Luring borrowers away from fixed rates

Australian banks are cutting variable rates even as funding costs rise in an effort to tempt borrowers away from fixed rates and reap the benefits of an eventual hike in the cash rate, according to analysts.

With wholesale funding costs rising recently, both Commonwealth Bank and Westpac hiked their fixed-rate loan offerings by between 10 and 50 basis points last week, according to a Reuters report.

At the same time, banks are slashing their variable rates. On Monday, ANZ cut rates on some of its variable-rate loan products, following the lead of CBA, National Australia Bank and Westpac.

“What they are doing is they are luring people in with variable rates that look really, really cheap now – but they mightn’t look cheap when rates normalise,” Brian Johnson, senior banking analyst at Jeffries, told Reuters.

The cost of funding a fixed-rate loan in the wholesale market, as measured by the three-year swap rate, has doubled in the past month to 1.1%, Reuters reported. That leaves banks with little choice but to hike their rates.

“The swap rate is usually what banks base their pricing for fixed rates – usually with a 2% to 2.5% spread between them,” Carlos Cacho, chief economist at Jarden, told Reuters. “So given three-year swap rates have picked up, we think in the next six months you’re going to see more repricing coming through, and probably the three-year fixed rate to move to above 3%.”

The Reserve Bank of Australia slashed its official cash rate to a record low of 0.1% last year in response to the economic impacts of the COVID-19 pandemic. The big four banks all responded by lowering their fixed-rate mortgages – but not their variable rates – as a way to attract borrowers. Those rate cuts brought in droves of customers looking to refinance at fixed rates, which now account for about 40% of banks’ mortgage books, Reuters reported.

Read more: Banks slashing variable rates as competition heats up

However, analysts predict that lower variable rates will now push the fixed-rate level back to its historic level of around 15% of the mortgage market – especially as more and more economists expect the RBA to hike the cash rate before its 2024 prediction.

“With the prospect of rate hikes now potentially within sight, I think [the banks] will be keen to shift more of the flow towards variable, so they get the uplift on interest rates as rate hikes come through,” Cacho told Reuters.