Moody's: Australia, Canada, New Zealand and Sweden sovereign credit profiles resilient to rising household debt

Moody's Investors Service says that Australia, Canada, New Zealand and Sweden -- all rated Aaa stable -- are exposed, through different channels and to varying degrees, to a potential housing market correction.

However, unless the reversals in house prices were accompanied by other long-lasting negative shocks, they would not fundamentally undermine the sovereigns' credit profiles.

Moody's notes that all four countries have strong banking systems with high capitalization levels, conservative business models and strong liquidity, which lower the sovereigns' banking system-related contingent liability risks. Such contingent liabilities were among the highest costs of housing crises elsewhere.

Moody's conclusions were contained in its just-released report, "Sovereigns -- Advanced Economies: Credit Profiles Resilient to Rising Household Debt and Stretched Housing Affordability."

The report focuses on the four countries that have experienced the largest increases, among advanced economies, in house prices and household debt over the last three years. House prices rose by more than 30% in real terms in New Zealand and Sweden and by approximately 20% in real terms in Canada and Australia. In all four cases, these increases have been accompanied by higher household leverage.

In the event of a reversal in house price gains or other economic or financial shocks, higher household debt levels raise the risk of consumer retrenchment and imply higher likelihood of stress in the banking system, all else being equal.

Compared to Spain, Ireland or the US in the period leading up to their mid-2000s housing peaks, the pace of increase in household debt relative to disposable incomes has been noticeably slower in the four countries covered in the report. However, their starting levels of household debt were higher relative to incomes than those in the US or Spain even at the peaks of their respective housing market cycles.

Given its elevated level of household debt relative to disposable income and liquid household assets, Australia faces the risk that households would be forced to deleverage abruptly in an economic or housing downturn. By contrast, large liquid financial assets in Canada and New Zealand would provide some financial cushion to economic shocks and reduce the risk of a sharp retrenchment in consumption.

New Zealand and Sweden are also vulnerable to potential reversals in population booms. In the event of a negative economic shock, the recent acceleration in immigration could reverse, acting as a further drag on housing demand and economic activity.

Canada and New Zealand have further grown reliant on residential construction. With the sector accounting for approximately 7.5% of GDP in both countries, a housing downturn could involve material spillovers to the broader economy.