Interest Rate Rise - Media Inflated Rates

Melbourne- November 2nd 2010: The Reserve Bank of Australia lifted interest rates by .25 basis points. It was always a matter of when the Reserve Bank raised official rates, not if it would raise them. In fact, the bank probably would have raised them last month – the minutes described the cases for and against an October rise as "finely balanced" – had it not been for the game of "chicken" the RBA was playing with the major banks.

So begins the hoopla - Australian media has once again jumped on the Bash-a-Bank band wagon, with little or no explanation, media sensationalism has taken a familiar route - Talking up Bank CEO salaries, calling on polies to legislate against exaggerated bank rate increases and on and on . . . 

Last we looked the CBA, Westpac, NAB and ANZ were listed business' ? In any other industry profits in the of $5+ billion would be smiled upon. The days of Mortgagees being battlers are far gone, the majority of Home owners view they're holdings as a form of income, an investment - WELCOME TO THE WORLD OF BUSINESS - of  course the other end of this is that for the past three years low mortgage rates have been subsidised by higher credit card and small business loans, would be nice to say these rates lowering a little?

The decision to move by 25 basis points today, of course, invited that same outcome of a rise in lending rates beyond the official increase and Commonwealth Bank was quick to accept the invitation. That the RBA moved despite the risk that has now been realised suggested that either it believed the banks would be cowed into passing on only the change in official rates by the relentless bashing they have had in recent weeks from Joe Hockey and others, or that it came to the conclusion that it couldn't sit on its hands any longer regardless of what the banks might do.

The statement from RBA governor Glenn Stevens that announced the rate change was relatively sanguine about the state of the global economy and markets but noted the prospect for some further strengthening in the domestic labour market and some growth in wages, with further increases likely over the next year.

It is almost inevitable that the combination of an economy running up against its capacity limits and the income shock created by the terms of trade will create significant inflationary pressures. That’s why the market anticipates further official rate hikes throughout next year, with some expectations of at least another 100 basis points to come over the next 12 months.

The Banks have made it very clear in the past month that they are anxious to protect interest margins that are being eroded by the continuing rise in their average funding costs as cheap pre-crisis funding is refinanced with more expensive post-crisis funding. The rise in their average cost of funds will, as CBA noted, probably continue well into next year as their remaining five-year money matures.

Had the RBA lifted rates in October it was near-certain that the majors would have added 15 or 20 basis points of their own. When it left rates unchanged the banks considered an out-of-cycle increase but were fearful of the backlash from their customers and the community, particularly if there were subsequent movements in official rates. They preferred to wait for the cover of an official increase. Now they've got it, the only question is how much they move.

With Senate inquiries into the industry, Joe Hockey’s nine-point plan, Wayne Swan’s usual threatening noises, proposed "anti-signalling" legislation to stop them talking about margin pressures and a general clamour for something to be done about the oligopoly that has emerged from the financial crisis, the banks will be wary about the backlash they might face if they move beyond the RBA.

With returns on equity in the low teens, the impetus of improving asset quality waning, relatively modest volume growth in business and household credit and a raft of tougher and more costly prudential regulation coming towards them, however, the temptation to take the opportunity the RBA has provided to restore margins would be acute. CBA succumbed to it immediately.