Why short term rates are rising

Fourteen lenders have increased short-term rates over the last 10 days and BNZ economist Tony Alexander says this is driven by three factors.

Wednesday, May 19th 2010, 10:41AM

by Jenha White

Firstly, swap rates have increased because it is believed that the Reserve Bank will raise the Official Cash Rate (OCR) at the June 10 meeting.

Secondly and more importantly, says Alexander, there has been a pricing behavioural change brought on by the events of last year and the current Greece crisis.

He says that last year tens of thousands of floating rate borrowers suddenly switched from floating to fixed and this cost banks millions of dollars.

"The cost arose because historically we have tended to bundle the fixed borrowing requirements up and maybe do our borrowing once a week whereas we are lending out every day.

"That process meant there could be near a one week lag between lending fixed and borrowing fixed and last year bank borrowing costs soared daily as we all tried increasingly desperately to cover our rising fixed rate lending. Millions of dollars of margin revenue was lost."

Alexander says the behavioural change in place now, is that the gap in time between banks lending to borrowers fixed and banks borrowing fixed, has been reduced - perhaps removed.

"In the past week and a half there has been a mild rise in the number of people moving from floating to fixed. The movement has not been large but it is enough to elicit a housing interest rate response which in the old days probably would not have occurred."

Alexander says the third factor influencing short term mortgage rate increases is that a week ago when the sharemarkets were in freefall worried about the Greek situation, banks in the northern hemisphere once again became less willing to lend to each other.

"To forestall the spread of the sovereign debt crisis in Europe into the banking markets once again we have seen the huge stabilisation fund announced by the EU under substantial pressure from the Americans only too keenly aware of how the world economy would be affected if the Europeans failed to stop the Greece - initiated rout.

"What that means is that with signs of banks finding it more and more difficult once again to raise fixed rate funding the danger of doing lots of fixed rate lending structurally increases.

"Hence the price response via higher fixed home lending rates."

Alexander says if the initial bits of interbank lending tightness grow again in the next while then borrowers should not be surprised if fixed rates rise further.

To find out what borrowers should do now that short-term mortgage rates are rising, click here.

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