Household debt is rising fast, boosted by the current extended period of very low interest rates in New Zealand, Westpac senior economist Satish Ranchhod says.
Since 2012, the disposable income of households had risen by about 10% while debt levels had increased by 22%.
The combinations of conditions had seen the amount of debt households were carrying rising to levels equivalent to 162% of their disposable income.
That was higher than the peaks reached before the global financial crisis and had completely reversed the reduction in debt levels seen in previous years, he said.
Low interest rates had boosted debt in two ways. The first was by making it less expensive for households to fund consumption spending using debt.
The second had been through low interest rates leading to higher asset prices.
In particular, strong growth in house prices had boosted household wealth and encouraged household spending, Mr Ranchhod said.
Much of it was a result of passive housing withdrawal.
With low interest rates generating low nominal returns on savings, the higher rental yields and capital gains housing assets had generated had been attractive for investors.
The resulting increased demand for housing, especially non-owner occupied investment housing, had generated a windfall for home owners, some of which had been spent.
Those conditions had resulted in house buyers borrowing more, while existing owners spent more.
The net effect on the economy was more borrowing and more spending and the low cost of borrowing was reinforcing those trends, he said.
The resulting debt-funded increases in household spending and strengthening in the housing market were helping to offset some of the weakness in other parts of the economy, particularly the dairy sector.
With the official cash rate likely to drop further during the current cycle and to remain low for an extended period, continued increases in debt levels were likely.
Some increase in debt levels in response to low interest rates was not necessarily a problem, Mr Ranchhod said.
‘‘In fact, with low interest rates encouraging borrowing, this indicates one of the key channels monetary policy uses to influence the economy is operating as expected.''
Although debt burdens had been increasing, low interest rates meant the proportion of household incomes spent on debt servicing had remained low.
It was likely debt servicing costs would drop further over the next few months, as recent interest rate reductions passed through to the rates faced by households, he said.
The recent run-up in debt still raised important concerns for the economy, signalling challenges for longer-term growth and increased vulnerability to unfavourable changes in economic conditions.
Increasing debt could not generate increases in growth indefinitely. Households would eventually need to repay debt, and larger increases in debt now would require larger reductions in spending in future years. That would be a drag on growth, Mr Ranchhod said.
Also, when interest rates did eventually increase, debt servicing costs would rise. Given the strong increases in household debt, the resulting pull-back in household spending could be stark.
If interest rates rose, many borrowers would find their debt-servicing requirements increasing and, for some highly indebted borrowers, debt could become unserviceable, he said.
Higher interest rates would make housing assets look a lot less attractive.
It would put downward pressure on prices and could result in debt-to-assets positions deteriorating, just as they did during the financial crisis.
‘‘Many highly indebted borrowers have used funds to purchase investment properties. High house prices have left rental yields at a low level. If interest rates increase, these yields may not be sufficient to meet debt-servicing requirements.''
Even in the absence of interest rate increases, higher debt levels meant the economy was more vulnerable to unfavourable developments in economic or financial conditions. Households had less of a buffer from such changes, Mr Ranchhod said.
‘‘It's important to remember GDP growth is set to slow in the latter part of the decade. If this also results in a softening in the labour market, more highly indebted households could find themselves struggling.''
