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EY Australian Financial Conditions Index: December 2024

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The EY Australian Financial Conditions Index entered expansionary territory for the first time since March 2022, with conditions easing sharply in the December 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 moved into expansionary territory in the December quarter 2024 despite the cash rate remaining unchanged, mainly driven by a significant improvement in consumers’ views of household finances.
  • 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 entered expansionary territory

Financial conditions eased sharply in the December quarter of 2024 compared to the September quarter of 2024, entering expansionary territory for the first time since March 2022 despite the cash rate remaining at 4.35 per cent.

Underlying inflation has continued to trend down, with the November monthly CPI release only slightly above the Reserve Bank of Australia’s target band. While there is greater certainty that interest rate hikes are likely finished, the timing of rate cuts in Australia remains uncertain. Financial markets are pricing in the Reserve Bank to commence the cash rate cutting cycle in the second quarter of 2025. Meanwhile, other central banks have continued to cut their cash rate, in particular the United States.

Consumers’ perception of their household finances over the last 12 months increased in the December quarter, with the outlook for the next 12 months also improving. This reflected that tax cuts, government cost of living rebates and stable interest rates were supporting consumers. In November, the family finances over the next 12 months index rose above 100 for the first time since April 2022, signifying that optimists outnumber pessimists, and remained so in December. This is likely driven by expectations of rate cuts by the Reserve Bank over the next 12 months. The improvement in consumers’ views of household finances was the main driver of the financial conditions index moving into expansionary territory in the December quarter 2024.

Australian bond yields increased in the December quarter, mainly due to the rise in United States bond yields, as well as the re-pricing of Reserve Bank cash rate expectations. Financial market pricing for United States interest rates shifted higher in response to the US election outcome, with expectations that a Republican administration will lead to a range of policy changes which are likely to be inflationary.

Total credit growth remained high over the quarter with business lending continuing to grow strongly, although growth in mortgage debt slowed as housing prices nationally fell slightly.

Commodity prices rose in the December quarter due to an increase in iron ore prices. This was in response to stimulus measures announced in China, which increased expected 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 shift further into expansionary territory through 2025.

Summary

Financial conditions are an important consideration for business assessing substantial investments. The December quarter 2024 EY Australian Financial Conditions Index showed that financial conditions entered expansionary territory for the first time since March 2022, easing sharply compared to the September quarter 2024.


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