Australia’s central bank is set to extend the developed world’s steepest interest rate cuts after banks failed to match its reductions, blunting their impact.
The Reserve Bank of Australia probably will lower its cash rate to a record-low 2.75 percent by February, from the current 3.25 percent, interest-rate swap prices show. The nation’s four biggest lenders, accounting for 85 percent of the bank mortgage market, have withheld about a quarter of the RBA’s 1.5 percentage points of cuts since November.
The efforts of RBA Governor Glenn Stevens to stimulate the economy with lower borrowing costs are also being hampered as Australians boost savings to a record and repay debt instead of increasing spending. Recent economic releases have suggested lower borrowing costs are needed as newly built homes fell to the lowest on record in August and mortgage lending is growing at the weakest pace since records began in 1977.
“The fall in the cash rate has overstated the degree to which monetary policy has eased,” said Shane Oliver, head of investment strategy at AMP Capital Investors Ltd. in Sydney. “The easing we’ve seen so far has just involved the Reserve Bank taking its foot off the brake, it hasn’t actually put its foot on the accelerator until perhaps now.”
National Australia Bank Ltd., Commonwealth Bank of Australia and Australia & New Zealand Banking Group Ltd. passed on 20 basis points of the RBA’s latest 25 basis point cut. Westpac Banking Corp. cut by 18 basis points. A basis point is 0.01 percentage point.
Standard variable home-loan rates from the four banks cost an average 6.62 percent, according to statements from the lenders. That compares with 5.85 percent when the RBA’s key rate was at 3.25 percent in February 2009, data from the central bank show. The RBA’s last easing cycle from September 2008 to April 2009 ended with the benchmark at a 50-year low of 3 percent.
A “neutral” cash rate setting in Australia is now about 1.6 percentage points lower than before the global credit freeze, according to Robert Mead, Sydney-based head of portfolio management at Pacific Investment Management Co., which manages the world’s biggest bond fund.
“The RBA looks to the effective end borrowing rate when setting policy,” he said. “To the extent that RBA policy rate changes are not fully passed on to borrowers, then all things equal, the RBA will need to do more.”
Banks have blamed competition to attract depositors and higher spreads paid when raising money on global bond markets as reasons for withholding part of the RBA’s cuts.
Funding costs for banks have “gone up and up, although it has stabilized this year,” ANZ Bank’s Australia Chief Executive Officer Phil Chronican said in an interview with the Australian Broadcasting Corp. that aired Oct. 7. “We’re refinancing this year borrowings that were made three, four and five years ago at materially lower costs.”
The extra yield investors demand to hold Australian dollar-denominated financial bonds instead of government debt has dropped 109 basis points this year to 199, Bank of America Merrill Lynch index data show. The spread was 61 basis points at the end of 2006.
While premiums on Australian residential mortgage-backed securities have also narrowed this year, they remain higher than before the global credit freeze.
Members Equity Bank Pty, established by pension funds, paid 135 basis points more than the bank bill swap rate on the largest class of notes in a A$800 million ($822 million) RMBS sale last month, down from 150 basis points on an offering in April, data compiled by Bloomberg show. The lender paid a 14 basis-point spread on a A$1 billion sale in May 2006, the data show.
Benchmark 10-year sovereign bonds have tumbled 1.27 percentage points in the past 12 months, the most among AAA rated nations, as investors bet on further RBA cuts.
Australian households are building a financial cushion by repaying mortgages faster and saving more, the RBA said in its financial stability review last month. “Most households appear well placed to meet their debt obligations,” the central bank said in the semiannual report released Sept. 25.
The RBA said business credit grew at an annual pace of 6.5 percent over the six months to July after declining for most of the prior three years, indicating companies’ “appetite for debt may be starting to recover.”
Even so, the central bank said overall credit growth will probably remain “fairly subdued for some time” due to weak demand, and banks may struggle to achieve the profit growth they’ve been used to in previous decades.
Australians’ household debt stood at 149.3 percent of disposable income in the second quarter, compared with a record 156.5 percent in 2006, RBA data show. That’s higher than the 133 percent Americans accumulated at the peak of the U.S. subprime mortgage boom, according to the Federal Reserve Bank of San Francisco.
“With aggregate indebtedness still around historically high levels, a continuation of the recent borrowing restraint would help strengthen the financial resilience of households,” the central bank said.
About half of home-loan borrowers are ahead of schedule on their mortgages, the RBA said, citing various data sources. That’s “high compared with many other countries” and comparable to Canada’s repayment rate, it said.
The behavior of Australian mortgage holders has changed since the global financial crisis, with home owners now more cautious, according to Craig James, a senior economist at a unit of Commonwealth Bank, the nation’s biggest lender.
“People nowadays are more worried about what’s happening in Europe, the United States and China, perhaps unduly so,” he said. For the RBA, “the response may be a little bit more delayed than in the past.”
Term deposits swelled 13 percent to A$544.3 billion in the year to August, the most in RBA data going back to 1984. The annual growth of outstanding home loans has fallen to 4.8 percent as of August, the slowest pace since at least 1977, from 14 percent in 2006, the central bank data show.
Still, there are signs the rate cuts are improving sentiment. House prices in Australia’s eight state capital cities jumped 1.4 percent last month, the biggest increase since March 2010, according to a report from RP Data Ltd. and Rismark International. Prime home-loan delinquencies in the second quarter declined to 1.54 percent from 1.6 percent, Fitch Ratings said in a report this month.
RBA Assistant Governor Guy Debelle said last month that monetary policy remains “very effective,” even as lenders aren’t fully passing on rate cuts.
“The Reserve Bank board is conscious of the various rates at which credit is being priced,” Debelle said in a Sept. 18 address in the southern city of Adelaide. “The board is able to set its cash rate target to appropriately take into account the effect on lending rates.”
Recent economic releases signal more cuts may be required. Retail sales rose at half the pace economists forecast while the central bank this month said the nation’s commodities boom is likely to peak next year at a lower level than earlier expected. The jobless rate climbed to 5.4 percent in September, the highest since April 2010.
“The fact that retail sales are still struggling and housing is battling to get off the ground, all at a time when the mining boom is starting to fade, tells me that monetary conditions aren’t easy enough yet,” said AMP’s Oliver, who predicts the cash rate will be reduced to 2.5 percent by March. “Mortgage rates need to fall back to the lows we saw at the time of the global financial crisis.”