Australian Dollar: RBA Concerns on House Prices and Household Debt Weigh

The release of the Reserve Bank of Australia’s August board meeting minutes show the Bank could be inclined to raise interest rates sooner than many in the market might be expecting.

However, that the Australian Dollar has not rallied in response to the prospect of higher interest rates tells us a lot about the current state of the Australian economy.

This is an economy that is seeing increasing levels of consumer debt while not firing on all cylinders.

The minutes betray a central bank that appears increasingly nervous about growing in household debt while appearing less-confident that house price growth is moderating to a satisfactory degree.

The RBA is clearly not in the mood to change interest rates in either direction right now as the Australian economy is not running in top gear with the Bank noting “ongoing low wage growth and the high level of debt…..raising the possibility that consumption growth could be lower than forecast”.

But, there are other developments elsewhere in the economy that could soon force its hand.

"We think the changes to the Minutes do elevate the focus on financial stability in a way that raises the risk of policy action at some point," says David Plank, an economist with ANZ Bank.

The RBA explicitly cites "the need to balance the risks associated with high household debt in a low-inflation environment".

Plank says this is an interesting change from the last couple of Minutes which had references along the lines that “developments in the labour and housing markets continued to warrant careful monitoring."

ANZ don’t think this evolution has yet reached the point where the RBA would move interest rates to better manage the financial stability objective at the expense of the other two.

"We do think, however, that we are closer to the point where the RBA might move interest rates for financial stability reasons if it had a high degree of confidence that the first two objectives were being achieved," says Plank.

The wording around the housing market has changed in a manner that suggests the Bank is less confident that price growth is moderating to a satisfactory degree. It now says that, “while there were signs that conditions in the Sydney and Melbourne markets had eased somewhat, housing price growth in these two cities had remained relatively strong.”

So it could be that an interest rate rise is in fact possible sooner than later - but the impact on the Australian Dollar might not be what we would expect.

Typically a currency rallies in anticipation of a regime of higher interest rates. Indeed, there are signs that the market has started pricing in such an eventuality, evident by the Aussie’s strong run over recent months.

But, were that rate rise be aimed at financial stability as opposed to one coming in reaction to a strengthening economy it might not necessarily be bullish for the currency.

While the rate rise might achieve financial stability by cooling debt growth and house price inflation, it might also spark a retreat by consumers and slow the economy further.

This is an example of where a rate rise turns out to be a negative for a currency.

Hence, the Aussie Dollar’s soft tone in reaction to today’s minutes.

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