Australian borrowers face out-of-cycle rate rises as cheap RBA funding to the banks matures

Australian banks will be under pressure to embark on out-of-cycle rate hikes as they refinance $188bn in cheap funding from the Reserve Bank.

The RBA loaned Australia’s banks $188bn in funding in two tranches, with the first set to expire in September, increasing wholesale borrowing costs.

Australian banks will be under pressure to embark on out-of-cycle rate hikes as they refinance $188bn in cheap funding from the Reserve Bank.

AMP Capital chief economist Shane Oliver says another potential hike – of about 25 basis points – is likely, and the banks could do it out of cycle from the RBA or by increasing discount rates.

Such a move would force the average borrower to pay up to $20,000 extra annually on their home loan compared to last April, as the RBA is expected to raise rates for the ninth consecutive time on Tuesday.

The RBA provided $188bn in loans to the big banks at record low rates as part of its pandemic emergency response. It was completed in two tranches, with the first set to mature in September.

It comes as economists are split on when the RBA will pause its most aggressive series of interest rate hikes in 30 years.

The central bank is widely tipped to raise the official cash rate another 25bps to 3.35 per cent on Tuesday after inflation rose higher than expected in the December quarter.

While consensus estimates predict the cash rate will peak at 3.6 per cent, Goldman Sachs and Deutsche Bank are expecting another three increases after Tuesday, with the RBA not pausing until it hits 4.1 per cent. This would take average variable rates to more than 6 per cent.

Dr Oliver said taking the cash rate to 4.1 per cent or more “would be a policy mistake, risking a major recession”, adding “we are near the top in rates”.

But he said the banks are likely to lift rates separately as they pass on higher wholesale borrowing costs when the RBA’s term funding facility matures.

AMP chief economist Shane Oliver says interest rate rises outside the RBA’s hikes are likely.

“The banks got access to very cheap funding at 0.1 per cent three years ago and took it out in a couple of tranches … roughly half of which expires this year and half of it next year.

“They then have to pay that money back and then of course issue a bond or borrow money in the short-term money market where you’re looking at rates which are 3 per cent or more – well up from 0.1 per cent. That boosts their funding costs.”

Dr Oliver said the RBA may factor the maturity of its term funding facility in its upcoming interest rate decisions

“But the RBA also has the complication that it wants to be seen to be tough on inflation. If it doesn’t get the announcement effect of rate hikes, it doesn’t impact inflation expectations,” he said.

“This was a problem in the late ’80s when the RBA didn’t announce interest rate moves. In the end they had to go a lot higher than they would otherwise because they didn’t get the announcement effect. The shock-and-awe headline that comes through as it gets blanket coverage in Australia and people think ‘that’s bad’ and ‘the RBA is pretty serious about its 2-3 per cent inflation target’.

“Whereas if they’re just relying on the banks to do it, it’s harder.”

Dr Oliver said the banks have several options to respond to increased borrowing costs. “Sometimes they can get around these things by doing it without a lot of publicity. There is the standard variable rate, which is the more obvious way of raising rates, but alternatively they could just increase the discount rate that some customers pay.

“Most mortgage holders at present are still trying to juggle the rate hikes that the RBA has been putting through and the banks passing on another one on top of that, or more modest ones on top of that, then it just adds to the burden.”

The RBA’s term funding facility closed to new drawdowns in mid-2021, and was part of a comprehensive set of measures to support the economy in the early stages of Covid-19. It provided low-cost, three-year funding to the banks, reinforcing the benefits of the record low cash rate.

The facility has two maturity dates – September 30, 2023 for funds drawn under the initial allowance, and June 30, 2024 for the second tranche.

Macquarie analysts said the banks remain well placed to deliver their strongest pre-provision profit growth in more than a decade, underpinned by a “17-27-basis-point margin uplift” from last year’s rapid rate rises.

“However, a strong earnings outlook appears to be increasingly captured in expectations, and the risk of ongoing upgrades is diminishing,” Macquarie said.

“Moreover, we see downside risk to earnings beyond the first half of 2023. Higher and persistent inflation and higher rates will likely result in lower asset prices, higher costs and the risk of impairments.

“Contrary to 2022, when we saw upside risk to consensus estimates a year out and were overweight the sector, with meaningful downside risk to consensus expectations in 2024, we expect banks to underperform the market throughout 2023.”

About 800,000 households are set to shift off cheap fixed-rate loans, locked in early in the pandemic, to substantially more expensive variable rates in coming months.

Marion Kohler, head of the RBA’s economic analysis department, told a Senate cost-of-living committee last week the bank estimated about $350bn in loans would roll off super cheap fixed rates to substantially higher variable rates this year, after the RBA hiked rates from 0.1 per cent in April to 3.1 per cent by December.

The full impact of the RBA’s aggressive rate hike cycle is yet to be felt, and how households respond will determine how severe this year’s economic slowdown will be.

Westpac chief economist Bill Evans expects the economy to “stagnate” in the second half of the year but won’t enter recession.

“This post-pandemic cycle is different to previous tightening cycles. Households have accumulated around $270bn in excess savings, around $110bn of which is held in mortgage offset accounts,” Mr Evans said.

“In aggregate, the bank calculates that the median mortgage borrower is currently 20 months ahead on their repayments, although 20 per cent of variable rate borrowers are only zero to three months ahead.

“ It will be the vulnerable marginal borrower who has the most difficult period ahead with higher rates.”

Westpac chief economist Bill Evans expects Australia’s economy will stagnate later this year but avoid a recession. Picture: John Feder

Mr Evans expects another 25bps rise in March, saying there will be scope to pause in April, before a final rise in May.

“Another 25-basis-point increase in May, in response to a likely 6.5 per cent trimmed mean inflation print, will mark the end of the tightening cycle with the cash rate peaking at 3.85 per cent.

“As the RBA awaits the June quarter inflation report the evidence around inflation, wages and demand will be sufficient to avoid an August move with rates on hold for the remainder of 2023.”

Interest rates forecasts have varied widely since the RBA began its tightening last May. Westpac expected hikes in most months of the second half of 2022 — which the RBA ended up doing — but predicted the cash rate would peak at 2 per cent in June 2023.

Meanwhile, CBA forecast last April that the cash rate would reach 1.25 per cent by this month, with NAB expecting a 2.25 per cent rate by August 2024 and ANZ tipping a 3 per cent rate sometime after 2023.

Currently, for a standard variable owner-occupier loan with a 20 per cent deposit, ANZ is charging 5.99 per cent, NAB 4.99 per cent, Commonwealth Bank 4.97 per cent and NAB 4.99 per cent.

UBS analyst John Storey believed the banks were well placed to weather the financial storm.

“The market is oscillating between a dovish and recessionary outlook for the banks, although we think the banks are well placed given (the) shock absorber to higher rates through NIM (net interest margin) expansion on back book repricing and rate sensitivity, (and) provision levels above pre-pandemic (levels),” Mr Storey said.

“We calculate $500bn of fixed rate mortgages to roll off before December 2024. We see Westpac and CBA as the best positioned for the roll off benefits, but Macquarie offers competitive rates which could be a potential threat to market share when consumers consider refinancing their loans.”