The RBA must confront its credit growth challenge

Talk of tax hikes and spending cuts in the budget will weigh on consumer, business and investor sentiment, with wildly uneven credit growth certain to complicate the RBA's rebalancing of the economy.

Housing is too hot; business is too cold; and personal lending is definitely not right. As the budget approaches, the challenges just keep mounting for the Reserve Bank of Australia.

Housing credit rose by 0.5 per cent in March, to be 5.9 per cent higher over the year. Growth continues to be led by investor activity, with investor credit rising by 0.7 per cent in March.

New investor lending activity continues to be elevated, and I anticipate that investor credit growth will push back towards its pre-crisis level of around 10 per cent by the end of the year. Owner-occupier credit growth will not be as strong but is also set to rise to levels that RBA Governor Glenn Stevens might find uncomfortable.


Graph for The RBA must confront its credit growth challenge

In March the RBA noted that “the pick-up in investor activity in the housing market does not appear to pose near-term risks to financial stability”, but it acknowledges that it will continue to monitor the market closely for signs of excessive speculation and riskier lending practices (Investors test the RBA’s homing instinct, March 26). Stevens said that it would be undesirable for annual housing credit growth to climb much higher. But higher it will surely go.

But while housing credit may cause problems because it is too strong, business credit is creating its own issues -- it continues to be fairly weak. Business credit rose by 0.2 per cent in March, to be just 2.6 per cent higher over the year.

Nevertheless, growth has shown tentative signs of picking up since December, rising at an annualised pace of 4 per cent over the past four months.


Graph for The RBA must confront its credit growth challenge

Many businesses are utilising low interest rates to expand their operations, but some firms are taking the opportunity to refinance or pay down existing loan balances.

According to the Australian Bureau of Statistics, business investment activity is set to improve for the non-mining sector over the next couple of years, although investment from manufacturing firms is set to fall sharply. On balance, we should see annual business credit improve, but at this point it seems unlikely that credit growth will return to its pre-crisis level anytime soon.

In contrast to housing credit, personal credit fell by 0.1 per cent in March to be just 0.4 per cent higher over the year. It is difficult to square this away with the rapid rise in house prices, but households are showing a cautious attitude to other credit purchases such as motor vehicles and durable goods.

Recent talk of tax hikes and budget cuts will inevitably weigh on consumer and business sentiment. With many firms already taking a cautious approach, a cut to government spending could result in further hesitation from Australian businesses and a reluctance to take on more risks. Spending cuts could also derail the investor-driven housing boom.

The contrast between housing, business and personal credit has created a difficult balancing act for the RBA. The housing market has arguably become too strong but low rates are necessary to generate greater momentum in business investment and facilitate the rebalancing of the Australian economy.

With sharp spending cuts expected when the budget is released in a fortnight, the RBA will be expected to do more heavy lifting to keep the rebalancing process on track. But unless spending cuts weigh on consumer sentiment and investor behaviour and slow the housing market, it will be difficult for it to provide further rates relief.