Analysis: Behind the fixed-rate war

Last week, borrowers were given even greater choice with a total of seven lenders cutting their fixed-rate mortgages by varying degrees.

The majors were able to lead the charge by issuing money into the wholesale market rather cheaply – the five-year swap rate is down to just over three per cent – which is the underlying dynamic here.

Another important factor to consider is the reluctance among Australian borrowers to fix their home loans.

This dates back to 1989, when fixed rates were first introduced into the Australian market; back then interest rates were in the high double digits.

Standard variable rates were up around 17 per cent when lenders introduced three-year fixed-rate alternatives at an attractive 15 per cent.

Unfortunately, those fixed rates didn’t look so good a year later when the economy started to recover and standard variable rates came down to 12 per cent.

Since then Australians have looked down upon fixed-rates with distrust.

AMP Capital chief economist Shane Oliver says the banks can be more competitive in their fixed-rate offerings knowing that not many people will switch.

“But it is great publicity advertising that their rates are now below five per cent,” Mr Oliver says.

“The reality is Australians like fixed rates as much as Americans like variable rates,” he says.

“The proportions are about the same – about 15 per cent of borrowing in Australia is fixed.”

History has a tendency to repeat itself, but then again, fixed rates have not been this low for some time.

CBA’s latest offering and Westpac’s matching product is the lowest five-year fixed rates in the history of each institution.

It will be interesting to see over the coming months whether the price is finally right to change our view on fixed-rate home loans.

In the meantime, there are greater implications for the Australian lending industry.

“The big picture story here is interest rates are at record lows – both variable rates and fixed rates – and that is supporting a housing boom that is ongoing in Australia,” HSBC Australian and New Zealand chief economist Paul Bloxham says.

“There was a brief pause in May which looks as though it might have been somewhat seasonal, but really house prices are still growing at very strong rates; at double digit rates nationally and in the strongest market, in Sydney, they are still running at rates close to 15 per cent, which is very strong house price growth,” Mr Bloxham says.

“The key question is whether the RBA will use other instruments other than the official cash rate,” he says.

In its latest minutes, the Reserve Bank makes no indication of further rate cuts – or rates rises – any time soon.

But we only need to look across the ditch to New Zealand to see how LVR caps have cooled the Kiwi housing market, or further afield to the UK where macro prudential tools are still being implemented to curb mortgage lending and the overheated London housing market.

“At the moment [the Reserve Bank] have made it clear that we haven’t got macro prudential tools here in Australia and that is not on the current working agenda,” Mr Bloxham says.

“We think that one of the reasons why the RBA won’t deliver any further interest rate cuts and why in fact they may have to lift interest rates in the first half of next year is that the housing market is continuing to boom,” he says.

APRA and the RBA have flagged the potential for the banks to hold more capital against their residential mortgages, an issue that was also highlighted in the Murray Inquiry’s interim report earlier this month.

But according to AMP Capital’s Shane Oliver, the likeliness of this happening is doubtful.

“I think the RBA sees the rise in house prices we have seen as a fairly normal response to low interest rates,” Mr Oliver says.

“If it continued at the current rate that would be a big problem,” he says. “But so far so good.”

As the rate debate rolls on, Australian borrowers continue to benefit from some of the cheapest mortgages on offer in decades.