Australia’s economy is giving off mixed signals: Even as GDP growth and income slow, household debt appears to be rising. Understanding what is driving household behaviour has important implications for policy and interest rates.
- To determine what is driving household leverage, we statistically tested the response (the change) in household leverage against changes in several key variables including wages, unemployment, asset prices, confidence and the cost of credit.
- We found that households’ decision to incur debt is dominated by the cost of debt (the mortgage rate) and recent asset price appreciation; we also found that Australian households appear to respond quickly, needing only two quarters of favourable changes in asset prices and mortgage rates to increase leverage.
- Based on our model, if an exogenous shock sparked a deleveraging cycle in Australia, it would be expected to be quite severe given the large co-efficient for asset prices and the quick household response.
- We believe macro-prudential measures should be strengthened to address financial stability risk and give the Reserve Bank of Australia maximum flexibility when setting policy for the aggregate economy.
- Given the sensitivity of households to mortgage rates, the peak in the cash rate in the RBA’s next hiking cycle is like to be much lower than in in previous cycles. This is in accordance with PIMCO’s New Neutral view that calls for much lower policy rates for an extended period.
Click here to read the full report from PIMCO.