Australian home loan borrowers shouldn't expect much relief from RBA rate cuts, if they actually occur

Jill Brady/Portland Press Herald via Getty Images
  • An increasing number of economists believe the RBA will cut Australia’s cash rate to 1% this year. Financial markets also see the cash rate moving lower.
  • If the RBA does cut rates, UBS estimates that Australia’s major banks may only pass on around half of the reduction to borrowers.
  • UBS does not expect lower mortgage rates will lead to a re-acceleration in housing credit growth.
  • It says credit growth will likely sloe further, increasing the risk of a “disorderly” correction in home prices.

An increasing number of economists believe the Reserve Bank of Australia (RBA) will cut Australia’s cash rate by 50 basis points this year, leaving it at just 1%.

Financial markets also regard a full 25 basis point reduction as a lock, with the growing risk of a second cut, over the same period.

While these views reflect expectations, not what will happen, it’s pretty clear many believe the cash rate will soon be lower. As such, if this hypothetical situation eventuates, mortgage rates should also fall.

However, as has often been seen in the past when the RBA has cut rates, that doesn’t necessarily guarantee that variable mortgage rates will fall by the same amount.

Indeed, even though the cash rate has been steady since August 2016, banks have actually announced out-of-cycle variable rate increases in recent years, citing higher wholesale funding costs.

So what’s likely to occur if the RBA cuts rates by 50 basis points this year? Will variable rates fall by the same amount, or will it not be passed on full as banks attempt to reduce pressure on net interest margins (NIM)?

After crunching the numbers, UBS — a forecaster that expects a 50 basis point reduction in the cash rate this year — believes it has a ballpark figure: 30 basis points, or just over half.

“We believe it is more likely the major banks pass through around 30 basis points of the RBA’s potential 50 basis points in rate cuts to mortgagors,” it says.

“One of the common misconceptions in banking is that the banks’ borrowing costs are tied or highly correlated with the RBA Cash Rate.

“While this works in theory during higher interest rate environments, in periods of very low interest rates or when credit spreads move wider, there may be a breakdown in this relationship.”


So borrowers shouldn’t expect the whole decline in the cash rate to be passed on in full, according to UBS.

While that would only provide modest relief to households with a mortgage, will the decline — if it happens — lead to a lift in demand for housing credit, leaving to a recovery in home prices as was previously seen when the RBA last cut rates?

UBS believes the answer will be no on this occasion.

“We believe that one of the most important measures introduced by APRA is the interest rate serviceability floor of at least 7%,” it says.

“This means that customers maximum borrowing capacity will not rise if the standard variable rate or fixed rates are reduced further.”

The serviceability floor is the minimum interest rate banks assess a borrowers capacity to service a loan.

Rather than an acceleration in housing credit growth from lower mortgage rates, UBS says the combination of tighter lending standards focused on household expenses, deteriorating sentiment towards the outlook for home prices and a change in government at the next federal election suggests credit growth will continue to slow.

“Given these headwinds we expect a sharp slowdown in credit growth,” it says.

“We believe the risks that the correction in the housing market becomes more disorderly are rising.”

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