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Speaking to Mortgage Business, AMP Capital chief economist Shane Oliver said that if the oil price keeps falling, global growth continues to remain uneven, expectations of interest rate hikes in the US keep getting pushed out and expectations for cuts in Australia intensify, then borrowing costs will certainly come down.
Meanwhile, fixed-rate funding costs have been falling alongside wholesale borrowing rates.
“A good guide to that is the five-year bond yield in Australia, and it’s come down quite substantially to 2.25 per cent,” Mr Oliver said.
“In the last six months we’ve seen quite a sharp fall in bond yields around the world and in Australia,” he said.
“Last year, that started to drive five-year borrowing mortgage rates below the five per cent level and that’s still continuing.”
Mr Oliver said the fall in bond yields has been driven by the expectation that inflation will remain low.
“The fall in the oil price has played a big role in that,” he explained.
“The oil price coming down has reduced inflation rates and expectations, which in turn is having the effect of pushing out expectations for short-term interest rates.
“In Australia, there is still some talking about short-term interest rate cuts.
“That all has an impact on longer-term borrowing costs. The people who benefit from that first are the lowest-risk borrowers – which is the federal government – so you’ve seen a sharp fall in bond yields over the course of the last year and particularly the last few months.
“That’s why the five-year bond yields have come down.”
Cheaper funding costs led to dramatic rate reductions across fixed-rate mortgages last year, a trend that appears to be continuing into 2015.
Last week, ME Bank undercut the market by slashing its five-year fixed rate from 4.94 to 4.69 per cent.
According to comparison website Canstar, the lenders that come closest to matching ME Bank on price are Qantas Credit Union at 4.74 per cent and Greater Building Society at 4.79 per cent.
ME Bank chief executive Jamie McPhee said the lender had been able to reduce its five-year rate due to cheaper funding costs.
“Unlike the majors, we’re keen to pass these opportunities on to customers and continue our aggressive position in the home loan market,” Mr McPhee said.
ME Bank unveiled a range of interest rate cuts during 2014, including a drop in its three-year rate from 4.69 per cent to 4.59 per cent during August.
However, while other lenders are likely to follow ME Bank’s path, Mr Oliver said five-year rates are unlikely to get much cheaper.
“The oil price might fall a little bit further and so deflationary pressures globally might intensify a little bit further, but not dramatically, so I don’t see five-year borrowing costs falling much below current levels,” he said.
“Usually what happens is that as bond yields in the wholesale money market come down, it’s usually government bond yields that are the focus of that initially.
“They start moving down and then, over time, the banks will adjust their long-term mortgage rates down.
“They don’t want to lock in the new lower rates too quickly because the decline in bond yields could just be noise.”
Mr Oliver noted that the longer bond yields stay down and continue to fall, the greater the chance that the banks will adjust their rates.
“In a long-term context, current rates are exceptionally low,” he added.
“For a country which has a growth potential of around 3 per cent real economic growth and inflation of around 2.5 per cent, given that wholesale interest rates normally track around nominal GDP growth, we’re already well below normal levels.”