The cash rate has until now been unchanged in 2012 and the decision yesterday marks the biggest cut since the global financial crisis in February 2009. Although economists widely agreed that interest rates would be decreased this month, the 50 basis point cut was double the expectation. This could account for the fact that perhaps the RBA doesn’t expect lenders to pass the cut on in full. In fact, only about 40 basis points of the 50 basis points that have been cut since November 2011 have been passed on to home loan customers by the big four banks.

For a typical 25 year, $300,000 home loan, homeowners could save about $96 a month if the cut is passed on in full. This is a huge relief for home owners struggling in the current climate. We now wait to hear from the banks to see whether they will pass on all or part of the savings.

An indication of inflation, the Producer Price Indicator (PPI) was today revealed to have slid in the first quarter of 2012. The 0.3% fall in wholesale prices has reinforced the expectations of already convinced economists that the next rate announcement will be to lower the cash rate by 25 or even 50 base points.

The real indicator will be the closely watched Consumer Price Index (CPI) due tomorrow.

Since the Board last met, concerns about sovereign creditworthiness in several European countries have been a focus of financial markets. Investors have generally displayed a good deal more caution. As a result, equity prices have fallen and long-term government bond rates have declined outside of the countries most affected by the sovereign concerns. The Australian dollar fell sharply as part of this adjustment. Commodity prices have also softened, though those important for Australia remain at very high levels.

European policymakers have responded by assembling a large package to provide financing for the relevant countries for a period of time, stabilise bond markets and provide liquidity. They have also committed to action to bring budget deficits down and stabilise debt over time.

The effects of these various factors on the world economy will need to remain under review. At this stage, global growth is still expected to be at about trend pace in 2010. Conditions in Europe overall have been relatively weak, and the foreshadowed budgetary tightening will probably mean that this will continue, but growth is becoming more established in North America. In Asia, growth has continued to be quite strong and may need to moderate in the year ahead.

In Australia, with the high level of the terms of trade expected to add to incomes and demand, output growth over the year ahead is likely to be about trend, even though the effects of earlier expansionary policy measures will be diminishing. Inflation appears likely to be in the upper half of the target zone over the next year.

Consistent with that outlook, and as a result of actions at previous meetings, interest rates to borrowers are around their average levels of the past decade, which is a significant adjustment from the very expansionary settings reached a year ago. Taking all the available information into account, the Board views this setting of monetary policy as appropriate for the near term.

Mortgage holders will be disappointed with the increase. After being told by the Reserve Bank Governor, Glenn Stevens, that rates were getting close to normal levels, borrowers would have been hoping the pace of rate rises had slowed. Today’s 25 basis point rise takes the official rate to 4.50 per cent.

It is the sixth increase since September and means mortgage holders are now paying about $300 a month extra for their mortgages than they were in the middle of last year, says Domain.com.au blogger and property author Carolyn Boyd.

“There were a lot of mixed signals this month that may have had mortgage holders thinking they were in for a break. While inflation last week came in higher than expected, consumers have been spending less at the shops.”

Until today’s decision, mortgage holders on variable interest rates were paying about 7 per cent to their lenders. The rates that borrowers pay to their financial institutions are expected to normalize at about 7.5 per cent to 7.75 per cent by year’s end. That could signal there are still one or two more rate rises to come before Christmas.

The increase will be of little surprise to mortgage holders, who have been bracing themselves for a higher interest bill after repeated warnings by the Reserve Bank Governor, Glenn Stevens, that rates are on their way up. Todays 25 basis point rise takes the official rate to 4.25 per cent.

“This is now the fifth increase since September and means average Australian mortgage holders are now paying about $250 a month extra for their mortgages than they were in the middle of last year,” says Domain.com.au blogger and property writer Carolyn Boyd. “The property market has been running hot and the Reserve Bank will be hoping that todays increase will take a little bit of that momentum away”

The rate has many more rises to go before it reaches the most recent peak of 7.25 per cent, which it hit two years ago, in March 2008.

Until todays decision, mortgage holders on variable interest rates were paying about 6.75 per cent to their banks. The rates that borrowers pay to their financial institutions are expected to normalize at about 7.5 per cent to 7.75 per cent by years end.

While the move came as a surprise to many, there was enough indifferent data in the past fortnight to provide reasons for a pause and the RBA has never been keen to hike for too many consectuive months. Indeed, their latest streak of three months was the longest in history.

