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Reserve Bank says Australia’s house prices could pose ‘risk to financial stability’

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Australia’s ballooning housing prices – and the associated household debt for mortgage holders – could pose a risk to the economy’s financial stability in the event of a sudden downturn in prices.

Ahead of its annual financial stability review, the Reserve Bank has been looking at Australia’s house prices, particularly the growth in New South Wales and Victoria, and the potential risks to the economy as a whole.

At the moment, the central bank could be described as alert, but not alarmed, with the strength of the housing market seen as being an overall positive for the economy. The flipside, though, is it could leave both households, and to a lesser extent Australia’s banks, vulnerable, if housing prices suddenly crashed.

In a speech, the RBA assistant governor responsible for financial stability, Michele Bullock, said housing credit was at an annualised rate of about 7%, with a peak of 11% probably around early next year.

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“With the increase in housing prices and housing debt, risks to financial stability could be building,” Bullock said.

Low interest rates were one of the reasons for market growth, with housing loans seen as serviceable, while Bullock also acknowledged government programs such as the Homebuilder scheme had helped support the construction industry.

But the growth in the housing market had led to Australia’s banks growing their loan sheets, with homes accounting for about 60% of bank’s lending.

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That doesn’t mean Australia’s banking system is at risk of a GFC-style collapse though, with their balance sheets overall still in a very strong position. But it does increase the risk Australia’s banks are exposed to.

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More exposed, though, are the borrowers themselves. Australia’s household debt has increased over the last 30 years.

The increase in housing prices has pushed up the level of debt Australian homeholders enter into. An economic shock, such as a longer than anticipated recession, downturn in the job market, or drop in the housing market, could lead to a drop in consumption, meaning the economy as a whole would suffer.

“For example, in a recession in which a large number of indebted households suffer reduced income, from say a loss of employment or reduced hours, they might choose to reduce their consumption,” Bullock said.

“It may be just precautionary. But if households are constrained, in the sense that they don’t have a great deal of income left after meeting their debt servicing requirements and the basics of their lifestyle, they are more likely to reduce consumption. This will amplify the initial impact of the economic shock.”

Which is why the RBA, which has no plans to raise interest rates until it sees inflation consistently reach 2% to 3% (which would mean a marked increase in wage growth) will be keeping a close eye on the housing market, in terms of what it could mean for the economy at large.

“Even though the banks have strong balance sheets and lending standards are being maintained, there is a risk that, in this environment, households will become increasingly indebted,” Bullock said.

“A high level of debt could pose risks to the economy in the event of a shock to household incomes or a sharp decline in housing prices. It is these macro-financial risks that warrant close watching.

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“Whether or not there is need to consider macro-prudential tools to address these risks is something we are continually assessing.”