Up until December 2007 the gap between variable mortgage rates and the Reserve Bank’s cash rate was 180 basis points; a gap which hardly changed between 1997 and the end of 2007. Since the onset of the GFC the only consistency between the variable mortgage rate and the cash rate has been a widening gap which reached a highpoint in May of this year at 330 basis points which is approaching double what the historic norm used to be.
Without doubt the cost of bank funding has risen since the onset of the GFC. If you’re interested in the topic of bank funding and how their costs have changed I can recommend reading this Bulletin (Banks’ Funding Costs and Lending Rates) from the Reserve Banks’ Cameron Deans and Chris Stewart which was released in March this year. The bulletin provides a comprehensive summary of the key factors which have pushed up bank funding costs since the GFC and highlights that as at March the costs of funding aren’t currently a great deal lower than during the peak of the GFC.
Importantly, the banks are now sourcing less of their lending funds from overseas. In fact, based on the March analysis from the RBA, more than 50% of Australia’s bank funding now comes from domestic deposits while short term debt and long term debt markets both comprise about 20% of funding originations. The reliance of the banks on deposits is likely to be even greater by now, as the trend is clearly upwards and recent GDP data highlights that households continue to show a preference for saving around 9% to 10% of their income.
As Australia’s banks seek more funding from local sources and strive to become less reliant on overseas funding, the competition for deposits is likely to heat up. That means higher term deposit rates which translates to higher domestic funding costs for the banks. Unless the banks are willing to see their margins shrink, I think we can expect higher deposit costs as well as overseas cost pressures to continue forcing the gap between the cash rate and mortgage rates further apart.
So it doesn’t look like there will be any lessening in the gap between mortgage rates and the cash rate, at least over the short term. Even if we see the cash rate fall a further 75 basis points as Westpac’s chief economist Bill Evans has predicted (taking the cash rate down to 2.75%), mortgage rates will still be higher than when the cash rate reached 3.0% between April and September 2009. The average standard variable mortgage rate reached a low point of 5.8% back then.
To receive that level of monetary stimulus we will need to see the cash rate drop do 2.5% and we will need to see the full rate cuts be passed on by the banks. That is unlikely. Based on the average bank cuts provided in May, which was about 74% of the cash rate cut, we will need to see the cash rate fall to around 2.0% to see standard variable mortgage rates fall to their recent lows recorded in 2009.