The race to transform the Australian economy and protect our prosperity is full of obstacles, and as this columnist has written many times, one of the biggest is household debt.

Forget government debt for a minute. It’s about one-sixth the size of Australia’s private debt and it’s financed by selling long-dated government bonds that are at present yielding their buyers just 2.1 per cent. That’s a bargain for the government.

In the private debt market, things are different. Households have bulked up on mortgage debt, at comparison rates as low as 3.4 per cent for variable rate loans.

The difference is that while the government’s latest bond issue will be repaid at maturity with a fixed interest payment known as a ‘coupon’, middle Australia owes $1.6 trillion in mortgages for which rates are likely to rise in the years ahead.

Clearly, if rates shot up now that would put a bigger hole in household budgets than the petrol price spike that is expected in mid-2017.

But as with the ‘cheaper for longer’ petrol, the cost of mortgage debt has stayed low much longer than many pundits thought it would.

That’s essentially due to central banks – the US Federal Reserve in particular – taking longer to raise interest rates than expected.

Waiting for the Fed

A year ago, during a bout of wild stock market gyrations, I wrote that a Federal Reserve rate rise “can’t come soon enough” – ultra-loose monetary policy was inflating dangerous asset bubbles around the world, including in Australian property and stocks.

A Trump presidency could change the Federal Reserves plans. Photo: Getty

Well the first rise was delivered three months later. The Fed moved rates from its target range of 0 to 0.25 per cent, to the higher range of 0.25 to 0.5 per cent.

But what happened next was unexpected. Most pundits thought that several more rate rises would follow through 2016, when in fact the Fed has sat on its hands for nine months.

Market economists think there’s a 15 per cent chance of a hike when the Fed’s Open Market Committee meets next week, on September 20-21.

As for a rate rise at the December meeting, Goldman Sachs sees a 40 per cent chance – though that could change depending on whether it’s President Trump or President Clinton smoking cigars in the Oval Office.

Double-edged rates

The Fed raises rates by charging commercial banks more to help them balance their books through the interbank lending market, while at the same time soaking up spare cash in the economy by selling government bonds.

When the Fed raises rates, the ripples are felt around the world.

Each time it raises rates in the coming ‘tightening cycle’, it will send ripples through global money markets and asset markets – and Australia’s pool of mortgage debt will definitely feel those ripples.

Australian banks source about a third of their funding through global wholesale markets.

However, even the deposits they raise onshore are a matter of supply and demand – if more attractive yields are available in the US, some money will pack up and leave.

So once again the Aussie banks will have to pay more interest to secure local deposits, as my colleague George Lekakis recently highlighted.

The Fed reprieve

The next Fed rate hike is, then, a double-edged sword for Australia.

On the one hand, it will start to return shares and property markets to more normal valuations. That’s why, in the middle of last year’s stock market turmoil, I wanted to see the tightening cycle start.

How will a Fed hike affect Australia?

On the other hand, a Fed hike will indirectly begin to crimp the spending power of Australian mortgage holders.

Don’t count on the RBA’s ability to offset Fed hikes by cutting local interest rates. It only has 150 basis points left to cut before it hits zero, and even if it made cuts within that range, the banks would pass on only part of those cuts.

So what we have is the second big ‘reprieve’ to assist with our painful transition away from the mining and housing finance booms.

The Fed started raising rates later than expected, and whether the next increase comes next week or in December, the tightening cycle is slower that expected.

Breathing space

That gives Australian households more time to realise the perils of bulking up on debt when rates are at record lows.

RBA data shows credit growth rates in have decreased substantially in the past two years – mainly because of tighter controls on lending to housing investors. That’s good.

Meanwhile, households are still relatively upbeat – this week’s consumer confidence index showed that for six months it’s been around 8 per cent higher than at the end of Tony Abbott’s time as PM.

That would not be happening if Australia’s over-indebted households had already felt the ripples of a faster US tightening cycle.

We should be grateful for the break we’ve had, but should be very wary about relying on it for too long.

Read more columns by Rob Burgess here.