Australia’s official interest rate has jumped to 0.35 per cent in its first rise in nearly 12 years after sitting at the historic low of 0.1 per cent for the past 18 months.
RBA governor Philip Lowe said now was the right time to begin withdrawing extraordinary monetary support put in place to help the economy during the pandemic, and signalled further lifts to interest rates in the coming months.
The economy has proven to be resilient and inflation has picked up more quickly, and to a higher level, than was expected. Mortgage lenders are influenced by the Reserve Bank of Australia, but not controlled by it. When the RBA increases or decreases the cash rate, lenders tend to change their home loan rates as well, although not always by the same amount and not always immediately. They are free to make what are known as ‘out-of-cycle’ rate changes, or changes that occur even when the cash rate is on hold.
This point has become increasingly relevant over the past year, because, even though the cash rate has remained at a record-low 0.10% since November 2020, lenders have been moving their home loan rates up and down.
Between November 2020 and October 2021, the average interest rate for new owner-occupied loans (see the blue line in the graph below) fell from 2.62% to 2.37%. The average interest rate for January 2022 was 2.50%.
For variable loans (see red line):
- Average interest rates have steadily fallen from 2.85% in November 2020 to 2.52% in January 2022.
For fixed-rate loans:
- Loans fixed for three years or less (see grey line), interest rates fell from 2.16% to 1.95% in May 2021 and since then, they’ve increased to 2.43%
- For loans fixed for more than three years (see yellow line), interest rates fell from 2.06% in November 2020 to 1.99% in February 2021 and now they’re 3.07%
So even though the cash rate has been on hold since late 2020, fixed rates have been increasing for about a year now.
Why fixed rates have been increasing?
- Retail lenders (like the big four banks) buy money in bulk from wholesale funders (which are often offshore institutions)
- Lenders divide that money into small portions (home loans) and on-sell them to us
- They charge us a higher price than their funders charged them
So why have these funders been raising their prices?
Big wholesale lenders get much of their funding from selling bonds. Bond yields have been rising, which means the funders selling the bonds have been forced to pay higher interest rates to the buyers of those bonds. The reason bond yields have been rising is because many central banks have been, and are expected to continue, raising their own cash rate – effectively, making money more expensive.
Another reason Australian lenders have had to pay more for their funding is because the Reserve Bank stopped subsidising their costs. In March 2020, at the start of the pandemic, the RBA introduced a temporary emergency measure called the Term Funding Facility (TFF), which offered low-cost three-year funding packages to lenders. The TFF ended in June 2021.
Why fixed rates are likely to keep increasing?
Fixed rates are likely to keep increasing, even if the RBA leaves the cash rate on hold for the rest of 2022. That’s because central banks around the world are continuing to raise their official interest rates, and because the markets have priced in future rate rises.
Wholesale funders are having to pay more for their money; these increasing costs are being passed on to Australian retail banks; and those lenders are passing on their increasing costs to us.
Interest rates will remain low for the foreseeable future
While fixed rates (and home loan rates in general) are likely to increase, this will happen from an incredibly low base. Mortgage rates aren’t going to be high anytime soon; instead, they’re likely to increase from very, very low to merely very low.