FX comment – RBA household stress test study paves the way for earlier rate cut; AUD to weaken

by: Roy Teo

  • Australian households are resilient to macroeconomic shocks and well positioned to service debt
  • Implications on monetary policy and the Australian dollar

 

Australian households are resilient to macroeconomic shocks and well positioned to service debt

According to the Reserve Bank of Australia’s (RBA) stress test on household sector’s financial resilience to macroeconomic shocks, the household sector remained resilient to scenarios involving asset price, interest rate and unemployment shocks. Despite rising levels of household indebtedness, household debt has remained concentrated among households that are in good positions to service it. In addition, lenders’ exposure to households with negative financial margins (incomes estimated to be less than minimum expenses) also appears to have remained limited. Stress tests by the Australian Prudential Regulation Authority in November 2014 also concluded that Australian banks remained above the minimum capital requirement of 4.5% in a severe shock.

Implications on monetary policy and the Australian dollar

Given the slow rebalancing in the Australian economy, this study by the RBA has reaffirmed our view that the RBA should increase monetary stimulus sooner than later. Tougher lending practices and other macro prudential tools can be implemented at a later stage if house price gains and/or speculative activities continue to rise. Though there is a case for the RBA to extend its wait and see approach before cutting the official cash rate (OCR) to 2% in May (after the release of Q1 inflation on 22 April), we maintain our view that the RBA will cut the OCR by 25bp in April. This is because the Australian dollar (AUD) remains above fundamental value and Australia’s key commodity export price, iron ore has declined by 7% to below USD 59 since the last rate cut on 3 February. Given that financial markets are pricing in less than 50% probability of a rate cut in April, the surprise element should provide a strong catalyst for the AUD to decline towards our Q2 target of 0.75.