What does rising US interest rate mean for the Australian housing market?July 9, 2018 / By
The US Federal Reserve raised the federal funds rate by 25 basis points in June to a target range of 1.75-2.00%. This is the first time in 18 years that the US official interest rate has overtaken the Australian cash rate (Chart 1). Financial markets are currently pricing in further increases in the US funds rate, whereas the Reserve Bank of Australia (RBA) is expected to maintain the current policy rate till at least mid-2019. However, Australian bank funding model means Australian mortgage rates could potentially follow US rates higher and impact the Australian housing market.
Chart 1: Australia & US Official Interest Rates
Source: RBA, FRED, JLL Research
Australia’s housing market has moderated, with the national dwelling prices slipping into negative territory for the first time since October 2012 (-0.4% year to May 2018). Similar to previous cycles, the current slowdown is driven by tighter credit conditions along with numerous other factors, including a pick-up in supply and a reduction in foreign investor demand.
Generally, a rising US interest rates is good news for Australia because it indicates a strong and growing economy, which has positive spillover effects to global and Australian growth. A rising US interest rate also puts pressure on the RBA to increase the cash rate. However, the RBA has clearly indicated that the Australian cash rate does not move in lock-step with the US rate and at present there is still spare capacity in the Australian labour market. This has led to subdued wages growth and inflation rate below the RBA’s medium-term target. With these circumstances, it is very likely that the Australian cash rate will remain at the current level for some time.
Nevertheless, mortgage rates could increase out of step with the cash rate because Australian banks are still quite exposed to global short and long-term debt markets to fund their lending. Since the GFC, Australian banks have significantly shifted away from short-term debt and securitisation towards domestic deposits, which are a more stable source of funds (Chart 2). However, short-term debt still accounts for around 20% of banks’ funding and about 60% of that debt is raised offshore. Similarly, a significant portion of long-term debts are also sourced from offshore markets. This means that as the US interest rates rise, the funding cost of Australian banks will also increase unless they change their funding composition towards deposits. While this is possible, it is difficult to implement as household savings rate has returned to low levels. Consequently, Australians banks have to either reduce their net margin rate (and profit) or increase lending rates.
Chart 2: Funding Composition of Banks in Australia*
Source: RBA, APRA
Rising funding costs, coupled with potential tighter lending conditions as a consequence of the Hayne Royal Commission into the banking system, could lead to higher mortgage rates and consequently exacerbate the current housing market slowdown. If that happens, the RBA which has consistently indicated that the next cash rate move is up, might have to step in and lower the rate. But that is something that only time will tell.
 Corelogic (June 2018), ‘Corelogic Hedonic Home Value Index, May 2018 Results’, https://www.corelogic.com.au/news/national-dwelling-values-post-first-annual-decline-2012#.WymrC3kUnGI.
 Short-term and long-term debt are financial instruments (e.g. bonds) with maturity of less than one year and greater than one year respectively.
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