Households weather increase in debt

By BRIAN FALLOW economics editor

Though household debt is relentlessly rising, it is less of a curb on spending than it was five or six years ago because interest rates are much lower.

New Zealand Institute of Economic Research economist Doug Steel says household debt levels have climbed from around 83 per cent of disposable income (after tax and debt-servicing costs) in the March 1996 year to 112 per cent in the year to last March.

Most of the increased debt has been used to buy housing assets and has been matched by rising house prices, leaving households' net worth (assets minus liabilities) broadly steady.

But despite the rise in debt, the costs of servicing it have remained in a relatively narrow range.

The amount households pay to service their debt (measured by Statistics New Zealand's household income and outlay account) rose from 7.5 per cent of disposable income in 1996 to a peak of 9.1 per cent in 1998 before falling back to 5.9 per cent in the year to last March.

Expressed as an interest rate, the ratio of debt-servicing costs to the stock of debt has declined from 9.1 per cent in 1996 to 5.9 per cent.

"This is a similar decline to the drop in mortgage rates over the same period," says Steel.

It has more than offset the effect of higher debt levels, and with a smaller percentage of households' incomes going in debt servicing it suggests that debt is less of a constraint on household spending than it has been over recent years.

Since March the Reserve Bank has raised interest rates a full percentage point. Its monetary policy statement on August 14 projected some further increase - 25 or 50 basis points - in this cycle but said that it was "not at all certain" that would be needed.

Even if rates were to rise that much, it would imply a peak in the floating mortgage rate of 8 or 8.5 per cent, compared with 11 per cent in the mid-1990s.

As in other countries low inflation has brought a structural shift downward in the trend level around which interest rates cycle.

"Interest rates will be lower over the next period, say five years, than over the last 10 or 20," Steel says.

In part this is because of the rise in household debt, which gives each increase in interest rates more teeth.

That is mitigated to some extent by the popularity of fixed rate mortgages.

"But that affects the lag with which monetary policy works," says Steel. "You can't fix forever. Even if you've got a fixed-rate mortgage, if you know rates are rising and your fixed rate is coming off in a year or two you may start altering your consumption patterns today."

Over the June quarter, households' net worth rose by $1 billion to $212 billion, say the WestpacTrust household savings indicators.

Households borrowed an additional $1.6 billion, 2.1 per cent more than in the March quarter. Most (90 per cent) of it went towards housing.

But households' assets rose even more, up $2.6 billion or 0.9 per cent. Almost all of that, $2.5 billion, was a rise in the value of the housing stock.

The housing market is enjoying its strongest growth since 1997, says WestpacTrust economist Donna Purdue. "But although we anticipate further wealth gains over the remainder of 2002 they are likely to be more muted."