How funding costs are affecting mortgage rates in Australia

Australian lenders, particularly smaller ones, are going against the steady cash rate by increasing their mortgage rates, much to the dismay of home loan borrowers. With nearly everyone expecting the big four banks to follow suit, it’s reasonable to wonder why these lenders are suddenly raising rates despite the central bank's hold on the cash rate.

In a think piece on Livewire Markets, senior credit analyst Peter Fullerton said nearly every bank that has hiked mortgage rates cite the increase in funding costs as the reason for doing so. Fullerton said the banks needed to pass on these costs to their borrowers in order to maintain their profit margins.

The bank bill swap rate is one of the main drivers of inflated funding costs. The bill swap rate rate is the primary short-term reference lending base rate used in debt capital markets.

"The swap rate has been, on average, 20bps wider than the RBA cash rate since 2003; however, it has recently spiked and currently sits 56bps wider than usual levels, effectively adding 36bps in additional wholesale funding costs," Fullerton said.

Also read: Why mortgage rates might go up, even without the RBA

Digging deeper into the issue, Fullerton said the major reason why the swap rate broadened was a decline in deposit growth, which compelled banks to outsource higher levels of funding from domestic and offshore debt capital markets. To put it simply, the amount Australians are borrowing is more than what they are saving in their deposit accounts, pushing banks to rely on debt capital markets.

It was Suncorp which first announced a mortgage rate hike in late March. Just as expected, it cited the increasing swap spreads as a main driver. Fullerton said around 17% of Suncorp's funding is from debt capital markets, making it vulnerable to changes in funding costs.

"Banks that have a higher level of deposit funding will be comparatively less affected with the increase in the swap rate," he said.

The central bank has maintained a 1.5% official cash rate since 2016 and Fullerton believes an increase would have a significant and direct impact on mortgage rates.

"However, we anticipate that there will be no change to the cash rate, potentially for another 12 months or longer. An increase in the cash rate would impact deposit rates and the swap rate, impacting almost all sources of funding," he said.

For Fullerton, higher deposit rates would send shockwaves across the market, especially if the current slowdown in deposit growth continues.

"Given deposit funding is such a large component of total funding, any increase in cost will have a proportionally larger increase in overall funding costs and place upward pressure on mortgage rates," he said.

"The bottom line is that, absent a rise in the official cash rate in Australia, any increase in Australian mortgage interest rates are likely to be modest."

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