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

MNI (London)
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
[TOPICS: MMLRB$,M$A$$$,M$L$$$,MX$$$$]
MNI London Bureau | +44 203-865-3812 | les.commons@marketnews.com

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