EY Australian Financial Conditions Index: June 2024

The EY Australian Financial Conditions Index remained restrictive, though conditions continued to ease in the June quarter of 2024.

In brief:

• The EY Australian Financial Conditions Index (the index) illustrates the state of financial conditions in Australia for businesses that wish to assess the macro investment environment.
• The index showed slightly less restrictive conditions in the June quarter of 2024, than in the March quarter of 2024, even though the cash rate was not changed by the Reserve Bank of Australia.
• The index illustrates the importance of examining a broader range of variables than just the cash rate to fully understand the conditions impacting Australian business.

Understanding financial conditions beyond just interest rates

Financial conditions are an important contributor to economic growth – an indicator of the stage of the business cycle and what’s ahead.

Tight financial conditions mean it is difficult for businesses to access funding and liquidity is hard to come by, while expansionary conditions mean it is easy for businesses to access capital for growth.

Expansionary conditions (a negative index value) indicate that the financial system is currently supporting the economy. If conditions are restrictive (a positive index value), the financial system is constraining the economy, indicating financial downside risks are present.

The first and most important data point in guiding financial conditions is the cash rate, which the Reserve Bank of Australia sets to steer the economy. However, there are many more variables that are also important.

We draw on a broad number of variables, including asset prices, interest rate spreads, credit and money growth, debt securities outstanding, financial market risk, and surveyed measures of consumers’ views on their household finances. We focus mainly on Australian variables, but also include variables from the United States to capture the strong influence this economy has on Australia’s economy.

Financial conditions remain restrictive

Financial conditions eased slightly in the June quarter of 2024 compared to the March quarter of 2024, but remain in restrictive territory given the cash rate remains elevated.

There has also been heightened uncertainty around the outlook for interest rates of late. Inflation has moderated at a slower pace than expected, leading financial markets to push back the timing of cash rate cuts, which has previously been expected at the end of 2024.

The May 2024 monthly Consumer Price Index release led markets to switch from pricing in a rate cut to a rate hike in the near term. Australian bond yields increased in the June quarter due to the re-pricing of Reserve Bank of Australia cash rate expectations, while financial market pricing for United States interest rates shifted higher as well due to stronger-than-expected economic data. There was also greater uncertainty in interest rate markets, leading to a higher term premia.¹

Consumers’ perception of their household finances over the next 12 months improved further in the June quarter, likely due to planned July tax cuts. The index has increased by 13.6 per cent from its low mid-last year, although the index remains below its long run average.

Total credit growth increased over the quarter as higher housing prices resulted in higher mortgage debt, while business lending has remained resilient. As expected, there was a large fall in the money base as the Reserve Bank’s Term Funding Facility, which had been supporting low borrowing costs to banks for three years, ended.²

Commodity prices declined in the June quarter, with most categories experiencing falls, although base metals increased.

The Reserve Bank continues to monitor ongoing inflation risks closely. As the Governor has warned, interest rates could remain around current levels or even increase if inflationary pressures remain high or fluctuate over the remainder of 2024.

Financial conditions are likely to remain restrictive through 2024.