Surging money rates flag warning for RBA

There’s fresh reason to think that the Reserve Bank of Australia (RBA), as the country’s treasurer anticipates, may not be raising interest rates anytime soon.

Short-term borrowing costs in Australia’s financial system have been surging, and will tighten financial conditions if it lasts, even without action by policy makers. The jump in a key benchmark, the three-month bank-bill swap rate, has been something of a head scratcher, though most explanations centre around the impact of overseas dynamics:

• For one, the Federal Reserve’s interest-rate hikes and a surge in Treasury bill issuance to fund American budget deficits has been sending US dollar funding costs higher, in the U.S. and offshore.
• That matters for Australia because its banks are net borrowers of dollars, so local lenders may need to tap more cash locally – sending those rates higher, too.
• Foreign investors hold more than half the Aussie government debt market, and appear to be lending the bonds more via repurchases, in effect draining liquidity. Some point to Japanese life insurers being behind this, seeking to boost returns. Higher repo rates have in turn driven up other short-term funding costs.

It’s all put funding costs for Australian lenders on track for the biggest monthly rise since 2010, the year the Reserve Bank of Australia last raised its policy rate. Key for market strategists is whether the increase proves to be more than just a quarter-end phenomenon, or starts to accelerate – forcing banks to decide whether to raise the cost of credit.

“Money is more expensive,” Martin Whetton, senior rates strategist at Australia & New Zealand Banking Group in Sydney, said in a phone interview. Banks "can either absorb it or pass it on.”

Commonwealth Bank of Australia, the nation’s largest, sources about 12% of its funding from short-term wholesale markets, illustrating the potential impact of higher costs. Australian banks hold $4.6trn in assets, more than double the size of the economy, leaving them reliant in part on foreign funding.

“I am watching this closely,” Philip Brown, a senior fixed-income strategist at CBA in Melbourne said by phone. “Most business loans that are on floating rate are either directly or indirectly tied to BBSW. If BBSW settles in at this new wider pricing in a sustained fashion,  that will likely slow the delivery of any future RBA hike,” Brown and his colleagues wrote in a note this week, referring to the bank-bill swap rate.

CBA forecasters currently expect the Reserve Bank to raise rates in the fourth quarter. Also in that camp, for now, are the strategists at the local unit of Nomura Holdings. But a sustained rise in bank funding costs could change the outlook.

“If we have structurally higher lending rates in the real market place, then that could potentially impact RBA thinking about how much tightening they might need to do in the coming cycle,” Andrew Ticehurst, a rate strategist with Nomura in Sydney, said by phone.