The transmission of monetary policy through cash rate changes to mortgage rates is a critical aspect of understanding economic dynamics, especially in a country like Australia with a significant proportion of variable-rate mortgage holders. Despite a substantial increase in the cash rate target between May 2022 and December 2023, the pass-through to average outstanding mortgage rates was somewhat slower compared to previous tightening periods in 2006 and 2009. There are two key factors behind this slower pass-through: a larger portion of fixed-rate loans in the outstanding mortgage pool and increased competition among mortgage lenders. However, as low fixed-rate loans expire and reprice at higher rates, it is anticipated that the pass-through will align more closely with past episodes of monetary policy tightening.
During the period from May 2022 to December 2023, heightened competition in the mortgage lending market had a notable impact on the pass-through of cash rate increases to variable-rate mortgage holders. As banks compete for market share, borrowers benefited from negotiating lower rates with their existing lenders or switching to new ones offering better deals. This competition was fueled by ample funding sources, particularly deposits, which kept banks’ overall funding costs relatively subdued compared to previous tightening phases.
In response to this competitive landscape, lenders offered incentives such as cashback deals and increased discounts on advertised variable rates to attract both new and refinancing borrowers. However, signs of easing competition began to surface in early 2023, with many lenders withdrawing cashback offers and reducing discounts on advertised rates. Despite this, lenders generally remained willing to negotiate discounts to retain existing borrowers, and external refinancing activity stayed high.
Comparatively, the funding environment during the recent tightening episode was less severe for banks than in previous periods, such as 2006 and 2009, when tighter funding conditions led to more substantial increases in variable mortgage rates. In those instances, banks passed on not only the cash rate hikes but also higher funding costs to borrowers, resulting in more significant pass-through to the overall outstanding mortgage rate.
Despite slower pass-through, higher cash rates still impact housing mortgage rates significantly in Australia. By December 2023, mortgage payments had risen to around 10% of household income, surpassing previous peaks. This is expected to increase further by end-2024 as fixed-rate loans reprice. However, other household debts aren’t considered here, though they have less impact than a decade ago.
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