Modelling by Morgan Stanley indicates Australia is the most at-risk country among G10 economies to a deleveraging of household debt.
The bank’s base-case is that the current housing downturn will be an “orderly correction”, and the RBA will raise interest rates in late 2019.
However, risks are skewed towards an extended “balance sheet recession” which could see rates fall sharply.
Analysts at Morgan Stanley have compiled a list of developed market economies which are most at risk of a deleveraging in household debt.
And look who's on top:
"Who is most vulnerable? Australia looks most exposed," the analysts said, citing high debt levels along with falling house prices and the prospect of further lending restrictions.
Ultimately though, they expect Australia's economy will enter a "benign deleverage phase" as the housing market downturn remains ongoing.
The bank's Household Deleveraging Risk Indicator makes an assessment of the outlook for each country in the G10, based on three variables:
1. Total levels of household debt;
2. Structural factors of the economy which could exacerbate the impact of deleveraging; and
3. Likelihood that deleveraging will be necessary in the near future.
In terms of total debt, the analysts noted a divergence in the G10 since the mid-2000s.
Household leverage has fallen in the US, UK, Japan and Europe -- offset by a continued increase in Australia, Canada, New Zealand, Sweden and Switzerland.
By extension, that leaves Australia's economy more sensitive to a change in interest rates.
In that context, Morgan Stanley noted that most mortgages in Australia "are on a floating mortgage rate (set by the banks), and so any change in interest rates flows through quickly to debt servicing".
That differs from the US, for example, where most mortgages are issued on fixed 30-year terms.
So the analysts used the metrics of each country to determine how much of a rate increase by central banks will flow through to mortgage costs.
They added two other factors into their model -- debt levels in other areas of the economy (such as corporate leverage) and the degree to which a given country's financial system is reliant on offshore funding.
"With this combined indicator, NZ and Australia stand out as the most structurally vulnerable, driven by sensitive debt servicing and large external exposure," Morgan Stanley said.
Ultimately, household debt only becomes a headwind to growth when deleveraging starts -- and that process is clearly well under way in Australia.
Credit growth to property investors has slowed dramatically as banks impose tighter lending standards. And some analysts have pointed to the risk of a "credit crunch" in the fallout from the Hayne royal commission.
Factoring in the employment outlook and real estate asset values, Morgan Stanley said Canada is most at risk, followed by Australia and Sweden.
Taking each factor in their model into account, the analysts said Australia's deleveraging phase will drag on domestic consumption.
At the same time, "strength in the global economy and support from public infrastructure spend are mitigating these headwinds". In addition, they described the current price falls in Sydney and Melbourne as an "orderly correction".
The bank's base case is for a recovery in wage growth to act as a catalyst for interest rates to rise by the second half of 2019.
However, "risks are skewed to the bear case", which would see the RBA cut interest rates by around 100 basis points over the next two years.