Five rate hikes accompany Australian warning over AI boom risks
Key Facts
The Reserve Bank of Australia warned in its October Financial Stability Review that the AI boom could amplify risks to the financial system, even as it lifts expectations for profits and productivity. The bank said a decline in expected returns on AI investments could trigger a disorderly correction in asset prices, particularly when investors use leverage to boost returns. The warning comes as institutions’ exposure to the AI investment cycle grows, with effects extending beyond equity valuations. The bank said borrowing linked to financing the boom could create hidden financial connections that are difficult to detect. Against this backdrop, Governor Michele Bullock said on November 3 that the effects of recent rate increases had yet to be fully felt, noting that 5 hikes were in the system by that date.
The review detailed an operational dimension of the risks, warning that rapid advances in AI could heighten cyber threats before defenses are fully developed. This could expose operational weaknesses at financial institutions as applications of the technology expand. At the same time, the bank said AI could support productivity growth and strengthen operational resilience by improving banks’ cyber defenses. According to the review, this potential extends to financial market infrastructure and other financial institutions. The bank’s assessment therefore weighed opportunities to improve efficiency against the risk that adoption could outpace the readiness of defensive controls.
Financially, the bank said a number of large companies had turned to on- and off-balance-sheet leverage to finance AI investments. These arrangements could create opaque funding links, making it harder to understand how stress would spread if expectations changed. Market sensitivity is heightened, the review said, by global equity and credit risk premiums being below historical levels. That means a reassessment of expected earnings could coincide with investors’ reduced willingness to take risks. In its March review, the bank had warned that the financial system’s growing exposure to the AI investment cycle could become a source of instability if the sector’s optimistic expectations were substantially revised.
The bank’s AI assessment is also linked to price developments. In September, it said the global investment boom had raised prices for some inputs in the technology supply chain, with costs beginning to pass through to companies and consumers. In its November monetary policy statement, the bank said strong AI-related demand, alongside supply disruptions, was pushing up prices for a range of goods and inflation in many economies. It added that limited production capacity in supply chains was increasing pressure, which had begun to feed into some consumer goods prices. Meanwhile, Brent futures had risen about 25% since the August statement and were near $115 a barrel when the November report was prepared. The bank expects headline and underlying inflation to remain above 3% through the end of 2027, before reaching the midpoint of the 2–3% target range in mid-2028.
The bank said inflation risks remained tilted to the upside, while it expects tighter monetary policy and a weak housing market to keep GDP growth below trend. Australian share prices had fallen since the August statement, the bank said, reflecting the impact of higher interest rates and weakness in sectors exposed to a housing market downturn. Bank, real estate and discretionary spending stocks also fell as earnings expectations weakened. On the bank’s calendar, minutes of the November meeting are due on November 17, followed by the next monetary policy decision statement on December 8. Assistant Governor for Economics Sarah Hunter’s speech at the UBS Australasia conference in Sydney was scheduled for November 9 at 9.30 a.m. Sydney time, after the date of this coverage.