Monetary transmission in Australia: Fairly efficient even at lower interest rates

Australian central bank has cut policy rates in June and July meetings by 25 bps. The policy rate is at 1% currently.

In this speech, Christopher Kent, Assistant Governor (Financial Markets) speaks about how interest rates are being lowered everywhere including Australia. The transmission in Aus has been quite efficient with most %age of rate cuts passed on to people:

The recent reductions in the overnight cash rate in Australia – and the decline in interest rates right along the yield curve – have reduced the costs of funding to historical lows for banks, businesses and households.

Banks’ funding costs have declined across the board (Graph 7). The cost of funding in short-term money markets has declined noticeably this year. Much of the fall follows from the decline in the cash rate and the anticipation of a further decline over the coming months – as captured by the rate for the overnight indexed swaps, or OIS for short.

Graph 7
Graph 7: Major Banks' Funding Costs

But in addition to the change in the stance of monetary policy, the spread of the 3-month bank bill swap (BBSW) rate to OIS has declined this year, more than unwinding the increase seen in 2018 (Graph 8). Indeed this spread has declined to its lowest level in many years.

Graph 8
Graph 8: 3-month Bank Bill Swap Rate

Yields on the major banks’ bonds have declined in response to both lower risk-free yields and a decline in the spreads of bank bonds to these reference rates.

Also, banks have passed through most of the cash-rate reductions to interest rates on retail deposits, which account for about a third of their debt funding. As is typical, the interest rates on transaction accounts (which are at or close to zero) have not been changed following the reductions in the cash rate. However, these account for only a small share of the total value of the banks’ retail deposits.[4] Other at-call deposit rates are estimated to have been lowered by 40−45 basis points, while interest rates on term deposits have fallen significantly over recent months.

The banks have passed on these lower costs of funds to borrowers. Interest rates on loans to large businesses – the bulk of which are closely tied to BBSW rates – have declined over recent months to very low levels (Graph 8). Lending rates on outstanding loans to small businesses decreased by around 20 basis points following the reduction in the cash rate in June (the latest data available). Small business lending rates remain noticeably higher than interest rates for large businesses. This partly reflects the higher default rates associated with small business loans.

Graph 9
Graph 9: Variable Business Lending Rates

Lenders have passed through most of the cash rate reductions to housing interest rates. Following the 50 basis point reduction in the cash rate from June to July, lenders lowered their standard variable rates (SVRs) on housing loans by an average of 44 basis points (Graph 10). The extent of pass-through was broadly consistent with the experience of the past decade.

Graph 10
Graph 10: Variable Housing Interest Rates

The average interest rate actually paid on outstanding variable-rate housing loans in the Reserve Bank’s Securitisation Dataset decreased by 23 basis points in June, the same as the average announced reduction in SVRs. Similar reductions in outstanding rates are expected to be recorded for July data. So the declines in SVRs are being pushed through to all existing borrowers, which make up the so called ‘back book’. Rates on new loans have also been lowered. Indeed, new borrowers, and those refinancing existing loans, continue to be offered interest rates that are on average well below those applying to existing loans. So customers who are actively looking around at what’s on offer, are able to take advantage of the strong competition among lenders that is focused squarely on the ‘front book’.

Meanwhile, interest rates on fixed-rate housing loans have also declined significantly over recent months.

Although housing credit growth declined further in June, approvals for new loans increased. This increase in approvals was broadly based, across owner-occupiers and investors, across states and across different types of lenders. It was also consistent with the improved conditions in housing markets evident in a range of indicators, such as auction clearance rates and housing price growth, particularly in New South Wales and Victoria.[5] If housing conditions continue to improve in the coming months, we would expect to see a further rise in loan approvals.

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