Oz set for monetary tightening – though the RBA won't hike anytime soon

Eleanor Creagh

Australian Market Strategist, Saxo Bank Group
Eleanor Creagh joined Saxo Bank Group in 2018 and serves as the bank's Australian markets strategist, responsible for creating, implementing, and monitoring equity strategies and research for traders and investors, as well as developing quantitative models and customised mathematical frameworks for institutional clients.

Funding pressure may see Australian commercial banks raise mortgage rates even though Reserve Bank of Australia won’t be increasing the official cash rate any time soon. Weak wage growth and lacklustre consumer spending have contributed to a lack of inflation in the Australian economy. This has been cited by the RBA governor, Philip Lowe, as the reason behind Australia’s period of record low interest rates since 2010.

The RBA cash rate is expected to remain on hold as a cocktail of both internal and external forces come to a head. Global monetary conditions are becoming more complicated and there is now a trade war wild card adding to the complexity. House prices in Sydney fell around 5% in the last financial year, the first annual decline since 2012. As house prices come under pressure and wage growth is persistently weak this exerts a negative pressure on consumer spending. According to the RBA, consumer spending accounts for around 60% of GDP in Australia so the negative effect further supports Governor Lowe's notion that "inflation might be just a bit lower than we would like for a while". 

Add to the above, tighter lending standards and the Royal Commission into misconduct in the financial services industry, and in as little as two months rate hike expectations have fallen dramatically. Money markets are now only pricing an eight basis points rise in May 2019, two months ago a 25bps rate hike was fully priced in. Some economists are now forecasting the next move up in the official cash rate could be as late as 2020. 

 

Source: Bloomberg

The real problem

But the real problem and cause for awareness comes as a widening differential between the official Reserve Bank cash rate and the cost of money for lenders emerges. Despite the official Reserve Bank cash rate remaining on hold at 1.5%, the bank bill swap rate has risen more than 40bps in recent months (equivalent to 1.6 25bps rate hikes). For the past ten years the gap between the official RBA cash rate and the BBSW has been close to 18bps, but it is now closer to 60bps. 
As funding pressures rise banks and smaller lenders may be forced to raise home loan rates. This could put pressure on the RBA stimulus as 80% of Australian households carry floating rate debt at record levels of 200% of disposable incomes. Any increase in home loan rates will put pressure on consumer spending and therefore inflation, thus challenging Australia’s growth outlook. 

Source: Bloomberg, ASX

Already, smaller lenders including the Bank of Queensland, AMP Bank and ME Bank, IMB, Greater Bank, Homestar Finance and AusWide, have responded to tightening money markets and increased funding costs by raising rates by up to 40 basis points to avoid eroding their profits. The big four banks are also under sustained financing pressure but are unlikely to raise lending rates out of cycle whilst the Royal Commission looms. 

If the BBSW rates continue to diverge from the official cash rate this highlights a problem as the RBA’s monetary policy lays its foundations on maintaining a low benchmark rate until consumer spending and inflation picks up. 

Access both platforms from your single Saxo account.

Disclaimer

Any opinions, news, research, analyses, prices or other information contained on this website is provided as general market commentary and does not constitute investment advice or a personal recommendation and does not take into consideration your objectives, financial situation and needs. Saxo Capital Markets UK Limited will not accept liability for any loss or damage including, without limitation, to any loss of profit which may arise directly or indirectly from use of or reliance on such information. We assume no liability for errors, inaccuracies or omissions contained within these materials.

It is important that you understand that with investments, your capital is at risk. We offer leveraged products which carry risk and can result in losses that exceed deposits. Past performance is not a guide to future performance. It is your responsibility to ensure that you make an informed decision about whether or not to invest with us. If you are still unsure if investing is right for you, please seek independent advice. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more here.

Additional Key Information Documents are available in our trading platform.

Saxo Capital Markets UK is authorised and regulated by the Financial Conduct Authority, Firm Reference Number 551422. Registered address: 26th Floor, 40 Bank Street, Canary Wharf, London E14 5DA. Company number 7413871

Please read our full disclaimer - https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer