MORGAN STANLEY: Australian banks are going to have to lift mortgage rates

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Australia’s major banks will need to raise their mortgage rates in the face of competition and requirements to hold more capital, according to analysis by Morgan Stanley.

The investment bank says that no matter what happens in the coming months — whether the Reserve Bank of Australia cuts rates further or starts lifting the official cash rate — the major players will need to move to their margins.

This process started in May when the banks started keeping a little more for themselves by not passing on all of the RBA’s cut of 25 basis points on the official cash rate to mortgage customers.

Banks share prices have flatlined recently as profit results, under pressure from increasing competition, disappoint and investors expect a slowing in dividend growth.

Morgan Stanley, in a note to clients, says it expects the cash rate to be unchanged at 2% when the RBA meets next week but its sees a final rate cut sometime in the closing three months of 2015.

“In our view, any future reduction in the cash rate by the RBA would provide an opportunity for the banks to further re-price home loan standard variable rates (SVRs),” says Morgan Stanley. “In fact, we think more SVR re-pricing is necessary to offset the downward pressure on margins from lending competition and lower interest rates.”

Morgan Stanley’s Chart of the Week shows the sensitivity of bank margins and cash profit to home loan standard variable loans re-pricing:

According to Morgan Stanley calculations, a 10 basis point rises in the bank rate adds 1.5% to 2.5% to cash profit for the major banks and 4% for the regional banks.

Margins at Commonwealth and Westpac, the two biggest banks, are most sensitive because housing represents 60% of loans.

The Morgan Stanley calculation assumes a 10 basis point movement in response to a $31 billion of additional capital raising.

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