Surprise! Funding costs rise again

Just as we had got accustomed to the idea that the worst might be over for mortgage rates, the market has sprung another surprise.

Thursday, July 3rd 2008, 5:44AM

by Maria Scott

Funding costs have increased again, forcing one of the largest funders of non-bank lenders, GE Money to raise its prices. This has already started to feed through to prices in the retail market, with several non-bank lenders have raised the cost of fixed rate loans, reversing at least some of the cuts of recent weeks.

John Grant, director New Zealand Business GE Money Home Lending said that the cost of funds in wholesale markets had increase, leading to another spike in the cost of funds.

"It's very volatile a the moment."

He predicted that banks would eventually be affected by the latest upswing in rates although they were cushioned from the immediate impact because of the funding supplied by their depositors.

Institutions seeking funds in the wholesale markets were being asked to pay a premium over the basic cost of funds. The market remained tight: "There are so many people out there looking for funding."

Markets continue to be affected by a shortage of funds and nervousness about lending.

ANZ economists warned of the renewed recent tightening in credit markets last month and it last week, Tony Alexander, chief economist at the BNZ said that New Zealand financial institutions had gone into the markets over the last two to three weeks looking to raise medium-term funds from foreign investors. "Not all banks have been successful in doing so and for those that have the premium cost has been exceptionally high."

Alexander said that the traditional relationships between official rates and even quoted wholesale rates had been broken.

It used to be the case that we would pay a premium above key wholesale interest rates overseas of maybe 0.1% a year or so ago. Now that premium is around 1.5%. The extent of that premium has nothing to do with the level of the official cash rate in New Zealand and it has blown out over a period of time when the Reserve Bank's cash rate has sat unchanged at 8.25%.

The relevance of all this to you borrowers out there thinking about interest rates going down as the Reserve Bank starts cutting its official cash rate from September is the following. Don't expect bank lending rates to fall all that much. They probably will decline but in light of the fresh deterioration in global credit markets over the past four weeks our previous comments about the two-year fixed housing rate perhaps getting to 8.5% late this year frankly now look way too optimistic given events of the past three weeks.

It's not because we don't expect the Reserve Bank will be cutting its official cash rate any lesser degree than we were thinking previously. In fact they may cut it more rapidly given the horrible economic data released recently. It's just that the cost to us banks of raising money internationally has gone through the roof and the sheer availability of those funds isn't what it would normally be in a properly functioning market.

As the Reserve Bank cuts its official cash rate from September (some think July 24 but for now we are sticking with September 11), housing and commercial interest rates will not fall by remotely similar amounts.

Westpac is continuing to predict that the Reserve Bank may have little scope to continue reducing official rates from early next year because the "inflation spike is not going to be as contained as they hope".

Economists are continuing to recommend shorter term fixes so that borrowers can hedge bets. Alexander is suggestion one-year while Westpac suggesting a wait-and-see approaching with a floating rates or "cheaper but with some risk of missing the window of opportunity, fixing for six months".

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