What Is Really Happening With Rate Changes?
With 2022 already ramping up, it is important to be keeping an eye on what is happening in the financial markets to ensure that you are managing your money effectively. It has been predicted for some time now that interest rate hikes were coming.
Many people are still not aware that this has already started happening. This article is designed to give you a deep dive into where things are at now and what we can expect as this year unfolds. Proper planning around property investments will ensure your financial position remains stable amongst the changes.
Interest Rates Moving Up
Westpac made the first fixed-rate move of 2022 on 21 January 2022 by increasing their owner-occupied and investor Principal & Interest fixed rates between 10 to 20 basis points.
Westpac is the first big four bank to hike fixed rates in 2022 and it certainly won’t be the last as the cost of wholesale funding is rising both in Australia and overseas.
There are now limited fixed rates under 2 percent with only a few smaller lenders still offering it and it is not expected to last long.
Mortgage holders who locked in their rate for 2 years at the start of the pandemic will have to start thinking about what their next step might be when they come off their fixed rate later this year. It will be a completely different interest rate structure.
What is happening?
The Reserve Bank of Australia (RBA) has said that it will not change the cash rate until 2024 at the earliest, essentially allowing inflation to happen to the point at which they need to slow it. So why are the big four banks suddenly increasing rates outside the RBA cycle?
Throughout the most part of the pandemic, RBA’s rhetoric has been to not increase the cash rate before 2024. However, in his speech after their November meeting, RBA Governor Lowe indicated that RBA was abandoning its commitment to a cash rate rise in 2024 and conceded that rate hikes in 2023 is on the table although he dismissed speculation that inflation could force the central bank to hike rates as early as this year.
Since it became clear that RBA will not wait until 2024 to increase the cash rates, the big 4 banks have engaged in a series of rate rises late last year, with more than 20 rate hike announcements between them in the last 3 months, in an attempt to factor in expected increases in the cost of funds especially in the longer 5 year terms.
According to RateCity website, 17 lenders have already hiked their 3-year fixed rates by the end of 2021, with none lowering their rates.
But why are rates moving up if RBA has not increased their cash rate?
The main sources of funds for Australian banks are deposits, with other major funding sources being long-term and short-term wholesale debt. Equity and securitisation provide other sources of funding.
As such, the banks lending rates are not depending solely on RBA’s cash rate. Although the RBA cash rate is still on hold, the wholesale rates are already rising, as such the banks cost of funds for the mid to longer term is increasing , which is what they are passing onto consumers.
When determining the fixed rates, the banks are incorporating what they think will likely happen in the medium term to the cost of funds.
The good times of low interest rates are coming to an end. While the exact timing of the next cash rate hike is still not certain, borrowers need to know that rates are on the rise – it’s just a matter of when.
How Bank funding works
The cash rate
RBA cash rate has an important role in determining the interest rates on banks' funding sources. However, the interest rates banks pay for different sources of funding don't necessarily move by the same amount or at the same speed as a change in the cash rate.
Market reference rates
Market reference rates are based on transactions between participants in a financial market that happen often enough to reliably measure these rates. Because market reference rates are reliably measured, they are often used as a benchmark for pricing bonds and other debt securities, including those issued by banks. An example of an important market reference rate for bank funding costs is the bank bill swap rate (BBSW).
As part of the comprehensive policy response to the effects of the pandemic, the RBA established the Term Funding Facility (TFF) in March 2020 to offer low-cost three-year funding to authorised deposit-taking institutions (ADIs). TFF provides a source of low-cost funding for the banking system, with funding available for three year terms at a fixed interest rate of 0.25 per cent.
This facility allowed the banks to offer historically low fixed rates in the last two years. As TFF closed to new drawdowns on 30 June 2021, it will only support low borrowing costs until mid 2024.
So, with inflationary pressures and TFF being no longer available, the banks still need to securitise billions of dollars through the bond market and therefore the cost of the money to lend has gone up and so it is passed to consumers.
In addition, Australian banks access large and deep foreign funding markets to supplement their domestic funding. Looking at the big 4 banks’ worldwide operations, such offshore funding accounts for about one-third of their assets.
With the US markets expecting the Federal Reserve to start hiking in either March or May, given it signaled that it's likely to raise rates three times in 2022 from the current rate between 0-0.25%, the cost of wholesale debt for banks is rising.
What to expect in 2022?
Earlier last week, ANZ in a surprise move started their 2022 by cutting their basic variable rate by 20 basis points in an environment where most lenders expect prices only to rise.
The new rate will see customers with over 30% deposit, or 70% LVR, charged 2.19% and those with an LVR of 80% charged 2.29%, taking ANZ to joint cheapest in the Big Four along with Westpac and NAB.
Banking analysts expect that while fixed rates are being hiked, variable rates will continue to fall over the next couple of months to attract new borrowers.
However, as we get closer to the next cash rate hike, some lenders could move ahead of the RBA, particularly if the cost of funding continues to soar.
Interest rate markets are pricing in three official rate rises by the end of 2022, despite the RBA’s suggestion that it won’t hike the cash rate until 2023 or when it saw significant wage and inflationary pressures.
Westpac chief economist Bill Evans predicted last week that the cash rate will rise to 1.75% by March 2024. The bank has brought forward its projection for the first cash rate hike to August of this year, when it expects the rate to rise to 0.25%. Westpac predicts a further increase in October to 0.5%.
On Tuesday morning, the Australian Bureau of Statistics (ABS) reported the consumer price index (CPI) jumped 1.3 per cent over the last three months of 2021 to be 3.5 per cent higher over the year.
CBA now expects the RBA will end the bond buying program at its Board meeting next week and shifted their scenario on the first rate hike from November to August 2022.
Current Interest Rates
Owner-occupied, Principal & Interest up to LVR 80% (as at 21 Jan 2022)
Investment, Principal & Interest up to LVR 80% (as at 21 Jan 2022)
What’s next?
You need to review your existing loans and create a plan for the short to medium term. With property price growth slowing down compared to 2021, it is still a good time to make a purchase and lock in the interest rates. Although fixed rates have risen, the current rates are still historically low compared to the last 30 years.
However, you should only fix your loans in line with any plans you have. If you sell or want to break a fixed-rate loan, it can be expensive.
Compared to the last two years, variable rates are now beginning to be lower than fixed rates - there are still sub-2 per cent options available. However, mortgage holders will have to be wary as banks can increase their variable rates at any time.
Give Darren a call on 0452 339 778 or email him at [email protected] to discuss what options you have available.
