Banks cheer with interest rates about to rise

After grinding it out for two years with interest rates near zero, there’s a palpable sense of relief in the major-bank sector that the cash rate is being readied for lift-off.

National Australia Bank chief executive Ross McEwan says official rates are likely to skip up from their current emergency level of 10 basis points to 75 basis points in the next 12 months. Picture: Aaron Francis / The Australian

After grinding it out for two years with interest rates near zero, there’s a palpable sense of relief in the major-bank sector that the cash rate is preparing for lift-off.

While the Veuve remains on ice, the champagne flutes are being lined up because calibrated rate hikes are unequivocally good news. That’s because banks can quickly pull the lever, charging more for loans but keeping a tight lid on their main source of funding – customer deposits.

They also benefit from higher yields on their holdings of cash and “near-cash”.

National Australia Bank chief executive Ross McEwan said on Friday that official rates were likely to skip up from their current emergency level of 10 basis points to 75 basis points over the next 12 months.

“Rates are going up,” he pronounced on Melbourne talkback radio station 3AW. “They’ve already started in (fixed-rate products), which is an indication.”

Fixed rates have indeed been going up. Mr McEwan’s commentary came on the same day NAB lifted its fixed-rate mortgages by up to 0.2 per cent for owner-occupiers and investors.

The bank’s fixed rates are now up to 1.56 percentage points higher than they were 12 months ago.

Lest he is accused of price signalling, Mr McEwan was endorsing the view of his economics team led by Alan Oster, who last week switched his view to the likelihood of an initial, 15 basis-point increase in the cash rate in November, followed by 25 basis-point hikes at each of the next two meetings. This would take official rates to a heady 0.75 per cent by February next year.

There are complicated swings and roundabouts associated with a switch in the interest-rate cycle.

However – in a report optimistically titled “Moving from Defence to Offence” – UBS estimated this week that the major banks could reap a $5bn – or 6 per cent – revenue reward in the next three years from a gradual rise in interest rates. This would translate to a 25 basis-point increase in the industry’s net interest margin – not bad compared to the 19 basis-point margin squeeze over the last five years.

UBS actually believes the banks have done a “phenomenal” job through interest-rate hedging and repricing their loans and deposits to contain the damage to their NIMs, while riding a 190 basis-point decline in the cash rate over the same period. On top of that, regulatory reforms have required a build-up of expensive, high-quality liquid assets to improve the industry’s resilience.

Reserve Bank research from June last year confirmed that bank profitability takes a hit when interest rates are low, especially when they’re low for a long time.

“In the short-term there’s a negligible to modest negative effect,” the RBA said.

“This is at least partly because of the positive effect that lower interest rates have on economic growth and banks’ asset quality, which offsets the negative effects of lower interest rates on NIMs.”

However, there is evidence that bank profitability falls further when interest rates are at low levels and remain low for a prolonged period. But now the unfavourable interest-rate tide is ebbing and expected to turn, with UBS assessing that the market has under­estimated the potential impact on bank earnings of a gradual rise in interest rates.

It also points to average forecast GDP growth of 4.4 per cent between 2021-23, and a further downward trend in unemployment. If the investment bank is right, the broader market will benefit from strong outperformance by the banks, which account for 22 per cent of the benchmark ASX200 index.

RBA governor Philip Lowe set the scene for a more frank discussion about the trend for official rates in a National Press Club address on Wednesday.

After the central bank left rates on hold for the 14th consecutive board meeting on Tuesday, Dr Lowe effectively dumped his longstanding guidance that the cash rate was unlikely to be lifted until late 2023 – or more likely 2024 – when inflation was sustainably in the target range of 2-3 per cent.

He said the faster-than-­expected economic recovery, rising inflation and the sharp fall in unemployment all meant that a 2022 rate hike was now a chance.

“It’s certainly a plausible scenario that rates go up later this year,” the governor said.

Unveiling Westpac’s first-quarter trading update on Thursday, chief executive Peter King declined to predict the next tightening in the cash rate, but noted fixed rates had been moving up consistently for six months.

If the RBA chose to hike rates, that meant the economy was performing well, with lower unemployment, some growth in wages and a bit of inflation.

“The risk is that the RBA overshoots but that risk is there and I think from what the Reserve Bank governor said (on Wednesday), he’s watching that closely,” he said. “But a rise in interest rates means a better economy, and we’ve assessed mortgages with buffers and floors on the expectation that rates won’t stay this low forever.”

Next week, ANZ and NAB show their hands with quarterly trading updates on Monday and Thursday, respectively.

Commonwealth Bank’s half-year result – as a result of its June 30 balance date – is sandwiched between its two rivals on Wednesday.

ANZ appears to be further advanced in its bid for an $8bn cost base, which should offset some of the volume and margin pressure in its underperforming mortgage business.

While CBA has far and away the best retail banking franchise in the country, its September quarter trading update highlighted that even CBA has not been spared from the profitability pressures suffered by its rivals.

The bank will have to pull a rabbit out of its hat to justify a rerating from an already-lofty multiple. Equities analysts covering CBA, according to Bloomberg, are expecting a $4.8bn profit for the half year to December 31.

Meanwhile, perennial underperformer NAB is relishing its new-found favouritism as the bank best-exposed to the economic recovery. The business bank is growing well in all segments without sacrificing its profit margin. The industry is shaping up pretty well, despite the horrors first expected from Covid-19.