From CoreLogic’s Cameron Kusher:
This column is going to be a little controversial however, lenders are well within their rights keep a portion of future rate cuts up their sleeve. Furthermore, the fact that banks have to consider mortgage holders as well as savers is an important consideration.
It is true that Australians are obsessed with housing. In no way is this better reflected by the fact that interest rate cuts are cheered because they lead to cheaper interest cost on our mortgages and interest rate rises are jeered because our repayments increase. This is notwithstanding the fact that lower interest rates typically reflect a slowing economy with low inflation and low wages growth that requires more stimulus. On the other side, higher interest rates typically reflect stronger inflation, stronger wage growth and an economy that is overall too strong.
Looking at data from the Reserve Bank to April 2019 shows that the value of deposits with authorised deposit-taking institutions (ADIs) was recorded at $1.584 trillion. By comparison, the total value of outstanding mortgages was recorded at $1.825 billion. The value of outstanding housing credit is larger than the value of deposits however, bank deposits account for 86.8% of the value of outstanding housing credit.
Since this long interest rate cutting cycle began in November 2011, the cash rate has dropped from 4.75% to 1.5% in May 2019 with an additional 25 basis points of interest rate cuts delivered this month, taking the cash rate to 1.25%. Between October 2011 and May 2019, an owner occupier with a principal and interest mortgage has, on average, seen their mortgage interest rate reduce by 218 basis points.
Over the current interest rate cutting cycle, mortgage interest rates to owner occupiers have reduced by 218 basis points however, the drop in savings and term deposit rates has been much greater. As an example the fall in some of the rates are detailed below (based on averages published by the RBA):
- Rates for banks bonus savings accounts with at least $10,000 have fallen 330 basis points to 2.15%
- Rates for online savings accounts with at least $10,000 have fallen 400 basis points to 0.85%
- Rates for cash management accounts at banks with deposits of at least $10,000 have fallen 320 basis points to 0.45%
- Rates for three month term deposit rates with at least $10,000 have fallen 320 basis points to 1.85%
- Rates for three year term deposit rates with at least $10,000 have fallen 330 basis points to 2.3%
As this data shows, while on average the benefit of the reduction in mortgage interest rates to owner occupier borrowers has been 218 basis points, the reduction in interest rates for savers has been significantly larger. Mortgages are a generally large and significant debt, so many view the drop in mortgage interest rates as more beneficial, especially with the increased use of mortgage offset accounts over recent years. However, with official interest rates as low as they are currently and savers having experienced much greater interest reductions than mortgage holders, it could be argued there is currently little benefit in saving. While that may potentially be good for the economy (more spending) and lower interest rates are certainly perceived as good for mortgage holders, there is a fairly large proportion of the population that rely on savings as well as those that have little or no mortgage debt.
Another factor to consider is that the major banks, which account for the majority of mortgage lending in the country, remain heavily reliant on domestic deposits to fund their mortgage lending. The latest data available shows that around two thirds of major banks non-equity funding comes from domestic deposits. Very low interest rates discourage saving and over time could lead to a drop in domestic deposits and an increase in the requirement for lenders to increase their reliance on other sources of funding (such as offshore).
Listed lenders also have a responsibility to their shareholders. Very low mortgage rates have the potential to further depress net interest margins. This increases the likelihood that future cuts to the cash rate may not be passed on in full and likely explains why the reduction to deposit rates have to-date been larger than the cuts to mortgage interest rates.
As always when interest rates are changed there are winners and losers. For the most part the focus is on the benefit of lower interest rates for mortgage holders what is often forgotten in the conversation, and has been throughout the current rate cutting cycle, is how much lower interest rates hurt savers and disincentive saving. Given cuts to interest rates for savers have been much greater than cuts to interest rates for mortgage holders and savers are not that much of a smaller cohort than mortgage holders it is reasonable for lenders to have greater consideration of the impact of the current ultra-low interest rates on this segment of the market.
Spot on. As deposit rates are already near zero, and cannot be cut much further, the banks will be unable to pass on RBA rate cuts in full, because to do so would require banks to squeeze net interest margins.
The same factors will likely also preclude the RBA from cutting the cash rate below 0.5%. Because at this point, bank deposit rates will likely have already fallen to zero, making additional cuts to the cash rate pointless.