Interest rates and debt

In minutes released of its February 17 board meeting, the Reserve Bank of Australia flags that its cuts to official interest rates may slow. It seems that the financial gurus at the RBA are unhappy that their cuts to interest rates (passed on only in part by the banks to home-buyers, and even less to credit-card debtors), have failed to stimulate enough spending.

The minutes state: "Households had not as yet scaled back their loan repayments after recent falls in interest rates, preferring instead to pay off debt faster." The minutes also note that housing prices had fallen. "In the established housing market, house prices fell by about 3 per cent on average across Australia over 2008", they report. They also note that "conditions in the labour market were softening" in 2008 and that unemployment was destined to rise.

Little wonder then, under these conditions, that home buyers are choosing to bank savings made on interest rates, by paying more than the minimum on their mortgage, rather than spend them. Household debt in Australia continues to remain among the highest in the world.

At the end of November, credit card debts had climbed to more than $45 billion, according to the RBA's own figures. Meanwhile, households were paying an average of 15% of their income servicing debts, which averaged 156% of their annual income — up from less than 35% in 1977.

Working people are in the precarious situation of owing billions of dollars in debt, at a time when their continuing job prospects are dimming. A steep rise in unemployment could see a big increase in mortgage defaults and a consequent slump in the price of houses.

A similar such slump set off the chain reaction that caused the subprime crisis in the US to unfold. What further impact might it have here?

From GLW issue 784