“Global financial markets are functioning much better than they were a year ago,” RBA Governor Glenn Stevens noted, upon releasing the news. “Credit conditions nonetheless remain difficult in the major countries as banks continue to face loan losses associated with the period of economic weakness. Concerns regarding some sovereigns have increased.

“In Australia, economic conditions have been stronger than expected, after a mild downturn a year ago. The effects of the fiscal stimulus on consumer demand have now faded, but household finances are being supported by strong labour market outcomes and a recovery in net worth.”

Mr Stevens said that the unemployment rate had probably peaked while inflation was likely to “be consistent with the target in 2010?.

The Board saw significant strength in the housing sector but they drew caution from soft business lending data. The central bank warned, however, that the cash rate would still trend up in the coming months.

“With the risk of serious economic contraction in Australia having passed, the Board had moved at recent meetings to lessen the degree of monetary stimulus that was put in place when the outlook appeared to be much weaker,” Mr Stevens noted. “Lenders have generally raised rates a little more than the cash rate over recent months and most loan rates have risen by close to a percentage point. Since information about the early impact of those changes is still limited, the Board judged it appropriate to hold a steady setting of monetary policy for the time being.

“Interest rates to most borrowers nonetheless remain lower than average. If economic conditions evolve broadly as expected, the Board considers it likely that monetary policy will, over time, need to be adjusted further in order to ensure that inflation remains consistent with the target over the medium term.”

Commercial financing increased four per cent to $26.677 billion, while personal finance was up 1.1 per cent to $7.053 billion. The two rises contrasted with a three per cent drop in lease finance and a 2.9 per cent decline in housing finance to $16.537 billion. The fall in housing finance was driven by a 5.6 per cent drop in loans on the back of interest rate hikes and a reduction in stimulus measures.

The rise in lending has enhanced the case for a 0.25 per cent hike to the cash rate next month. The Reserve Bank Board will meet on February 2, with inflation data later this month a key to their decision – although most analysts are currently expecting a fourth consecutive rise.

The soft result was forecast by analysts who pointed to rising interest rates and a reduction of stimulus measures as reasons for the decline. Indeed, first home buyers, the key sector behind last year’s strong property market, represented the primary cause of the decline as the Boost to the First Home Owners Grant had been wound back the month prior.

The number of first home buyer commitments, as a percentage of the total, decreased from 26.0 per cent in October to 22.0 per cent in November. While investors, who are less sensitive to rate movements, began to pick up the slack.

David Airey, President of the Real Estate Institute of Australia, said the news did not come as a shock – although economist expectations of a two per cent fall had fallen short.

“This is exactly what the REIA said would happen as the First Home Owners Grant Boost (FHOG Boost) was phased out and the Reserve Bank of Australia (RBA) began its series of interest rate increases,” he noted.

“First home owners have come down from a high of 28.5 per cent in May to the lowest since October 2008 when the Boost was introduced, with more decreases expected as the effects of the cessation of the Boost in December are realised.”

The news is considered unlikely to stop the Reserve Bank of Australia hiking once more next month, although a low inflation reading later this month could see that opinion change. Credit markets are currently pricing in a better than 60% chance of a 0.25 per cent increase on the back of recent strong approvals, retail and jobs data.

The researchers noted that the industry had systemically changed in Australia, but saw numerous opportunities in the year ahead. They cautioned, however, that this year’s growth rate – below 10% for the first time in a decade – may become more common.

“This means that the days of outstanding system lending growth of between 10-15% p.a. are over. We anticipate current lending growth levels of around 7.5% are most likely to remain into the near future,” said James Hickey, a banking partner with Deloitte Actuaries and Consultants.

Informed by a roundtable of Australian mortgage lenders and distributors, the Deloitte Australian Mortgage Report considers the challenges and opportunities for the industry in 2010 across competition, margins and credit performance, product design and distribution.

“The overarching sentiment is one of renewed hope,” Hickey advised. “In 2010 lenders will seek to position for the opportunities ahead. Where 2009 was the year of the major banks, 2010 will provide opportunity for the re-emergence of other lenders in the marketplace.”

“The Big Four roundtable participants said they would welcome more competition and the smaller lenders said they intend to tackle them. So the game is on,” according to Graham Mott, Audit Partner and Deloitte Australian Securitisation lead.

To meet the challenges ahead the roundtable and Deloitte’s analysis show that the evolution of the mortgage market is likely to take place on a number of fronts:

* Differentiation around brand, strategy, pricing and operating models
* Competition between the Big 4, from regional and non-bank lenders, and other ‘left field’ industry players
* Distribution channels indicating continued M&A activity in 2010 of third party broker groups, and natural attrition driven by regulation
* Innovation around product design, customer service, delivery channels and operating efficiency, where leveraging technology and mining and understanding data will be key.

