Australia rate policy potent despite bank breakaway
Australia can still boast one of the most powerful monetary policy mechanisms in the developed world even as domestic banks threaten to gum up the works with higher home loan rates.
Blaming global pressures on funding costs, banks have lifted their rates despite official rates staying steady. That broke a decade-old convention and sparked talk the Reserve Bank of Australia (RBA) was somehow losing control of policy.
“It’s rubbish,” was the response of Shane Oliver, chief economist and head of investment strategy at fund manager AMP Capital. “It hasn’t made policy any less potent and the RBA has more than enough scope to keep it that way.”
In fact, there are signs the spike in bank funding costs may have already peaked, nipping the problem in the bud.
The fracas began last month when the country’s four major banks — Australia and New Zealand Banking Group (ANZ.AX: Quote, Profile, Research), Commonwealth Bank (CBA.AX: Quote, Profile, Research), National Australia Bank (NAB.AX: Quote, Profile, Research) and Westpac (WBC.AX: Quote, Profile, Research) — lifted home loan rates by between 6 and 10 basis points.
In all, 45 lenders lifted their standard variable rates by an average of 12 basis points, even though the RBA left its cash rate unmoved at 4.25 percent. The central bank is widely expected to again hold the rate on Tuesday, at its March meeting.
Home loan rates have tended to move in lockstep with the cash rate in recent years though the linkage has really been fraying since the global crisis of 2008.
Yet, despite the out-of-cycle step, most mortgage rates are still around 40 basis points lower than they were in early November when the RBA cut its cash rate by a quarter point to 4.5 percent, and followed with an second such move in December.
“The RBA’s rate cuts last year are having the desired effect of boosting domestic demand,” said Rob Henderson, chief economist markets at NAB. “Monetary policy still works, despite many reports of its demise.”
Recent data on jobs, retail sales and consumer and business sentiment have all shown signs of improvement in the first two months of this year.
Monetary policy is a powerful instrument in Australia as the vast bulk of the A$1.2 trillion ($1.3 trillion) of home loans are variable so their rates are directly impacted by changes in the cash rate.
That is a stark contrast with the United States, where most loans were fixed for 10 to 30 years and largely set based on Treasury yields. That gave the Federal Reserve the much more arduous task of having to move long-term yields to affect mortgage rates.
This is a major reason the Fed has not only had to cut rates to near zero but also buy hundreds of billions of dollars of Treasuries to try and pull yields down.
“We at least have the luxury of operating at the front of the curve to affect mortgage rates,” Guy Debelle, the head of the RBA’s financial markets unit, noted last month.
“The fact that relationship is not exactly one-for-one makes our life a little harder than it otherwise would be, but it’s a hell of a lot easier than in a lot of other countries.”
He also said that the level of the cash rate had already taken into account the sharp rise in bank funding costs that followed the global financial crisis.
The RBA has estimated the extra cost for the banks at between 100 and 125 basis points. To compensate for that, the current cash rate is around 100 basis points lower than it would be otherwise.
PAYING FOR THE MISTAKES OF OTHERS
There’s no doubt the banks face a trio of troubles: higher funding costs, weak credit demand and intensified competition.
Ever since the events of 2008, investors have demanded greater risk premiums for lending to banks globally, putting an end to years of cheap funding. Australia’s banks have had to pay more, like everyone else, though they remain among the most highly rated borrowers in the world.
Indeed, the spread they have to pay for funds began to widen further as Europe’s debt woes came to the boil late last year.
Australian banks have also been engaged in a fierce battle for deposits that is adding to costs. Deposits lessen the reliance on wholesale funding and are favoured by regulators.
As a result, the share of deposits in funding has climbed to almost 52 percent, from under 40 percent back in 2007 and 2008. But that has not come cheap, with banks routinely paying rates between 5 and 6 percent for online and term deposits.
Since the major banks are keen to lift the share of deposits toward 60 percent, the cost is unlikely to come down soon.
Competition has also sharpened on the other side of the ledger as Australian households choose to save more and borrow less. Annual growth in mortgage debt has shrivelled to 5.3 percent in January, the slowest pace since at least 1977 and a long way from the peak of 22 percent in 2004.
Desperate for business, the major banks offer ever deeper discounts on mortgage rates for new loans. While standard rates for existing loans range from 7.31 to 7.46 percent, a few phone calls can easily get a quote 80 to 100 basis points lower.
Yet with the worst averted in Europe in the last few weeks, there have been signs that funding costs are easing again.
When CBA launched its first offer of covered bonds in January, it had to pay an expensive 240 basis points over government yields. But that spread has since come down to 198 basis points.
Also helping has been a recent rush of offshore issuance in Australian dollar paper, or Kangaroo bonds, since it helps lower the cost to local banks of hedging money they raise abroad.
Neither have the banks had any trouble in getting all the funding they desire, even if they have to pay up for it.
While many European banks are effectively locked out of the market, the four Australian majors have issued almost A$20 billion in covered bonds alone since October.
So far this year, they have raised around 5.6 billion in euros, 8.2 billion in Norwegian crowns and 1.5 billion in Swiss francs. Just last week, NAB sold $2.5 billion of three- and five-year notes in the United States.
And it’s not as though the banks are unprofitable. In their last full year, the top four enjoyed a combined net profit of A$24 billion with a respectable return on equity of around 15 percent.
So with spreads now narrowing and the banks ahead on their funding needs, it is far from clear they will risk more customer anger by lifting mortgage rates further this month. The first move was highly unpopular and drew a torrent of negative press, as well as considerable political heat.
Assuming the RBA keeps the cash rate at 4.25 percent on Tuesday, that would leave the ball in the court of ANZ which will announce its mortgage rates on March 14.
Even were ANZ to risk it, any increase would likely be by a few basis points and the RBA has, essentially, 425 basis points of cash rate to work with. Which may have been one reason RBA Governor Glenn Stevens has sounded sanguine about the prospect.
“If the movements in the spreads start to take things for the overall economy significantly away from where we think they should be, then we would act to kind of offset that,” he told lawmakers last month.
“We are still making the calls as to where monetary policy ought to be,” Stevens added. “There is just a small bit of slippage in part of the transmission mechanism that I do not think is going to cause us a huge headache at this stage.” ($1 = 0.9264 Australian dollars)
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