Why are mortgage interest rates still rising?

Market competition and higher wholesale funding costs are cited as two reasons why some retail mortgage rates are increasing, despite no change to the official cash rate since June.

But Auswide Bank acknowledged that the lengthy pause meant that longer-term funding costs had started to reduce, while Mortgage Ezy anticipates that the recent increase to 10-year bond rates may translate to increases in fixed rates over the coming months.

The official cash rate has remained at 4.1% since June, although economists are reluctant to rule out a further rate hike this cycle, citing the risk that certain aspects of inflation remain sticky.

MPA spoke to financial experts and commentators from BOQ, Auswide Bank, Mortgage Ezy, Canstar and RateCity.com.au to find out the key interest rate movements over the last month and the likely drivers of the changes.

BOQ chief economist and head of market strategy Peter Munckton (pictured immediately below) told MPA that expectations around the official cash rate, appetite from investors to lend, and overall supply and demand around lending and deposit volumes were among the key influencers of bank funding costs.

Munckton acknowledged that 10-year bond rates had increased globally, however while funding strategies and appetite for risk differs among lenders, long-term funding forms a relatively small part of total funding costs for Australian banks. Deposits represent a significant funding line, and thereafter, funding sources are fairly evenly distributed across short and long term maturities, he said.

Home loan comparison websites Canstar and RateCity.com.au confirmed that it was not uncommon for rates to change outside of official cash rate announcements, both companies acknowledging that lenders were making changes as they continued to balance their books. 

Interest rate market described as ‘a mixed bag’

Canstar editor-at-large Effie Zahos (pictured above left) confirmed that its database showed that 10 lenders had increased their fixed rate loans, while nine put through fixed rate cuts over the last month.

Summing up the interest rate market as “a mixed bag”, Zahos said that competition among lenders remained strong, and that there was “plenty of different pricing” taking place.

According to Canstar’s database on Monday, there was a 1.5% gap between the maximum standard variable rate and the cheapest variable rate (6.94% versus 5.54%).  The average overall variable rate (includes basic and packaged loans) was 6.68%, and the cheapest overall variable rate was 5.44%.

Canstar had recently observed greater increases for new customers, a move that Zahos said indicated that banks were looking to protect their net interest margins amid lower new business volumes.   

ABS lending indicators for July showed that new loan commitments fell 1.2% for housing, to $24.3bn, while the value of external refinancing rose by a record 5.4% to $21.5bn.

“Obviously, their cash cow is their existing customers … that margin between existing and new began to close a little bit,” Zahos said.

RateCity.com.au research director Sally Tindall (pictured above second left) said that since March 2023, variable rates for new customers had generally increased by more than the three official cash rate hikes (a total of 75 basis points over March, May and June).

Noting that the data was influenced by the number of home loan variations a lender had on its books, Tindall said many of the rate movements observed by RateCity.com.au were based on lenders “trying to get the balance right”.

The increase in the cost of wholesale funding had put pressure on banks’ net interest margins, while the refinancing boom had also come at a cost, she said. While Australia’s biggest banks helped to ignite the refinancing boom with new customer discounts and cashback offers, after almost a year of intense competition, they had changed tack.

“As a result, we’ve seen the big banks hike new customer variable rates a total of 22 times in addition to the standard RBA hikes, while three of the big banks have axed their cashback offers completely,” Tindall said.

Over the past 10days, Tindall said that the number of rate hikes to rate cuts had started to even out, as the official cash rate stabilised off the back of inflation data showing the headline figure was trending downwards.

Longer-term funding costs easing – Auswide Bank

Auswide Bank chief customer officer Damian Hearne (pictured above, second right) said that he expected to see heightened competition for deposits as authorised deposit takers looked to repay the term funding facility put in place by the Reserve Bank in response to the pandemic.

He said this competition, coupled with relatively expensive wholesale funding, had an impact on margins.

“That means that banks, irrespective of RBA cash rate decisions, will look to adjust pricing to ensure that new loans written are above the cost of capital and provide a suitable return,” Hearne said.

