Brace For Higher Interest Rates

The Age

Monday March 3, 2008

Jacob Saulwick and Danny John

HOME loan and business borrowers face an extended period of higher interest rates as Australian banks begin to fix their fund-raising efforts at more costly prices in the face of deteriorating local credit markets.

A sudden jump in the cost of borrowing has also all but locked in the chance that the big banks will top up the Reserve Bank of Australia's anticipated rise of 0.25 of a percentage point tomorrow with their own rate rises.

Key money market rates blew out last week, on the back of a scramble among banks to access short-term money. At the same time, the latest funding pressures have wiped out the relative advantage offered by Australian markets over their US counterparts.

This is set to dash the hopes of bank bosses, such as National Australia Bank chief executive John Stewart, that major financial institutions would avoid having to pass on the increased borrowing costs to millions of mortgage holders after two such rises in January and February.

Since the credit crunch hit, Australian banks have raised home loan rates by an average of 15 basis points above the RBA's recent 0.25% increases.

Mr Stewart told business leaders in Sydney last week that the banks had absorbed twice the amount of higher credit costs than the bill they had asked their customers to pick up - about 30 basis points. If there was no further deterioration in pricing then NAB would only lift interest rates again by the same level as the RBA, Mr Stewart predicted.

However, the outlook for the coming months and next year was not so bright, given that banks were taking out longer-term loans at higher rates of interest, he indicated.

Similar funding pressures were identified by major regional bank Suncorp at its half-year results last week when it said costlier pricing would be a feature of the 2008-09 year.

The Brisbane-based bank expects to take a $16 million hit to its bottom line during this financial year to cover funding costs it continues to absorb.

The pressure on bank balance sheets has been highlighted by the head of research at nabCapital, Peter Jolly, who said Australian money markets had offered a relative advantage to US funding costs in late 2007, but that advantage had been blown apart.

"Australia is no longer 'de-coupled', with funding premiums for Australian banks similar to those in the US," Mr Jolly wrote to clients last week.

The prospect of the banks passing on higher rates is seen in the gap between the three-month bank bill swap rate - the rough cost of corporate borrowing - and the three-month overnight index swap rate, which is where markets expect the RBA's rate to sit in 90 days. For years the gap has been less than 0.1 of a percentage point. But after last month's rate rise it was about 0.35 of a point, and last week it blew out to 0.66 of a point.

"If these pressures are sustained it is reasonable to expect that at least part of this 30 basis points will be passed through to mortgage and business borrowers in the weeks/months ahead," Mr Jolly said.

ABN Amro chief economist Kieran Davies said banks had been relatively slow to pass the pressures on to borrowers, preferring to claw back customers from non-bank lenders.

This strategy has largely worked, with the non-bank share of housing finance contracting by 40% in the past few months.

Mr Jolly said the funding pressures were driven by a fundamental imbalance between the supply and demand for short-term money.

Banks are having to increasingly tap short-term money markets because other companies, which used to be able to fund themselves from international markets, are having to appeal to banks for funding since the onset of the global credit crunch.

At the same time, lenders are thin on the ground, and charging a premium because of concerns about economic growth and higher default rates. The result is a log-jam, which is driving up the cost of borrowing.

© 2008 The Age

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