- The RBA hasn’t moved official interest rates since August 2016, and many think it will be deep into next year before that changes.
- Even with expected stability in the cash rate, Credit Suisse says there’s a “material risk” that mortgage rates may increase independently.
- It says elevated interbank funding costs could see the RBA reevaluate its view that the next move in the cash rate is likely to be higher.
The Reserve Bank of Australia (RBA) hasn’t moved official interest rates since August 2016, the longest period of policy stability ever seen.
If financial markets are on the money, that won’t change until the second half of next year. Some think it will be even longer.
However, just because the official cash rate looks set to remain steady for the foreseeable, that doesn’t mean that borrowing costs won’t increase.
Interbank lending rates — those that apply to how Australian banks lend to each other on an unsecured basis — remain at elevated levels, mirroring similar moves seen in other major markets such as the United States.
The cost of money is increasing at an institutional level.
As seen in this chart below from Credit Suisse, when this has happened in the past, it has usually led to an increase in mortgage rates.
(For clarity, the red line shows the difference between the RBA cash rate to 90-day BBSW, the rate at which banks lend to each other. The blue line is the rolling six-month change in the difference between the RBA cash rate to the average mortgage rate.)
While not perfect by any stretch, there’s a reasonable relationship between the two.
When institutional money becomes more expensive, it often flows through to higher mortgage rates.
Although some believe that such a scenario won’t play out on this occasion, pointing to the wrath that will almost certainly ensue during Australia’s Banking Royal Commission, Damien Boey, Research Analyst at Credit Suisse, says there’s a “material risk” that mortgage rates will increase.
“Interbank credit spreads are a powerful leading indicator of the change in the mortgage rate spread to the cash rate,” he says.
“Currently, wide interbank spreads — around 45 basis points (bp) — are consistent with a widening of the mortgage spread of at least 30 bp over the next few quarters.
“If the RBA does not cut rates, we could see out of cycle rate hikes from the major banks.”
And even if the RBA does cut official interest rates — which appears unlikely at this point given it has stated on numerous occasions that the next move in the cash rate is likely to be higher — Boey says it’s unlikely banks will pass much of it on to borrowers should interbank funding costs remain elevated.
“If the RBA were to hypothetically put through multiple rate cuts in the second half of 2018, the degree of pass through would be very low.”
The neutral rate
He also thinks it could lead the RBA to rethink whether the next move in the cash rate will be higher.
“We totally agree with Deputy Governor Debelle’s recent hint that the interbank funding situation is the ‘one thing’ that could reshape the bank’s [cash rate] outlook,” Boey says.
“If spreads narrow from here, the bank is well placed to carry through on its medium-term plan to hike rates. But if spreads remain elevated, or widen even further, the bank must revise down its view of the neutral rate, and rethink the appropriateness of current rate settings.”
The neutral cash rate is the level where policy settings neither add or detract from demand. The economy grows at its potential trend level (thought to be between 2.75% and 3% in Australia) leading to stability in unemployment and inflation.
The RBA currently sees Australia’s neutral cash rate level at 3.5%, some 200 basis points higher than where it sits today. However, with unemployment rising, inflation weak and economic growth sub-trend, many, including Boey, think its likely lower.
“The neutral rate could actually be well below 2%,” he says.
And if he and others are correct, Boey says the RBA may not be able to ignore persist weakness in Australian economic data for much longer.
“In our view, what all of this means is that the RBA is likely to become more, rather than less sensitive to the economic data,” he says.
“Whereas in the Lowe era, it appears that the bank has changed its reaction function to be less sensitive to inflation and growth undershoots, and more sensitive to financial-stability considerations, going forward, it is likely that the Bank’s reaction function will have to change again to account for risks stemming from impaired monetary transmission.”
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