Australians are being "irrationally exuberant" in taking on household debt, one of the world's biggest bond fund managers says.
PIMCO says households are being driven by low mortgage rates and rises in house prices, which may not be sustainable.
"Of concern, households are exhibiting irrational exuberance because they are placing little weight on broader fundamentals like unemployment that may be more representative of future incomes or asset price returns, increasing the likelihood of asset price bubbles," its research report says.
"Australian households appear to respond rather quickly, needing only two quarters of favourable changes in asset prices and mortgage rates to increase leverage."
The PIMCO analysts say Australian households will react faster and more vigorously to a shock in asset prices or mortgage rates, meaning if a deleveraging cycle was sparked it would be expected to be quite severe.
It said the response to low interest rates may be more subdued than history would suggest.
"However, it is also possible that lower mortgage rates and asset price appreciation may drive a more irrational response relative to the macro fundamentals, a `herd mentality' that assumes continued capital price appreciation and creates the fear of `missing out'."
Australian house prices are at the higher end of international comparisons, the report said.
"With this starting point, it seems questionable to embed expectations of continued high price growth."
PIMCO said its modelling highlights the potential vulnerability of high and rising household leverage incurred on the basis of past asset price movements.
"We believe macro-prudential measures should be strengthened to address financial stability risk and give the RBA maximum flexibility when setting policy for the aggregate economy."
PIMCO believes that given the sensitivity of households to mortgage rates, the peak in the cash rate in the Reserve Bank's next hiking cycle is likely to be much lower than in previous cycles.
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