Terror strikes: “Eight years of rate hikes”

Herald Sun terror that is:

The cost of borrowing money in offshore markets — a key source of funding for Australian banks — has been increasing steadily for more than six months.

“This is the beginning of a new phase of normalisation of interest rates — the new normal,” BIS Oxford Economics associate director Kim Hawtrey said.

“After eight years of subnormal, artificially low interest rates we are witnessing a new stage, which will run for the next five to eight years, of rising interest rates.”

About 25 per cent of the funding used for loans in Australia is sourced from overseas and the cost of this funding is affected by changes in interest rates offshore.

OK, so this is pure hysteria. The notion of a 5-8 year hiking cycle is absurd. The RBA is not going to hike at all, and probably cut, while the bank’s wholesale funding costs may have risen a little but not much. They are influenced at the margin by rising offshore interest rates but the spread has actually fallen a lot year over year so it’s nothing to worry about. Moreover, the Fed is not going to get anywhere near its mooted targets for interest rate normalisation. It has maybe three hikes left before its caput.

However, there is a potential problem in the future when global interest rates fall during the next global shock. Australian interest rates may not follow them down. Rather, depending upon how the shock plays out, how it impacts China and commodity prices, it may result in a downgrade to Australia’s sovereign rating and banks, and bank funding costs will go up. The RBA will cut of course, whatever it has left, which the IMF says is 0.75%, but the banks won’t pass all of it on so there’ll be very little relief for households.

If that triggers an asset price bust then the banks will see funding costs rise even further as capital flees and they may have to increase mortgage rates even as asset prices fall.

Again the RBA can intervene using its “cash for coconuts” facility which is effectively QE for banks. But that will also put downwards pressure on what will at this stage be a collapsing currency with the result that inflation goes through the roof, again pressuring rises in rates.

You can game the global monetary system for a long time but not forever and if it does catch up to you it is not pretty!

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