MNI INSIGHT: Rising Money Market Rates RBA's Immediate Concern

By Sophia Rodrigues

     SYDNEY (MNI) - Of all the risks to the Reserve Bank of Australia's monetary

policy stance, the most immediate one is that the rise in money market rates is

persistent, keeping the cash rate on hold for longer, with even some outside

risk of a cut, MNI understands.

     The RBA has acknowledged this risk and is closely monitoring developments

in the money market for confirmation.

     The pressures on money market rates in Australia began as a knock-on effect

from developments in the U.S. money market, where rates rose for reasons other

than the increase in the Fed funds rate. Because Australian banks raise a

portion of their funding to finance their domestic assets in U.S. markets, they

responded to higher U.S. dollar rates by seeking to borrow more in domestic

markets, which put upward pressure on rates in Australia.

     It started sometime in the first quarter and some of it was wound back in

the early months of the second quarter. However, prior to the end of the second

quarter, there was renewed upward pressure on money market rates and this time

it has happened despite stable spreads in the U.S. money market.

     The 3-month Bank Bill Swap Rate(BBSW) was around 2.10% on Tuesday, 60bps

above the 1.5% cash rate. In early 2017, it was trading just 26bps above the

cash rate.

     --LOCAL MARKET-SPECIFIC FACTORS

     The RBA is now concerned there are developments specific to the local

market that are causing the rise in short-term rates. 

     In the cash rate statement published Tuesday, the RBA said, "In Australia,

short-term wholesale interest rates have increased over recent months. This is

partly due to developments in the United States, but there are other factors at

work as well. It remains to be seen the extent to which these factors persist."

     The RBA's admission is important, because back in May it expressed

uncertainty about how long and to what extent the pressures in money markets are

likely to persist, but it said that in the context of movements in the U.S.

market. Back then, it didn't occur to the RBA that the local market is also

behaving differently to previously.

     Specifically, it appears that such rate movements open arbitrage

opportunities for the market but they are not being tapped and that is giving

the RBA reason to suspect some other factors are at play.

     Analysts at National Australia Bank cite a few reasons for the persistence

in rates. They include regulation that is leading banks to accumulate cash and

limit money market lending at quarter-end, structural pressures in the repo

market, compounded by higher offshore participation in repo and greater demand

to fund longs in Aussie bonds. There is also increased recognition that

quarter-end pressures may be leading to greater defensiveness among investors in

short term paper and selling ahead of the bill futures roll a few weeks prior to

the quarter-end.

     --IMPACT NOT RESTRICTED TO JUST FUNDING COSTS

     Whatever the reason, if short-term rates remain elevated compared to the

cash rate, it has an impact on not only funding costs for banks but also on some

business lending rates, and could affect retail deposit rates.

     In case of banks' funding, higher BBSW rates affect short and long-term

wholesale debt rates. They also increase some of the costs associated with

hedging the risks on banks' debt, and they directly impact wholesale deposit

rates because they tend to be closely linked to BBSW rates. Business lending

rates are impacted to the extent they are linked with the BBSW rates.

     Already the higher funding costs have led some smaller banks to raise their

mortgage rates and there is a worry that the large banks may follow suit if the

pressures on their funding costs persist.

     Any such developments would exacerbate the weakness in the housing markets

and threaten household spending prospects, and thus the outlook for the economy.

It is noteworthy that in the cash rate statement, the RBA downgraded the view on

the housing market by pointing to easing conditions in the Sydney and Melbourne

markets and decline in prices in both.

--MNI Sydney Bureau; tel: +61 2-9716-5467; email: sophia.rodrigues@marketnews.com

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