Over the past month, we have seen a shift in cash rate predictions for 2019 from economists. Some see it holding throughout the year, some anticipate one 0.25 of a percentage point cut, and Westpac is now projecting two 0.25 of a percentage point cuts to reach 1.00 per cent by year-end.
Looking at these forecasts from a mortgage holder’s perspective, does it still matter if the RBA holds or cuts the official cash rate, given Australian banks have increased their rates in recent times independently of the cash rate?
Since August 2016, the RBA has held the official cash rate steady at a record low 1.5 per cent; however, during that time, the standard variable rate set by the banks has declined once and been lifted twice.
The margin between the standard variable mortgage rate and the RBA’s official cash rate has widened over the past nine years.
At the peak of the post-GFC rate cycle, in November 2010, the RBA lifted rates by 0.25pp to 4.75 per cent. At that point in time, RBA data showed that the standard variable rate for owner-occupiers was 7.80 per cent — a difference of 3.05pp compared to the official cash rate. A year later, the RBA dropped the cash rate by 0.25pp to 4.5 per cent and though the variable rate also fell to 7.55 per cent, the difference remained the same.
During the 12 months to November 2012, the cash rate was cut four times to sit at 3.25 per cent. In conjunction, the standard variable rate also fell, but not at the same pace, to 6.63 per cent. This broadened the gap between the two rates to 3.39pp.
Fast-forward to January 2019, the cash rate stands at 1.5 per cent and the variable rate is 5.37 per cent — the highest margin on record of 3.87pp.
The widening gap applies whether standard or discount variable rates are used, and in order to return to the margin of 3.05pp seen in 2010, the RBA would have to lift the cash rate by 0.25pp three times throughout the year. Considering the Australian housing market is currently going through a period of adjustment and borrowers have been hit with rate hikes due to increasing interest rates in overseas markets, many economists are predicting that the RBA will cut the cash rate even further in an effort to achieve its inflation objective.
Impact on mortgage rates
Although banks are generally expected to keep rates in line with the RBA’s cash rate, it’s not guaranteed, as funding costs for mortgages are based on many economic and financial factors.
One factor is the strength of the Australian economy. Indicators like unemployment and GDP, which determines household wealth and drives changes in the Aussie dollar, influence the demand for home loans which can either propel rates higher or lower. Presently, the RBA is keeping an eye on household consumption, which accounts for approximately 60 per cent of spending in the economy.
Mortgage rates can also be influenced by the banks’ short-term borrowing such as bank bill swap and overnight cash rates, which impacts the funding costs of our major banks. If short-term borrowing rates are on the rise, banks could pass on that savings to mortgage holders by hiking interest rates.
Trends like a narrowing of the credit-deposit gap — the amount of borrowing compared to savings — is another factor impacting interest rates. An ongoing credit-deposit gap would add pressure to short-term funding, and again, the banks could pass that savings to mortgage holders.
In addition, global economies and financial markets impact the cost of funding for our local banks. These include government bond rates and the monetary policy settings of the world’s major economies. All eyes are currently on China as its economy has slowed more than expected and tensions with the United States squeezes finance to the private sector.
What it means for borrowers
A report by Deloitte found that 41 per cent of Australian mortgage holders do not keep track of the cash rate or consider its impact on their home loan. And with the cash rate being at a record low for 30 consecutive months, Australians can be absolved for underestimating its importance.
As illustrated, banks do not have to keep interest rates in line with the RBA’s cash rate. However, the cash rate will impact the cost of funding for the banks, sequentially impacting mortgage repayments as banks pass on those costs to consumers. So, yes, it’s still relevant for mortgage holders to stay up to date on the RBA’s monthly decision.
Despite the cash rate being kept on hold, the regulatory and economic environment has already triggered changes in mortgages rates — hence why it’s vital for mortgage holders to also be across all major economic news, domestic and global.