20% house price drop wouldn't erase equity for most mortgage holders: RBA

The Reserve Bank's benign assessment of the housing market removes a potential reason to hold back on tighter policy, consistent with its own statement that it stands ready to raise rates further following the latest increase on Tuesday. The message with greater relevance for markets is the central bank's concern about overseas risks: it specifically pointed to leveraged investors in bonds and AI equities as factors amplifying volatility, with elevated asset prices leaving global markets vulnerable to a sharp correction. This means changes in the mood surrounding AI investments could act as a conduit through which international stress transmits to Australian holdings. The document is an evaluation of financial stability, not a verdict on monetary policy, and does not in itself alter the policy trajectory.

---

Earlier:

• Australia manufacturing PMI falls to 49.6 as new orders drop for first time since June

---

The RBA's view is that a decline in house prices is not the primary threat to the nation's financial stability. Instead, it highlights AI-driven markets, leverage, and overseas cyber risks as the factors that warrant close attention.

• Most households and businesses can manage a weaker economy and lower house prices, according to the RBA's Financial Stability Review published on Thursday.
• Currently, fewer than 1% of borrowers have negative equity, and about 2% of owner-occupiers are experiencing a cash flow deficit, with the majority having savings to cover at least six months.
• The RBA estimates that a further decline of 20% in prices would result in only about 5% of mortgages being in negative equity.
• Under a more severe scenario featuring 6.3% unemployment, 7% inflation, and a 5.6% cash rate, the proportion of borrowers at risk of default climbs to around 5%, a level slightly above the 2023 peak.
• Banks remain highly capitalised and profitable, with lending standards holding up and riskier lending kept in check.
• The RBA identifies the primary risks as coming from overseas: opaque and circular AI funding, leveraged investors, cyber threats, and the potential for a market crash.

According to its Financial Stability Review, issued Thursday, the Reserve Bank of Australia stated that most Australians with a mortgage would retain positive equity even if house prices dropped a further 20% and unemployment surpassed 6%. The report came out after the central bank's fourth rate increase in this cycle on Tuesday, which brought the cash rate to 4.6%, its highest point in 15 years, and was accompanied by an RBA warning that it was ready to increase rates again if necessary.

The RBA acknowledged that economic risks had increased, but it found that most indebted households were well positioned to manage a variety of adverse conditions, aided by the previous run-up in house prices and cautious lending standards. It stated that fewer than 1% of borrowers are presently in negative equity, and around 2% of owner-occupiers have a cash flow deficiency, with most of these holding savings sufficient to cover at least six months of costs. Under the scenario of a 20% price drop, the bank calculated that roughly 5% of loans would be in negative equity. In a more severe scenario—unemployment climbing to 6.3% from the current 4.6%, inflation at 7%, and the cash rate at 5.6%—the proportion of mortgage holders at risk of default would reach about 5%, a tick above the peak seen in 2023.

The RBA described banks as highly capitalised and profitable, with robust lending practices that position them to withstand a significant downturn in the housing market. The central bank acknowledged areas of stress among households and businesses, but stated that arrears on loans remain low. Cash flow strain is projected to intensify for smaller and energy-intensive businesses, though the majority of firms can handle higher costs, with some passing these on to their customers. Australia's private credit sector has expanded considerably, yet it remains modest in size and does not currently pose a danger to overall stability.

The broader housing environment is weakening. Figures from Cotality released on Thursday indicated that home prices dropped for a sixth consecutive month in September and sit more than 5% below their peak. Meanwhile, economists at AMP project a decline of 10% to 15% during this cycle, which would represent the most severe slump in 30 years.

The RBA stated that the principal dangers to financial stability are originating more and more from overseas, encompassing regional conflicts, cyber attacks, elevated sovereign debt, and a potential collapse in financial markets. It highlighted a change in mood surrounding the AI investment surge as a potential trigger, noting that funding is growing more obscure and circular and is vulnerable to poor returns. The central bank further noted that swift progress in cutting-edge AI has made cyber threats more intricate. The review implies that the central bank does not feel constrained on policy by the housing situation, regarding AI-connected markets and cyber risks as the developments to watch.