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Australian mortgages: rates set to surge

11th September 2007
By Petter Ingemarsson

Liquidity continues to be in short supply in the Australian finance market as the rate on 90-day bank bills has increased to over 7%. Although this should decrease the likelihood of the Reserve Bank further raising interest rates this year, it looks likely that home loan lenders will still pass on additional funding costs to consumers.

The rate on 90-day bank bills has shot up as high as 7.06% in trading, or a full 56 basis points higher than the Australian Reserve Bank's (RBA) official cash rate. Yields on 90-day bank bills have not been this high since 1996. Since commercial lending rates are so high, there is less reason for the RBA to raise the cash rate before the end of the year.

However, borrowers may still face higher rates on their mortgages as lenders pass on higher funding costs due to the global credit squeeze. Two of the major Australian banks, CBA and ANZ, have already warned consumers that mortgage rates are set to be increased. Non-bank lenders have also felt the impact of the global credit crisis, with RAMS's stock price losing half of its value since its IPO.

The RBA has announced that the cash rate will remain at 6.5% through September 2007, which was expected by the market. Due to the low level of liquidity for wholesale funds, the market expects no further rate rises from the RBA this year, placing the likelihood of another rate rise at 35%.

The RBA is in a difficult position when it comes to determining the appropriate rate to set. It recognizes that the global credit crisis has dried up liquidity and would not want to exacerbate this by raising rates. On the other hand, the Australian economy is growing robustly with low unemployment, and the RBA is wary of this causing inflation. Moreover, the Australian economy runs at two speeds, with significantly higher growth in the resource states of western Australia and Queensland.

The RBA must thus balance the threat of a credit crunch against the threat of inflation. However, whether the RBA decides to raise interest rates or not, it is expected that Australian home loan lenders will still increase their mortgage rates as a result of the global credit squeeze.

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