German-Italian clash pushing down rates

The market expectation that the combination of Italian President Mario Monti and European Central bank President Mario Draghi will overpower the Germans, led by the Bundesbank, is putting downward pressure Australian interest rates.

I explained yesterday how the Monti-Draghi combination was working (Monti, Draghi and the Goldman pact, August 20).

The current ECB plan is to define an upper limit for borrowing costs in countries such as Spain and Italy and intervene in the markets to that ensure upper limit is not breached.

The Bundesbank opposes the plan and there are renewed threats that Greece will leave the Euro, adding to the mix of dangerous forces.

But, despite this there is calmness on the wholesale lending market which major Australian banks source for around 40 per cent of their funds.

At the moment, Australian banks can borrow overseas at about half a per cent less than equivalent rates paid on Australian term deposits.

It is very tempting for Australian banks to lift their overseas borrowing and so cut their funding costs. At this stage they do not appear to be doing that.

However the gap between short term overseas rates and local term deposit rates had allowed UBS to offer to lend its clients money, sourced overseas, to take up NAB six-month term deposits via UBank (NAB eyeballs a term deposits raid, August 14). Despite the UBS raid, UBank has held its six months term deposit rate above 5 per cent.

Will lower overseas borrowing costs mean that if the Reserve Bank lowers official rates that Australian banks will now pass on the full reduction or even reduce mortgage rates without an official reduction? Unfortunately for mortgage holders the answer is "no”.

Although the overseas borrowing rates are lower than the Australian term deposit rates, they are higher than the very low rates that were locked in a few years ago. Those low rate borrowings are now maturing, so bank-borrowing costs are still rising.

At the same time, local Australian term deposit rates are much higher in relation to the cash rate than they were, say, a year ago.

Both our bank wholesale borrowing rates and our share market have a lot riding on Monti-Draghi defeating the Germans.