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The global banking system affecting the Australian economy
Article

The global banking system affecting the Australian economy

Our outlook for the Australian economy is framed around a backdrop of considerable uncertainty. The collapse of numerous banks in recent weeks in the United States and the enforced takeover of Credit Suisse, has highlighted the fragility of the global banking system and sent shudders through global investment markets.

Although swift action by central banks to prevent contagion has appeased markets for now, it is too soon to determine if this banking crisis will be contained. If the Global Financial Crisis (GFC) taught us anything, it is that sometimes the first signs of trouble can prove to be just the tip of the iceberg of a much bigger problem, portending further trouble ahead. In this instance, the much bigger problem is not so much a liquidity problem but a solvency problem – the growing inability to service debt. This looming risk stems from the decade of ultra-low interest rates and seemingly endless rivers of cheap money.

Initially this was necessary for economies to recover after the shock of the GFC, with low rates helping companies focus on debt reduction and balance sheet repair. However, low rates also encouraged a new group of companies and households to borrow amounts beyond their means. The future solvency of these companies where they are currently unprofitable will be heavily reliant on either shareholder injections or the ability to rollover loans on maturity. With lending standards tightening significantly[1] after the collapse of Silicon Valley Bank (SV)B, it is this cohort of companies that is likely to struggle to be able obtain refinancing and be next in line to fail. Similarly, households that can no longer afford their mortgage repayments may soon be forced sellers or face bankruptcy in the absence of sufficient equity. As the chart below highlights for Australian households this burden has climbed significantly over the past year, adding to growing concerns of mortgage stress[2]. Accordingly, it would be premature to suggest that the worst is over given the underlying risks.

Mortgage Repayments – percentage of household disposable income (Mar-09 – Dec-22) 

Source: RBA, APRA, ABS; Note Dec-22 observation is an estimate

Regardless of any deterioration in the current banking crises, our view that the Australian economy will continue to slow over the rest of the calendar year remains unchanged. This is because a number of key events already set in motion are unlikely to be derailed. The first and foremost is the impending ‘mortgage cliff’.

Borrowers who took advantage of the ultra-low rates offered during the onset of the pandemic progressively roll off fixed rates of 2.0%-2.5%p.a. to much higher rates of at least 5.5%-6.0% this year and next. According to the RBA[1], the number of fixed rate loans peaked at around 40% of total outstanding home loans in early 2022. Of these, 880,000 fixed rate loan facilities will expire in 2023 and 450,000 in 2024. Based on the average new loan size in NSW of $725,000[2] over a 30-year term, repayments will increase from $32,150 to $52,160 when the fixed rate period ends, an increase of 62%. This ensures that disposable incomes will be significantly eroded, if not in some circumstances, entirely depleted. Impacted households will have no choice but to dramatically pare back on expenditure.

Second, while generous government payments during COVID-19, coupled with lockdown induced savings provided generous savings buffers, these have been progressively unwound as mortgage payments have moved higher and will only accelerate in the months ahead.

Third, as activity moderates, businesses will start to feel the impact as orders decelerate and production lines slow. Fourth, this will naturally lead to a reduction in shifts or hours for workers before job cuts become inevitable.

Fifth, inflation, which was the buzz word of 2022, is virtually assured of decelerating. Wage demands will lessen as employees become more concerned about their future job prospects. Supply chain disruptions have already eased significantly and will continue to do so. Energy prices which peaked during the onset of the Ukraine war, have already fallen materially. Commodity prices too, will likely fall further as the global slowdown gathers more momentum.

Sixth, with inflation no longer a problem, the RBA will soon hit pause on ten consecutive interest rate hikes by taking comfort in the fact that demand suppression is virtually assured. This view now aligns with the futures market, which now implies that the cash rate has already peaked at 3.60% and is projected to fall to 3.20% by year end.

ASX 30 Day Interbank Cash Rate Future Implied Yield Curve (27 March 2023)

Source: ASX

Conclusion

In the RBA’s latest Statement on Monetary Policy[1], economic growth is expected to slow to 1.50% by calendar year end compared to the 2.7% growth recorded for the December quarter in 2022. The RBA’s preferred measure of inflation (the trimmed mean) is forecast to fall to 4.25% by year’s end, and unemployment is expected to only rise marginally to 3.75%. This Statement was released before the banking crisis began to unfold and so we believe risks remain skewed to the downside, increasing the risk of a recession. Despite the impending downturn, the likelihood of interest rates potentially falling by year’s end should provide welcome relief to most heavily indebted households that have been anxiously watching developments unfold with a mix of both fear and trepidation.

Part 2: Key economic indicators 

[1] Net percent of domestic banks tightening lending standards to large and middle-market firms, FRED, 28 March 2023: https://fred.stlouisfed.org/series/DRTSCILM  [2] Mortgage customers showing early signs of stress: NAB, AFR, 27 March 2023: https://www.afr.com/companies/financial-services/mortgage-customers-showing-early-signs-of-stress-nab-20230321-p5cu3d   [3] RBA Bulletin March 2023: https://www.rba.gov.au/publications/bulletin/2023/mar/pdf/bulletin-2023-03.pdf [4] ABS Lending Indicators August 2022 released 4 Oct 2022. Loan size in NSW as at December 2021. [5] Statement on Monetary Policy February 2023, RBA: https://www.rba.gov.au/publications/smp/2023/feb/economic-outlook.html

Economic snapshot Last reported result Date 
Growth (GDP) 2.70% Dec-22
Inflation 7.80% Dec-22
Interest rates 3.60% Mar-23
Unemployment rate 3.50% Feb-23
Composite PMI 50.6% Feb-23
Economic snapshot Last reported result Date 
Growth (GDP) 1.80% 1.60%
Inflation 5.40% 3.10%
Interest rates 4.00% 3.20%
Unemployment rate 3.90% 4.40%
US Dollars per 1 Australian Dollar ($) 0.72 0.75
Any advice included in this newsletter has been prepared without taking into account your objectives, financial situations or needs. Before acting on the advice you should consider whether it’s appropriate to you, in light of your objectives, financial situation or needs. You should also obtain a copy of and consider the Product Disclosure Statement for any financial product mentioned before making any decisions. Past performance is not a reliable indicator of future performance. Advisors at Pitcher Partner Sydney Wealth Management are authorised representatives of Pitcher Partners Sydney Wealth Management Pty Ltd, ABN 85 135 817 766, AFSL number 336950.
Charlie Viola

Charlie Viola

Partner | Managing Director - Wealth

Sydney


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Jordan Kennedy

Jordan Kennedy

Partner

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Martin Fowler

Martin Fowler

Partner

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Andrew Wilson

Andrew Wilson

Principal

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John Fisher

John Fisher

Director, Lending Services

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Chris MacKenzie

Chris MacKenzie

Insurance Advisor

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