UPDATE 2-Australian banks strong enough to withstand economic shock, support recovery - RBA

(Recasts, adds details on households savings)

SYDNEY, Oct 9 (Reuters) - The rate of non-performing loans to Australian households was set to rise over coming months, the country’s central bank said on Friday, though the financial system has the strength to withstand any shocks.

Low levels of interest rates, loan repayment deferrals and massive government stimulus have so far supported the economy, helping prevent large defaults and business failures, the Reserve Bank of Australia (RBA) said in its biannual Financial Stability Review.

Over the first six months of 2020, the Australian economy contracted more than 7% under the weight of strict mobility restrictions to suppress COVID-19 while unemployment jumped to about 7% from under 5% pre-COVID.

While the economy has broadly re-opened, there are still risks on the horizon with unemployment expected to rise, loan deferrals being wound down by banks and some government welfare payments tapering off.

The RBA said it was likely the share of loans exiting from repayment deferrals and then beginning to miss payments will increase over coming months.

That, together with a sharp rise in savings, has cast a cloud over households’ ability to borrow more and spend in the economy despite interest rates at record lows.

“A key uncertainty is the extent to which those households that have strengthened their financial position by saving extensively will run down these savings to support consumption in the coming period,” the RBA added.

The vast majority of housing loans were in positive equity, which should limit the extent of losses to banks. In addition, an “overwhelming majority” of households were well placed to service their debt, having boosted mortgage prepayments, paid down personal loan balances and increased savings.

Household saving rates increased sharply in the June quarter for renters, mortgagors and outright homeowners, the RBA said.

To ensure lending rates remain low, the RBA is widely expected to further cut its cash rate to 0.1% from a record low 0.25% at its November policy meeting and expand its government bond buying programme. (Reporting by Swati Pandey Editing by Ana Nicolaci da Costa and Sam Holmes)