Recently in Australia we have seen the majority of commercial banks raising their variable home loan rates for their customers anywhere between ten basis points to around ¼ of a percent. It’s important to understand firstly, why this is occurring and secondly, whether it can and will continue?
I’ll step back a little at first just to give you some important information which will help with the understanding. As you know banks are intermediaries that buy money on one side and sell it out on the other side, pocketing a margin through that process. Because businesses and consumers transfer money between each other every day in countless numbers of transactions and volumes it’s important for both parties to know that the transactions will actually take place and that’s where the Reserve Bank of Australia (RBA) performs one of its very important functions. It acts as a ‘policeman’ through its Reserve Bank Information & Transfer System (RBITS). Banks hold what is referred to as ‘Exchange Settlement Funds’ with the RBA. These are accounts which, at the close of business each day, must be in a positive position. If a bank looks like it will be in a negative position, it must borrow from other banks to make the adjustment. The weighted average of this overnight borrowing is called the ‘cash rate’. The RBA influences this cash rate by buying and selling its own ‘Government Notes and Bonds’ depending on whether it wants the cash rate to rise or fall. This is referred to as ‘Market Operations’. It’s the old supply and demand position. Increase demand for money by reducing supply and vice-versa.
Now following on from the above, this overnight borrowing between banks only makes up a small part of a bank’s borrowing commitment. Banks also have a commitment to longer term borrowing, and that is made up from longer term investors and other banks. A bank will typically fund 50% of its commitment from onshore sources, depositors and wholesale money markets, and 50% offshore. Of course this funding mix changes daily. It’s the ‘offshore’ money borrowing which is a significant factor in explaining the recent interest rate increases. Since the Global Financial Crisis (GFC) sources of investors became more difficult to locate and some were perhaps too risky to consider? Much of Australian banks’ offshore borrowing comes from the more reputable and established USA, and since 2015 the US Federal Reserve has lifted their prime cash rate Federal Funds Rate (FFR) no less than eight times. Back in 2015, it was coming off a ‘zero’ starting position. As the US economy showed signs of strengthening, the Federal Reserve changed their stance on printing money because they no longer needed to stimulate the economy. Go back to supply and demand. The less money circulating, the greater the demand and the higher the cost. If Australian banks are borrowing offshore via the USA then their cost of that portion of their borrowing is rising, and they then pass that on to the Australian home borrower. The Federal Reserve in the USA, according to markets, could quite likely raise the FFR once more in 2018, possibly three times in 2019, and maybe once again in 2020. At that end point the FFR could stand at what they believe to be a more ‘normalised’ rate of say 3.50%. The end position is, regardless of what our own Reserve Bank of Australia does with the Australian ‘cash rate’, it’s the offshore component of borrowing costs that could quite likely trigger more rate rises. Of course, the magnitude of each and any rise is likely to be a lot less than say the quarter of 1% that the USA Federal Reserve has been lifting. So please do not panic. The current bank three year fixed home loan rates on offer are still, in many cases, reflecting a position under 4% and very close therefore to many banks’ basic variable rates, so that in itself is telling you something.
If you’d like to chat more about this and discuss your own financial lending position, I’m only a phone call away on 02 6583 2211.