Virtual Reserve Bank cash cut lowers rates

A virtual easing of monetary policy by the Reserve Bank – which has allowed money market rates to fall to almost half the official 0.25 per cent target – is helping lenders reduce mortgage rates to record low levels.

While the Reserve Bank cut the target cash rate to a record low of 0.25 per cent on March 20, it has allowed the actual cash rate to fall to 0.13 per cent, which has acted to further ease financial conditions.

Short-term interest rates such as the overnight cash rate and the bank bill swap rate which banks charge to borrow to each other have plunged as billions of dollars of cheap central bank funding and hoarding by households and super funds have left the banks awash with cash.

These lower rates are allowing some banks to offer bigger discounts on mortgage interest rates, supporting the weak housing market, while also relieving pressure on margins as deposit interest rates approach zero.

"You are seeing some evidence, mainly anecdotally, that lower funding costs are being passed through to mortgage rates to drive some growth in that space," said Evans & Partners analyst Matthew Wilson.

According to data from RateCity, 54 lenders have cut at least one variable rate for new customers since April 1, even though the official cash rate has not been reduced since March 19.

While standard variable rates at the major banks have not changed since late March – they remain at 4.58 per cent at Westpac, 4.55 per cent at CBA, 4.52 per cent at National Australia Bank and 4.39 per cent at ANZ – the lower cash rate in the market is providing flexibility for larger discounts to be offered, as banks fight for market share.

The big banks offer an average discount of 1.28 per cent to their standard variable rates (SVRs), according to the Australian Competition and Consumer Commission.

Yet analysts say the benefit of the lower-than-targeted cash rate is not likely to be passed on to customers in full, because banks will need to use profits in the coming years to soak up higher loan losses.

These are expected to exceed $10 billion each year over the next three years, as customers struggle to get back on track after COVID-19.

Banks are also facing a revenue crunch as hedging contracts are rolled into lower-yielding assets over the coming years.

"Banks will need to offset the structural pressures in net interest margin [NIM] due to the replicating portfolio run-off and the very flat yield curve," Mr Wilson said.

"While banks have historically emerged from a credit cycle with higher net interest margins, unconventional monetary policy will constrain the price of risk and revenue."

Other analysts also expect banks will remain wary of making across-the-board reductions to mortgage rates despite the lower cash rate, providing tailwinds to banks’ near-term margins.

"While we expect the [bank bill swap rate-overnight index swaps] spread to return to more normal levels over the medium term as the level of liquidity increased, banks may benefit from lower spreads staying for longer in the second half of 2020," said Macquarie analyst Victor German.

The banks were quick to pass on the first COVID-19 emergency official rate cut to customers – most lenders reduced the standard variable rates on housing loans by 25 basis points in early March – but very few decreased SVRs following the second 25 basis point cash rate reduction in mid-March.

ANZ was the only major bank to reduce its mortgage rates after the second cut, by 0.15 per cent.

The banks have warned that as the cash rate has fallen towards zero, they face a profit squeeze.

At its interim results early this month, Westpac illustrated the margin pressure on all the banks.

After gains from its treasury and markets operations were excluded, its "net interest margin" – the difference between what it charges borrowers and pays for funding – fell by 0.03 per cent over the half to 2.04 per cent. It was dragged down by deposits, which were not able to be reduced further given rates were already near zero.

Dynamics in the overnight cash markets are also helping non-bank lenders, given almost all their funding costs are benchmarked against the BBSW.

Meanwhile, banks have reduced interest rates on small business loans by up to 100 basis points since early March.

About 0.20 per cent of this was announced after the 0.25 per cent reduction in the cash rate target on March 4, and a further 80 basis point reduction followed the additional official rate cut on March 19, the RBA said.

The big banks have also reduced interest rates on unsecured loans to small- and medium-sized businesses by up to 650 basis points following the announcement by the federal government of its SME loan guarantee scheme.