What triggers home loan rate changes?

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 For some time there has been the peception that floating rates move in lockstep with changes to the official cash rate. In the past that has been true, but the linkage between the two has reduced in recent years. Jenny Ruth explains.

Thursday, July 12th 2012, 10:07AM 3 Comments

by Jenny Ruth

New Zealand and Australia have much in common, not least that our “big four” banks are owned by Australia's “big four,” but there are also major differences between the two countries, particularly between their two mortgage markets.

In Australia, where the vast majority of mortgages have always been at floating rates, every time the Reserve Bank of Australia (RBA) moves its cash rate, the banks have always moved within minutes to reflect the extent of each move in their floating rates; until recently, that is.

Not surprisingly, when such a long-term tradition is broken, that's been making headlines across the Tasman. The key factor which has changed is that bank funding costs have risen sharply and are no longer closely tied to the RBA's cash rate.

While bank funding costs have also risn on this side of the ditch, here there's never been such a lockstep relationship between the official cash rate (OCR) and banks' floating mortgage rates.

And the impact of rising bank funding costs on banks' floating mortgage rates is old news here.

Before the global financial crisis (GFC), there had been a kind of “rule of thumb” that floating rates were mostly about 200 basis points above the 90-day bank bill rate which, in turn, was mostly about 25 basis points above the OCR – from inception, the government's Kiwibank undercut this relationship by about 50 basis points but since late 2009, its floating rates have been closer to the rest of the pack.

The blow-out in bank funding costs began to be reflected in their floating mortgage rates from around mid-2008 and most banks' floating rates are now about 300 basis points above the 90-day bank bill rate.

But even before the GFC, it wasn't usual for banks here to immediately follow the central bank's OCR moves. At times, some banks would pre-empt OCR or, more commonly, they would generally take a week or so to fall into line.

But not always. Westpac, for example, has long followed a pricing strategy of having the highest standard floating rate by far of any of the larger banks, chosing instead to compete fiercely on fixed-term rates.

Westpac's standard floating rate is currently 6.24% when other banks' floating rates range between 5.65% and 5.8%.

Westpac's strategy isn't so odd, considering fixed-term mortgages play a much larger part in the New Zealand mortgage market.

In August 2007, floating rate mortgages accounting for just 12.4% of bank lending on housing. As the GFC wore on and a much lower OCR started looking more and more permanent, the balance began tipping until by April this year 63.1% of bank mortgage lending was on floating rates.

May, when floating mortgages fell to 61.7% of total mortgage lending, may prove to be the turning point, spurred by the price war on fixed-term mortgages the bank started waging.

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