Analysis: Has the RBA cash rate become irrelevant?

The answer all comes down to perception, which may sound philosophical, but it’s really quite practical. Anyone sitting opposite a client who is asking them why their mortgage rate keeps moving when the RBA has made no changes in 22 months will be eager to give them an explanation.

Late last week, the US Federal Reserve raised rates by 25 basis points for the seventh time since it started hiking in December 2015. This takes the Fed Funds rate to a range of 1.75 per cent to 2 per cent.

So, what impact does an event like this have on Australian mortgage rates?

Well, Aussie banks get about 65 per cent of their funding from domestic deposits. It’s really the remaining third that is affected by global money markets.

About half of that third comes from longer-term bond markets and half comes from shorter-term markets, AMP Capital chief economist Shane Oliver told Mortgage Business.

“To the extent that banks might source some of that shorter-term money and longer-term money from the US or global markets affected by bond yields in response to the Fed rate hike, then there will be some flow-on,” Mr Oliver said. “But the Fed has been raising rates since 2015. It hasn’t had a huge impact on bank funding.”

Mr Oliver believes there could be upwards pressure on local variable rates due to a blowout in the spread of interbank borrowing rates. But hiking rates out of cycle has become very unfashionable, particularly as scrutiny of the lending sector has intensified, arguably reaching its crescendo with the ongoing royal commission.

This has left banks in a tough spot, as rising funding costs need to be absorbed somehow.

“The banks seem to be absorbing that onto their profit margins,” Mr Oliver said. “If they are going to be raising rates, it would be for borrowers who are less protected by public scrutiny. I find it very unlikely that they would raise rates for owner-occupiers on P&I loans.”

Widespread dissatisfaction over out-of-cycle rate hikes is nothing new. In fact, it’s been brewing since 2008, when the banks began hiking rates regardless of the RBA’s movements.

Consumer perceptions were arguably formed during the decade previously, between 1997 and 2007, when the RBA cash rate’s correlation with the standard variable rate was very consistent (see the green line on the graph above).

“Most people associate their borrowing costs with whatever the Reserve Bank does,” Mr Oliver said.

“The era between 1997 and 2007 was one where other sources of funding were relatively stable and also correlated with what the Reserve Bank was doing,” the chief economist said. “It gave the perception that there was a one-for-one relationship.”

But if we consider the 10 years from 2008 to today, it becomes clear that funding costs have diverged significantly from what the RBA does; in 2009 we were hiking rates, while the Fed left rates at zero from the financial crisis until 2015. We then started cutting rates as they began to raise them.

The RBA has now left rates on hold for a record 22 months. Mortgage rates have fluctuated significantly over that time, due to funding costs and banks reacting to macro-prudential measures. These have been relatively modest movements: 25 to 50 basis points, say.

But according to AMP Capital’s Shane Oliver, the big swings will still be originated by the central bank.

“The huge reduction in mortgage rates that have occurred in the past in response to developments in the economic cycle has been determined by what the Reserve Bank does,” Mr Oliver said.

“In terms of the big cyclical swings in mortgage rates, the Reserve Bank will still be the one to watch.”