The Reserve Bank's role is to manage monetary policy to assist in the 'smoothing' of economic factors impacting the economy. In particular, the RBA will attempt to influence the domestic inflation rate by moving the official cash interest rate.
This will encourage or discourage spending in the economy as interest rates in the financial markets react, and eventually impact households and businesses. But recent events in financial markets indicate that the RBA monetary policy is no longer the only dominant factor affecting interest rates in the financial markets.
As Chart 1 shows, there is a high degree of correlation between the wholesale 90-day money rate (usually bank bills) compared to the RBA's cash rate. Traditionally in a tightening cycle, as there is at the moment, the 90-day rate tends to anticipate higher rates by trading at a margin above the cash rate.
This margin between the 90-day bank bill and cash rate has, in recent times, oscillated somewhere between 0.10 to 0.25 percentage points over the cash rate. This is consistent with the bank risk margin and any expectations of a near-term change in the RBA rate. In the past few years, and until the middle of last year, the RBA pointedly had argued the margin for risk in this cash rate / bank bill rate margin was too low.
However, with the onset of the global credit crunch in August 2007 things started to change. Chart 2 shows the wholesale margin began to expand from the low teens to in excess of 0.50 percentage points and at one point in late December 2007 to be close to 0.80 percentage points over the RBA rate, (a point already revisited as INTHEBLACK goes to press). This margin is way in excess of what could be reasonably justified by rate expectations about RBA policy, as in that month it had only just announced that it did not adjust the cash rate higher.
Clearly there is a blow-out in credit margins (in excess of the recent RBA official rises in 2007). It represents the increased cost of the funds that banks access to on-lend to clients. In blunt terms it is a cost squeeze that banks (like all businesses) under normal competitive pressures will need to pass on to borrowers to keep getting access to available funds.
These blow-outs in credit margins that are now being passed through the banking and financial system, represent a de facto and unofficial rate rise that is hitting borrowing costs in early 2008 on top of RBA policy adjustments. It is a trend that the RBA noted in the minutes of its last meeting of 2007. It stated that this was reason enough not to officially raise rates because unofficially the blow-out in credit margins had partially done its job for it.
The implication and irony is that any possible future lessening in the current tight wholesale money markets credit conditions will likely prompt the RBA to step up and compensate the fall in margins with another official rate rise in its place.
Either way high / higher rates will remain the rule rather than the exception for the time being.
Further information
Reference: April 2008, volume 78:03
