Over the past few weeks three of the four major banks in Australia have announced that they are going to be increasing variable mortgage rates. While there has been a lot of adjustments to mortgage rates over recent years, the big difference with the latest announcement is that the higher mortgage rates are going to affect owner occupiers. Most of the previous mortgage rate changes announced by the major banks have only affected investors and those with interest only mortgages.
Many of the smaller regional banks have pushed mortgage rates for owner occupiers higher over recent months citing higher short-term funding costs. Although until now the major banks had resisted making an adjustment to mortgage rates it seems they too have had their hand forced by higher funding costs. The above chart highlights the cost of short-term funding to banks (the three-month bank bill swap rate) and it clearly shows that the cost of short-term funding has increased. It currently sits at 2.26% compared to the official cash rate which remains unchanged at 1.5% since August 2016.
Short-term funding costs have certainly risen recently however, it is also interesting to look at the composition of funding to Australia’s banks. Short-term funding is not an insignificant part of the funding profile (slightly more than 20%), although the share of funding from short-term debt has fallen over recent years as domestic deposits have increased. There are other ways to handle higher short-term funding costs rather than lifting mortgage rates but that would likely mean cutting dividends which lenders seem reluctant to want to do or reducing deposit interest rates which would likely see a further reduction in the primary funding source: domestic deposits.
From a housing market perspective the timing of the announcement of higher interest rates is an interesting one. After many years of strong value growth, Sydney and Melbourne housing is now well embedded in a downturn. Tighter credit conditions, higher mortgage rates for investors and interest-only borrowers and reduced affordability have already led to the falls of -5.6% from the peak in Sydney and -3.5% from their peak in Melbourne. This has occurred so far without higher interest rates for owner occupiers paying off principal and interest however, that is about to change.
The timing of the hikes to mortgage rates is also interesting in that it has been announced right at the beginning of the Spring Selling Season. Although spring, in my mind and according to the data, is somewhat overhyped as a good time to sell, more stock does typically become available for sale over the period and buying activity typically increases. The other usual occurrence at the beginning of spring is that lenders offer enticing mortgage rates to the market to jostle for market share. By contrast this year, major lenders are announcing higher mortgage rates.
Higher mortgage rates have already driven a slowing of demand for investors over the past year. Although the magnitude of the mortgage rate increases announced is fairly small (around 15 basis points by each lender) it is likely that the higher mortgage rates will impact on housing market sentiment. Furthermore it may end up further exacerbating the declines which are already occurring in Sydney, Melbourne, Perth and Darwin and the slowing of value growth being experienced elsewhere. Overall this move seems likely to lead to a continuation of the currently weak housing market conditions over the coming months and may weaken the market further. From the lenders perspective, clearly they realise that the housing downturn is becoming entrenched (particularly in Perth and Darwin, but more recently in Sydney and Melbourne) and they are doing what they can to maintain profitability in the face of lower mortgage volumes.