News and Media

Christmas rate cut likely if the banks don't play Scrooge

The chance of a pre-Christmas official rate cut has increased significantly as the European debt crisis begins to hammer Australian banks.

But whether banks decide to pass on the joy to home owners is another matter.

The Reserve Bank cut rates by 0.25% on November 1 and AMP Capital chief economist Shane Oliver reckons there is now a 60% chance it will wield the axe again in two weeks time.

'If you'd asked me a few weeks ago I would have said it was unlikely, but the situation in Europe has significantly worsened and that means there is a much greater chance the RBA will cut in December,' he says.

'There's a 60% chance they will, but I think 100% they should. The risks are just too great.'

RBA Governor Glenn Stevens warned last week that 'the damage to us and everyone else will be unacceptable' if European leaders did not quickly find a solution to the rapidly spreading crisis.

But if the bank's monetary policy committee sits on the interest rate sidelines at its December 6 meeting it won't have another opportunity to cut rates until February.

'Therefore they would have to hope the situation in Europe isn't going to get any worse between now and then and that the banks don't raise mortgage rates,' Mr Oliver says.

The European crisis has now officially moved from the smaller, peripheral countries of Greece, Portugal and Ireland to the core countries of Italy, increasingly France and now even Germany. The euro zone's pillar of strength saw its bond yields rise last week.

Combined with this, a 'credit crunch' similar to the one triggered by the collapse of Lehman Brothers in 2007 has taken hold, which is making it increasingly difficult for even relatively safe Australian banks to borrow the money they lend to families and businesses.

During the global financial crisis, banks were reluctant to lend to each other because they were suspicious that risky sub-prime mortgages from the US might be involved.

This time, banks are scared to lend to each other because of fears about their exposure to European debt which they cannot be sure struggling countries can pay back.

'The concern is that banks have high exposure to public debt and that will lead to large losses,' Mr Oliver says.

'Consequently the lending markets in Europe are starting to seize up and while Australian banks are considered relatively safe and our exposure to European debt would be extremely low, cautiousness on the part of investors is making it more difficult for our banks to borrow in these credit markets.

'You would think investors would discriminate but when credit markets start to seize up like they are, all borrowers get hit regardless of whether you are safe or not.'

Australian banks should still be able to borrow on these global money markets but their cost of funding will be rising.

Inevitably, they will pass on this increase to customers - by not passing on future rate cuts in full, or even by raising mortgage rates.

'There is increasing pressure on banks and that is likely to see them threatening to raise their mortgage rates relative to the cash rate,' Mr Oliver says.

'If that happens, the RBA might have to cut rates by more. If they want to cut 1% off the mortgage rate, the RBA might have to cut by 1.5% for example.

'At the moment all that the bank is talking about is a 0.25% rate cut, but it may become necessary to make much bigger moves.'

Reproduced in full with permission: news.com.au 'Christmas rate cut likely if the banks don't play Scrooge', 26 November 2011.