, putting the RBA in a tough spot.
Stagnant wage growth and the risk of slowing down consumer spending, which accounts for around 60 per cent of our economy, makes it very difficult for the RBA to increase the official cash rate.
This is bad news for retirees who have been receiving less income from savings and investments as a result of the lower official cash rate. Many retirees are already feeling the pinch of living off a limited income, possibly making it more likely for them to take risks with their investments.
So, while the low cash rate is currently working for the economy, increasing it in the future will certainly have some benefits for retirees. And if the increasing ageing population can start spending again, it may offset some of the reduced spending of other generations
Is the low cash rate a blessing or a burden on you?