Auswide Bank group treasurer Dale Hancock said that fixed rate home loans were generally priced in line with the market swap rates at any given point in time.

“For example, the three year swap rates are reasonably steady coming slightly off highs in July. This steadiness in the swap rates would suggest fixed rates are currently on hold for now,” Hancock said.

Commenting on whether increases in 10-year bond rates affected Auswide Bank funding costs, Hearne said that the bank aimed to have somewhere between 75% to 80% of its funding through its retail network.  Therefore, bond markets had “less of a significant impact” on Auswide Bank compared to larger banks, which he acknowledged relied on higher levels of wholesale funding.

Hearne said that the lengthy pause in the official cash rate had seen longer-term funding costs start to reduce in both the retail and wholesale markets, noting that upcoming economic data and the impact on RBA decisions would be followed closely.

Higher funding costs evident in fixed and variable rates – non-bank

Mortgage Ezy founder and executive director Peter James (pictured above right) summed up funding costs over the 2022/23 financial year as under “intense upward pressure”.

He cited factors such as the rising cost of wholesale funding, a contracting risk appetite among investors (leading to higher yields demanded) and anticipated increased competition for funding from banks.

The flow-through impacts of higher funding costs have been evident in both fixed and variable interest rates, James said.

“Fixed rates have risen to the point of non-banks becoming uncompetitive to banks as these lenders have sought to cover their higher wholesale funding costs and as a result, demand has dried up almost completely,” James said.

“Variable rates have also risen, but to a lesser extent, as non-bank lenders have absorbed margin compression as they try to avoid losing more market share to banks.”

Overall, James said that the rising cost of funding was a “significant challenge” facing all non-bank lenders, particularly those operating in the prime lending space.  Non-bank lenders must differentiate through continual innovation in origination and servicing to remain competitive and survive through the next phase of consolidation, he said.

James said that non-bank lenders typically sourced funding for a range of maturities, mainly from one to three years, and to a lesser degree, up to five years (although this depended on their funding strategy). 

The recent increase in 10-year bond rates is likely to lead to some increase in fixed rates over the coming months, he said, noting that long-dated bonds have a “knock on effect” to shorter ones that dictate non-bank pricing.

While fixed interest loans represented less than 2% of loans at Mortgage Ezy, James said that the increase in 10-year bond rates suggested that interest rate pain may not be over, as it may cause  depositors to demand a better deal, pushing up fixed rates further.

“The greater the period that 10-year rates remain elevated, the more depositors will expect to be paid and banks will pass on any higher cost of funding to borrowers,” James said. “However, the extent of the increase will depend on several factors, including the level of competition in the market and the lender's appetite for risk.” 

James said that since the RBA started raising the official cash rate in May 2022, competition had decreased, as authorised deposit institutions were able to increase their net interest margin by passing on increases to borrowers in full, while short-changing depositors in the form of savings rates.

This was in contrast to non-banks, where spreads in funding costs increased by up to 1% more than the RBA as investors sought an ever-increasing premium.

James said that many non-banks had since moved away from competing against the banks, filling the gaps in lending where banks refused to engage. 

While the current cash rate of 4.1% is comparatively low compared to the early 2000s, including 2008, when it rose to 7.25%, Muckton acknowledged that the over the last decade, the level of household debt had increased. Another consideration is the pace of monetary policy tightening this cycle, which he said was the most aggressive change in 30 years.

"[The official cash rate] went from zero to 4% in just over a year, and we haven't seen anything like that since the 1990s," he said.

Discussing the level of interest rates in August, Westpac Business Bank chief economist Besa Deda said that with inflation still elevated and the Reserve Bank not expecting it to return to its target range until late 2025, there is considerable risk and uncertainty associated with its future path.  This may mean that the cash rate will stay on hold, but high for longer, she said.

What is your view on recent mortgage interest rate changes? Share your thoughts in the comments section below.