Interest rates could be living on borrowed time

The nation’s banks could use higher funding costs to justify ­interest-rate hikes.

Former Reserve Bank board member Warwick McKibbin. Picture: Ray Strange

The nation’s banks could use ­higher funding costs to justify ­interest rate hikes on $1.7 trillion in mortgage debt, if the current volatility in global markets ­persists.

Former Reserve Bank board member Warwick McKibbin said yesterday that, all other things ­remaining equal, a change in the US long-term bond rate would eventually feed through to borrowing rates in Australia. “It can happen reasonably quickly,” Professor McKibbin said.

The yield on a 10-year US Treasury bond, which sets the cost of money around the world, has this week climbed the most since the November 2016 US election, with stocks having their worst week in two years. The cause has been the return of animal spirits to markets amid a strengthening of the global economy.

The yield on government bonds tends to be higher when the economy is robust, with interest rates having plummeted to historical lows — in some countries even negative — after the 2008 financial crisis.

Since the last time the RBA ­increased the cash rate, up 25 basis points to 4.75 per cent in 2010, the benchmark rate has plunged to “emergency” levels, now at 1.5 per cent.

Board members again kept the rate on hold yesterday, saying ­inflation remained low but was likely to increase over the next couple of years because of higher commodity prices and tight labour markets.

The inflation forecast for this year was “a bit above 2 per cent”.

Professor McKibbin said his modelling indicated an extra 100 basis points on bond yields in the US would cause a 70-basis-point spillover in Australia. However, some bank analysts played down the prospect of hefty ­mortgage rate increases, because of several factors.

Since the GFC, banks have progressively increased their reliance on more stable deposit funding, at the expense of wholesale debt.

About 60 per cent of funding now comes from deposits, with about 30 per cent from long- and short-term debt raised in local and offshore markets.

Collectively, the big four banks’ appetite for wholesale debt runs to $100 billion a year, or about $2bn a week, but CLSA bank analyst Brian Johnson said each bank was well ahead of schedule in raising debt for lending. In the first 10 days of January, the big four raised about $9bn in some of the more benign conditions in wholesale markets for a long time.

Credit growth is also slowing, partly due to speed bumps on ­investor lending imposed by the Australian Prudential Regulation Authority, and Mr Johnson said the need for funds would be further crimped by the industry’s reliance on an RBA liquidity facility. “So I would say it’s unlikely there’s going to be any medium-term impact on mortgage rates,” he said.

“The way things are at the ­moment, the banks could stay out of wholesale funding markets for many, many weeks.”

Peter Jolly, head of research in the global markets area at Nat­ional Australia Bank, said bond yields had been rising for about 18 months, although the trend had accelerated this year.

“Rising yields make equity markets flinch, but we’ve had many years of super-low interest rates and it’s been a slow turn,” Mr Jolly said.

“There’s been an aggressive fall in the market and the bears are starting to come out, but that’s not how we’re reading this one.

“We believe rates are rising for good reasons, mostly due to a stronger global economy.”

More insight on funding costs will emerge at this morning’s half-year profit announcement by the Commonwealth Bank. It will be the last result unveiled by outgoing chief executive Ian Narev, who is expected to announce $5.3bn in earnings for the six months to December.