Funding pressures are forcing some Australian lenders to lift mortgage rates

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  • Short-term money market interest rates in Australia have increased this year, leading to funding pressures for banks.
  • Two Australian lenders — the BOQ and Auswide Bank — have announced they will increase variable mortgage rates due to higher funding costs.
  • Earlier this month, the RBA noted that “slightly higher funding costs for banks appeared to have had little effect on mortgage rates”.

While official interest rates from the Reserve Bank of Australia remained steady for the best part of two years, short-term money market interest rates in Australia have been anything but this year.

They’ve increased substantially since February, leading to margin pressures on some Australian lenders, including the Bank of Queensland (BOQ).

Late Monday, the bank announced it will increase variable home loan interest rates for its customers from July 2, citing a sharp increase in funding costs.

“Funding costs have significantly risen since February this year and have primarily been driven by an increase in 30 and 90 day BBSW rates, along with elevated competition for term deposits,” said Anthony Rose, Acting Group Executive for Retail Banking at BOQ.

“While the bank has absorbed these costs for some time, the changes announced today will help to offset the ongoing impact of the increased funding costs.

“These decisions are always difficult and BOQ balances the needs of our borrowers and depositors when making changes.”

For owner-occupier facilities with principal and interest (P&I) repayments, rates will increase by 9 basis points. Variable rate interest-only (IO) owner-occupier loans, as well as P&I and IO loans to investors, will rise by a larger 15 basis points.

Like the BOQ, Auswide Bank has also announced that it will increase mortgage rates for both owner-occupier and investors due to higher funding costs.

“Despite no increase in the official cash rate, we’ve had to make this difficult decision due to a sustained increase in 30 and 90-day BBSW levels,” said Martin Barrett, Managing Director at Auswide.

“We are now paying significantly more for funding than we were six months ago which this increase will help offset.”

The move from both lenders follows a warning from Credit Suisse last month that there was a “material risk” that higher short-term interest rates could prompt out-of-cycle mortgage rate increases from lenders.

“Interbank credit spreads are a powerful leading indicator of the change in the mortgage rate spread to the cash rate,” Damien Boey, Research Analyst at Credit Suisse said, pointing to the chart below.

(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.)

Credit Suisse

Given the sharp increase in Australian short-term interest rates, now an even larger spread than when the chart was first produced, Boey warned that “if the RBA does not cut rates, we could see out of cycle rate hikes from the major banks”.

While the BOQ is not a major, it’s not all that far behind.

And given its decision to lift variable rate mortgages because of higher funding costs, it suggests that other banks could well follow suit, especially as out-of-cycle mortgage rate increases from one lender have often led to similar moves across the sector in the past.

It is clearly a risk should short-term money market rates remain elevated, potentially leading to higher mortgage repayments for borrowers despite no movement in the RBA cash rate.

“The longer it’s sustained the more it will pressure Australian banks to raise some mortgage rates,” says Shane Oliver, Head of Investment Strategy and Chief Economist at AMP Capital, adding that banks source 20% of their funding from short-term interest rate markets.

Although the increase initially followed a spike in US short-term interest rates, as Oliver points out, they have continued to rise in Australia despite a recent decline in US markets.

“While US short term funding costs have come down, they have risen further in Australia,” he says.

“The reason for the divergence remains unclear but may be related to a desire to lock in funding ahead of the financial year-end, the Westfield takeover and regulatory reforms including the impact of the Royal Commission.”

Some have also speculated that with Australian credit growth outpacing growth in deposits, it has reduced money market liquidity, increasing short-term funding costs for banks.

Changes in US tax policies, encouraging US corporate to repatriate funds from abroad, along with increased issuance of short-dated US treasuries earlier this year, have also been cited as factors pushing up money market interest rates.

While the reasons for the increase remain unclear, should other lenders follow the lead of BOQ and Auswide, it could have ramifications for the RBA policy settings.

At its June monetary policy meeting, the Board noted that “slightly higher funding costs for banks appeared to have had little effect on mortgage rates”.

It also added that average mortgage interest rate on outstanding loans had fallen since August last year, driven by lenders competing for high-quality borrowers.

Should Australia’s major banks follow the lead of smaller institutions, it will be hard for the RBA to ignore, especially given its concerns around Australia’s heavily indebted household sector.

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