20/03/2014 - 09:21

Strap in, we’re slowing down

20/03/2014 - 09:21

Bookmark

Save articles for future reference.

High debt levels and rising interest rates are an unpleasant combination, but everyone with an interest in the retail, property and share markets would be wise to see that one factor has arrived and the other one is on its way, potentially producing a pincer-squeeze on spending and growth.

Strap in, we’re slowing down

High debt levels and rising interest rates are an unpleasant combination, but everyone with an interest in the retail, property and share markets would be wise to see that one factor has arrived and the other one is on its way, potentially producing a pincer-squeeze on spending and growth.

Debts, particularly those being carried at the personal level by Australian households, rose sharply over the 20 years to 2008; and while no longer rising, they remain high.

Interest rates, which have been at record low levels, are starting to rise in the country where it matters, the US. How quickly they travel to Australia is the critical question, but it is worth noting that rates rose in New Zealand last week, and are tipped to soon rise in Britain.

The US has not yet moved its interest rates off the low set in the years after the GFC, but the first firm indication that a move up is on the way came last night from the head of that country’s central bank, Janet Yellen.

Her warning of an increase in official rates to 1 per cent by the end of next year sent a shudder through financial markets overnight, taking the gloss off the gold price as investors weighed up the challenge of holding a commodity that pays no interest in a climate of rising rates, and knocking US1 cent off the value of the Australian dollar.

Commodity and share prices can react instantly to fundamental changes in critical pricing elements such as the cost of money. Property prices will react more slowly but it’s a fair bet the recent rising trend in property prices, particularly for residential property, will soon end, if it has not already done so.

While Ms Yellen’s warning about US interest rates heading back to some sort of normal levels after several years of crisis setting is a powerful reminder that the world must eventually move off artificial financial support, the high levels of debt in Australia are not something that can be fixed as quickly.

Government debt, which exploded in the aftermath of the GFC, is a problem for all levels of government in Australia; but what a recent study by Bank of America Merrill Lynch revealed is that personal debt is a bigger problem.

In a report with a headline taken directly from the climate change movie ‘An inconvenient truth’, analysts at the investment bank concluded that Australia’s high levels of debt pointed to a period of “low growth, at best”.

Written before Ms Yellen’s overnight interest rate wake-up call, the Merrill Lynch research revealed that Australian households were at the top end of personal debt levels with a debt-to-income reading of more than 140 per cent, and while that is down slightly on a few years ago it compares with a debt-to-income ratio of less than 80 per cent in the US and less than 60 per cent in Germany.

“By international standards Australians have deleveraged (paid back their debts) only modestly and debt remains high,” Merrill Lynch said.

“Australians, consequently, have limited capacity for higher leverage. This implies modest prospects for Australian growth.”

The bank’s analysis is that the potential for the Reserve Bank of Australia to cut its official interest rates any further is limited, and might not deliver the boost intended.

“We believe we are near the peak impact of rate cuts for building approvals and retail sales,” Merrill Lynch said.

For Australia, the outlook is for a period of below-average growth as it deals with the challenge of the construction phase of the resources boom coming to an end, high household debts, and now the threat of rising international interest rates.

Or, to put it another way, buckle up for the slowdown. 

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

Subscription Options