High household debt and shrinking economic growth are clouding Australia's financial stability, while the property price slump in Sydney and Melbourne could lead to a renewed tightening of credit, the Reserve Bank says.
The RBA said on Friday that while domestic economic conditions remain broadly supportive of financial stability, risks to the household sector had increased over the past six months given weak house prices.
But economists said the sombre outlook in the central bank's latest Financial Stability Review was a reflection of an earlier shift in its thinking, rather than anything new.
The half-year report card said the continued deterioration of the housing market would weigh on already subdued consumption, while also increasing the share of borrowers in negative equity.
"Housing constitutes a large share of households' wealth and further large declines in housing prices could cause households to pull back on consumption, particularly for those who are highly leveraged," the RBA said.
"This, in conjunction with falling dwelling investment, could add to rising unemployment... such a scenario would have adverse consequences for financial stability to the extent that it increases both households' likelihood of default and the losses banks would experience in the event of default."
The RBA said the economic ramifications would be tempered if unemployment remained low and households continued to be able to repay their debt.
But falling prices may mean borrowers find it harder to resolve their situation by selling their properties.
The housing market decline could also increase banks' perceptions of the riskiness of housing lending.
"(This could compound) the somewhat tighter availability of credit seen to date," the RBA said.
The Aussie dollar dipped from 71.30 US cents to 71.16 US cents on the release of the report card, but clawed back the lost ground within 45 minutes.
ANZ said while the RBA was clearly more sombre than it was in October, it judged the financial system to be more resilient.
"The discussion of negative equity is probably of most interest... the RBA estimates that just under 3 per cent of securitised loans by value are in negative equity, with close to 60 per cent of negative equity loans in Western Australia or the Northern Territory.
"The fact that few recent purchasers had high loan-to-value ratios will limit the extent to which negative equity becomes an issue".
On Wednesday Reserve Bank Deputy Governor Guy Debelle said there were conflicting signals about the health of the Australian economy.
Mr Debelle told an audience in Adelaide that weak Sydney and Melbourne property markets had contributed to the lower-than-expected levels of consumption that have held back GDP growth to the point that economists are predicting as many as two cash rate cuts before the end of the year.
But unemployment fell to an eight-year low 4.9 per cent in February and, while that could be a lagging indicator, Mr Debelle told the American Chamber of Commerce in Australia event he believed it spoke of an underlying strength in the economy.
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