Comments on Australian bank costs:
“Much like in the US bank funding costs have been rising and the BBSW-OIS spread widened to 60bps last month, the widest since 2010. This is a similar trend to what was experienced in the US earlier in the year. However, in the US the spread has narrowed, while the Australian spread has kept widening. The risk is that this leads to out-of-cycle rate hikes by retail banks, further squeezing highly indebted households. Smaller lenders, such as Bank of Queensland, have already increased mortgage rates, but now Macquarie Bank (a larger lender) has increased its variable mortgage rate.
Higher funding costs are likely a structural rather than cyclical shift, and banks have delayed raising lending rates as they tried to figure whether the funding costs change wold be temporary or not. The shift in funding costs is a function of a few things:
• Higher US costs impacting the local market
• Widening gap between credit and deposit growth, and credit growth increasing faster than deposits
• Higher issuance of bonds by the government.
The last factor is one reason why Australian bank costs have moved out of step with the US. The government is still issuing bonds in line with its plans at the start of the year, but the deficit is much smaller than initially thought so more debt than needed is being issued to meet the funding deficit. This inflates the RBA’s balance sheet as retail banks buy the government bonds, but the RBA doesn’t release the unwanted cash into the economy so its balance sheet increases and liquidity is removed from the system increasing short term funding.
This might not be an issue in the US, where mortgage rates a fixed for 30 years, but in Australia many households still have variable rate mortgages and household finances are more sensitive to short term changes. The chart below highlights the problem with the housing market, the extreme levels of leverage, and the threat of a worsening of debt affordability.
I don’t think that the RBA will cut rates in response (although unlikely other central banks, they do have the capacity to do so) as they have been talking up the health of the economy for some time, and a cut would be a sharp U-turn on current policy and positioning. The big 4 retail banks may even hold off on rate hikes given the poor view that the public have of the finance industry after the royal commission.”

Published by Kerry Craig, Global Market Strategist, J.P. Morgan Asset Management