“The consensus of the industry players was that a return of the residential mortgage backed securities (RMBS) investors was both necessary and anticipated,” Mott noted. “We are already seeing solid evidence that the RMBS market is returning and at this rate it will reach ‘break even’ levels in 2010 – triggering the environment for more competition.”

Mr Mott added that all industry participants expressed concern as to the possible ‘double whammy’ of higher unemployment and rising interest rates in 2010 and its effect on arrears. But, despite the challenging credit conditions, their current losses were remaining stable – helped by the unexpected decline in unemployment.

Housing market

The researchers noted that supply constraints would help fuel the property market in the year ahead, negating the impact of stimulus reduction.

“Housing demand currently exceeds supply, and although fuelled to large extent by the boost to the first home buyers grant, lenders and distributors anticipate that will be replaced by growth from investor lending in 2010 and so continuing a settlement growth rate of 5-10%,” Hickey explained.

The report suggested that non-bank lenders – hit hard by the global financial crisis – would begin to make inroads once again next year.

“Non bank lenders are optimistic and the market is anticipating their return in 2010,” Hickey said. “While the major lenders positioned themselves well during the GFC in terms of strategic acquisitions and capabilities, they will now increasingly compete on price, strategy and service. This, together with a continued demand for distribution by third party brokers, means the outlook for 2010 will be one of competition, greater choice and differentiation.”

The researchers noted that the industry had systemically changed in Australia, but saw numerous opportunities in the year ahead. They cautioned, however, that this year’s growth rate – below 10% for the first time in a decade – may become more common.

“This means that the days of outstanding system lending growth of between 10-15% p.a. are over. We anticipate current lending growth levels of around 7.5% are most likely to remain into the near future,” said James Hickey, a banking partner with Deloitte Actuaries and Consultants.

Informed by a roundtable of Australian mortgage lenders and distributors, the Deloitte Australian Mortgage Report considers the challenges and opportunities for the industry in 2010 across competition, margins and credit performance, product design and distribution.

“The overarching sentiment is one of renewed hope,” Hickey advised. “In 2010 lenders will seek to position for the opportunities ahead. Where 2009 was the year of the major banks, 2010 will provide opportunity for the re-emergence of other lenders in the marketplace.”

“The Big Four roundtable participants said they would welcome more competition and the smaller lenders said they intend to tackle them. So the game is on,” according to Graham Mott, Audit Partner and Deloitte Australian Securitisation lead.

To meet the challenges ahead the roundtable and Deloitte’s analysis show that the evolution of the mortgage market is likely to take place on a number of fronts:

* Differentiation around brand, strategy, pricing and operating models
* Competition between the Big 4, from regional and non-bank lenders, and other ‘left field’ industry players
* Distribution channels indicating continued M&A activity in 2010 of third party broker groups, and natural attrition driven by regulation
* Innovation around product design, customer service, delivery channels and operating efficiency, where leveraging technology and mining and understanding data will be key.

“The consensus of the industry players was that a return of the residential mortgage backed securities (RMBS) investors was both necessary and anticipated,” Mott noted. “We are already seeing solid evidence that the RMBS market is returning and at this rate it will reach ‘break even’ levels in 2010 – triggering the environment for more competition.”

Mr Mott added that all industry participants expressed concern as to the possible ‘double whammy’ of higher unemployment and rising interest rates in 2010 and its effect on arrears. But, despite the challenging credit conditions, their current losses were remaining stable – helped by the unexpected decline in unemployment.

Housing market

The researchers noted that supply constraints would help fuel the property market in the year ahead, negating the impact of stimulus reduction.

“Housing demand currently exceeds supply, and although fuelled to large extent by the boost to the first home buyers grant, lenders and distributors anticipate that will be replaced by growth from investor lending in 2010 and so continuing a settlement growth rate of 5-10%,” Hickey explained.

The report suggested that non-bank lenders – hit hard by the global financial crisis – would begin to make inroads once again next year.

“Non bank lenders are optimistic and the market is anticipating their return in 2010,” Hickey said. “While the major lenders positioned themselves well during the GFC in terms of strategic acquisitions and capabilities, they will now increasingly compete on price, strategy and service. This, together with a continued demand for distribution by third party brokers, means the outlook for 2010 will be one of competition, greater choice and differentiation.”