Why are interest rates rising?

2010 was the last time the Reserve Bank of Australia raised the cash rate. So where are interest rates now?

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Can you remember back to November 2010? Julia Gillard was Prime Minister, Brad and Angelina were still a happy couple and Donald Trump as leader of the free world was still a funny joke on The Simpsons.

It was also the last time the Reserve Bank of Australia raised the cash rate, to 4.75 per cent.

A lot has happened since then, including plenty of interest rate cuts: the cash rate now stands at 1.5 per cent – a historical low.

We are now at a point in time where the economy is improving and the official cash rate is tipped to rise sometime in 2018, which will put an end to the easing cycle.

So why are the big banks, such as Westpac, hiking their rates for homeowners?

Our big banks source between 30-40 per cent of the money they lend from overseas sources, and over the past year the cost of this funding has risen.

Around the world the flood of cheap money that followed in the wake of the Global Financial Crisis in an attempt to stimulate the world economy has slowly been stemmed.

All the big central banks have gotten behind the third basel accord, which requires banks to hold more capital to buffer them from any financial shocks.

Even China is pulling back the reins to reduce its high debt levels.

All of which means borrowing money on the world stage has become more expensive for our banks.

And then along came Donald Trump.

The day after the election the sun rose on a new world – one that can now boast a leader who once waged a Twitter war with Cher.

Nobody knows what the next four years will bring, but markets are already betting on higher inflation as he spends big on infrastructure to “Make America Great Again”.

US bond yields are already up and the flow-on effect is spreading around the planet.

This will lead to higher interest rates and borrowing costs – something that our banks are already factoring in to their bottom lines.

At home too, the banks are facing increased regulatory pressure from the Australian Prudential Regulation Authority (APRA).

It is the job of the government regulator to ensure that our banking sector remains strong and, over the past couple of years, it’s sharpened its focus on higher risk and overseas mortgage lending.

Australian banks face some of the toughest guidelines in the financial world, which set out how much cash and assets banks must hold respective to their loans, and the risks associated with their lending.

Faced with elevated funding costs, increased regulation, and intense market competition for new customers, all the banks are being squeezed. 

Yes, they are still generating healthy profits, but they’re under the 10-year average.

And, after all, banks are in the business of making as much money as possible for their shareholders.

At its latest meeting, at the start of December, the RBA left the cash rate unchanged, something it felt was consistent with sustainable growth and the low-inflation environment at home.

However, as we’ve seen by the increase in the banks’ interest rates, the ripples from the changes in the global economy have already reached us.

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