The Reserve Bank of Australia (RBA) has kept interest rates on hold for the 24th consecutive month, meaning that the official cash rate remains at a historic low of 1.5%. While no firm predictions are given for future rises, the indications to date are that these rates look set to stay for a while yet. In fact, markets have suggested that we might not see a rise until 2020 barring unexpected developments.
However, some of the banks have chosen to increase their rates out of cycle: that is, instead of following the RBA’s lead.
Initially, it was the smaller lenders who increased their rates. Westpac followed suit, with an announcement on 29 August to take effect on 19 September. Commonwealth Bank and ANZ have also raised rates, with the NAB the only hold out. Rate rises vary, but have been kept to below the 0.25% change that the RBA treats as standard.
An out of cycle rise of this nature is unusual, and the banks are conscious that it’s likely to attract negative attention. Why, then, has the decision been made? As with so many financial issues, it’s more complicated than it appears. We look at the three main issues affecting the bank’s decisions, and asked John Rolfe, head of Elders Home Loans, about what consumers should do.
Rising wholesale funding costs
Banks incur borrowing costs in order to obtain the funds that they provide to homeowners and other domestic borrowers. A number of factors can affect those borrowing costs, which in turn affect the margins at which the banks can operate.
Put simply, the banks are paying more to borrow money, but because interest rates have stayed low, they aren’t receiving more to lend it out.
Throughout 2018, there has been a consistent increase in how much banks pay in wholesale money markets to obtain funding. The gap between the three-month bank bill swap rate (BBSW) and the overnight index swap affects the cost of banks’ wholesale borrowings. From 0.25% in December 2017, that number has increased to 0.55% for June 2018.
The reasons vary. An increase in US Treasury bills has meant Australian institutions are paying more for access to US markets. Increased demand for Australian dollar funding amongst international investors may play a part. Many foreign banks have also increased their local currency funding requirements.
These trends mean that the spread between banks’ funding costs and average lending rates have widened. This directly impacts the banks’ bottom line, with the potential to cut hundreds of millions of dollars in profits.
Slowdown in broad money growth
Adding to the banks’ woes is a sharp slowdown in broad money growth. Broad money is the currency and cash held by banks in deposits, which accrues value to the institution and adds to profits. It’s currently growing at its slowest pace since 1993, and the gap between broad money growth (the money that consumers and businesses, including superannuation funds, deposit with banks for safekeeping) and credit growth (the money borrowed by consumers from banks) has widened over the past decade.
This means that banks may need to start paying more in interest to attract new deposits in an increasingly scarce environment.
Increased operational costs
Banks aren’t just facing increases in funding costs. Operational costs are also on the rise. John Rolfe, who has 35 years of experience in the finance industry, is watching closely.
“The thing I’m expecting down the track is that, with the increased scrutiny of finance applications, there’ll be increased costs for the banks”, says John.
“There’ll be more staff time involved in looking at deals, with more training and higher qualified staff overseeing everything. That comes at a cost and might mean that we see further interest rate rises to cover it”.
What should consumers do?
So as a consumer, what’s the best thing to do? John sees the latest developments as positive for borrowers.
“Whenever increase rates increase, people get in touch with their brokers”, he explains.
“So it provides an impetus to look around. The longer people have been with one product, the more opportunity there is to find something better for them. If people sit on the same interest rate for a long time, they might be missing out on a product that’s actually more suitable and saves them money. So in that sense, the out-of-cycle rise creates motivation and energy that’s good for consumers”.
John also recommends that anyone not on a fixed rate consider switching while rates are still low. “There are some really good fixed rates at the moment, which are cheaper than the current variable rates. You can lock your rate for two or three years, and people should be looking to do that. You can also consider fixing just part of your loan, to look after that side of the ledger going forward”.
So if you haven’t got in touch with your broker yet – and a good broker should be communicating with you in any case – give them a call and get some advice. In the meantime, remember that rates are still at a historic low even with the recent changes, so it’s a great idea to take advantage of it while you can.