EY Australian Financial Conditions Index: September 2024

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

In brief:

• The EY Australian Financial Conditions Index illustrates the state of financial conditions in Australia for businesses that wish to assess the macro investment environment.
• The index indicated slightly less restrictive conditions in the September quarter 2024, than in the June quarter 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 September quarter of 2024 compared to the June quarter of 2024, but remain in restrictive territory given the cash rate remains elevated.

The outlook for interest rates has become a little clearer with rate hikes likely finished, as underlying inflation continued to fall in the August monthly CPI release and other central banks commenced their cash rate cutting cycle, in particular the United States.

The timing of rate cuts in Australia is less certain, with financial markets pricing in the Reserve Bank of Australia to commence the cash rate cutting cycle in the first quarter of 2025.

Australian bond yields decreased in the September quarter, mainly due to the fall in United States bond yields, as well as the re-pricing of Reserve Bank of Australia cash rate expectations. Financial market pricing for United States interest rates shifted lower in response to forward guidance from the Fed as the economy slowed.

While consumers’ perception of their household finances over the next 12 months declined in the September quarter, this was due to a weak reading in July when consumers were worried about persistent inflation and the possibility of interest rate hikes. In the month of August the index increased to its highest level since the cash rate started increasing in May 2022, and the index increased further in the month of September.

Total credit growth increased over the quarter as higher housing prices resulted in higher mortgage debt, while business lending has also continued to grow. The September quarter recorded another large fall in the money base as the full effect of the Reserve Bank’s Term Funding Facility, which had been supporting low borrowing costs to banks for 3 years, ending in June was reflected.¹

Commodity prices declined in the September quarter due to falls in iron ore and coking coal prices. This was in response to weaker economic conditions in China, with lower demand for steel production.

The Reserve Bank continues to monitor ongoing inflation risks closely. As the Governor has stated, the Board needs to be confident that inflation will sustainability return to the target band before the rate cutting cycle can commence.

Financial conditions are likely to remain restrictive through the remainder of 2024.