Interest rates have never been this low for this long…
To boost the economy after the 2008 crisis, central banks in developed economies around the world lowered interest rates. Now they are looking to normalize rates, and the Bank of England and the US Federal Reserve have started to raise them slowly.
Differently from the Fed and the Bank of England, the Reserve Bank of Australia (RBA) has not raised rates…yet.
It has been keeping interest rates steady at a low 1.5% since August 2016, a you can see in the chart below.
Here is an excerpt from the latest statement from RBA governor Philip Lowe on 1 May:
‘The global economy has strengthened over the past year. A number of advanced economies are growing at an above-trend rate and unemployment rates are low. The Chinese economy continues to grow solidly, with the authorities paying increased attention to the risks in the financial sector and the sustainability of growth. Globally, inflation remains low, although it has increased in some economies and further increases are expected given the tight labour markets. ‘As conditions have improved in the global economy, a number of central banks have withdrawn some monetary stimulus and further steps in this direction are expected…
‘The Bank’s central forecast for the Australian economy remains for growth to pick up, to average a bit above 3 per cent in 2018 and 2019. This should see some reduction in spare capacity in the economy… One continuing source of uncertainty is the outlook for household consumption, although consumption growth picked up in late 2017. Household income has been growing slowly and debt levels are high.’
Interest rates to blame for Australia’s debt
While the global economy is strengthening, the recovery has been slow since the 2008 crisis.
Salary growth has been sluggish, even with low unemployment.
And low interest rates could be part of the reason for this.
Low interest rates have been punishing savers, and rewarding those taking on more debt.
In fact, Australians are now one of the most indebted people in the world.
Is all this debt good? And is it helping Australians build wealth?
Much of this cheap debt has gone to fuel the property market, into mortgages and investment properties.
As you can see in the graph below, housing debt in relation to disposable income has risen from about 50% in June 1997 to 136.4% in June 2017. That is, it has almost tripled in 20 years.
It’s no secret that Australian’s love property. Their belief in the housing market — unlike the US and Europe — hasn’t been shaken…yet.
And, to be honest, I don’t blame them.
At the rate at which housing prices have been rising in the last few years, putting your money in property seems like a great investment.
With such high rates of return, it is not surprising that more people have been looking to get in on the property market, and they are willing to take on increasing amounts of debt to do just so.
The ‘wealth effect’
Yet as property prices keep rising, Australians have had to borrow more than ever just to get a home, or to fund investment homes.
Meanwhile, wages have barely increased.
And, the increase in house prices has not only fueled debt, but has also inflated perceived household wealth. You may have already heard of this, the ‘wealth effect’.
It basically means that, as households perceive that the value of their assets increase, they spend more. This wealth effect is making people feel like they are sitting on a lot of money. Money that they are spending to buy investment homes, to renovate, buy new cars…you name it.
Yet people’s wealth has not increased because of higher wages, but rather because their home values have appreciated. And, as incomes haven’t grown, and the money is tied up on the property, they are taking on more debt to fund that spending.
This is clearly unsustainable. There is only so much you can stretch your salary.
As you can see in the graph below, the percentage of homeowners without a mortgage has been decreasing in the last years.
Source: Business Insider
According to a recent report by SQM, homes in Sydney and in Melbourne could be overvalued by 45% and 49% respectively.
Home prices have started to fall after an increase in credit restrictions.
It’s not surprising. After all, how long can a property market that requires us to take on debt faster than our income is growing go for?
If they keep falling faster, we could see quite the opposite. That is, a ‘negative wealth effect’, where home owners are left with assets that are worth less than what they owe.
The Reserve Bank of Australia has been keeping rates on hold, but lenders are already rising them. And the RBA could very well be raising rates this year for the first time.
This delicate house of cards could collapse if unemployment increases…if interest rates rise…if banks cut access to credit…
We have never had such a long period of low interest rates…and such high levels of debt.
And, in my view, interest rates have only one way to go: up. When they do, those in the best position will be the ones will low level of debt or no debt.
It’s only a matter of time…
Editor, Markets & Money