Rising mortgage rates headache for Gillard

Australian Prime Minister Julia Gillard, who defeated a leadership challenge on Monday, faces rising mortgage premiums as banks protect profits amid credit market costs at about the highest in more than 2 years.

The nation's four biggest banks, controlling 86 per cent of home loans, boosted interest rates independent of the central bank this month, showing rising funding costs are a bigger priority than avoiding government attacks.

The difference between the standard rate on home loans, currently 7.3 per cent, and the benchmark cash rate has held at 305 basis points since 2010, the biggest gap since 1994, central bank data show.

Mortgages are a sensitive issue for Gillard, whose Labor Party trails the opposition by 10 percentage points in opinion polls with an election due next year. A 10-year fixed-rate home loan, the longest listed by three of Australia's top four banks, costs at least 7.59 per cent, while US 15-year mortgages average 3.15 per cent.

"Bank funding costs will be a headache for the Government because voters want action that leads to lower mortgage rates," said John Sorrell, head of credit in Sydney at Tyndall Investment Management Australia.

"The Government's hands are tied due to the perceived need for a strong banking system."

Policy makers will lower the developed world's highest benchmark rate to 4 per cent in May from 4.25 per cent now, then keep it unchanged through year-end, according to the median estimate of economists surveyed by Bloomberg News.

The central bank unexpectedly kept its benchmark lending rate unchanged on February 7, confounding the forecasts of 24 of 27 analysts surveyed who predicted a cut.

Commonwealth Bank of Australia increased the rate on a variable rate home loan by 10 basis points to 7.41 per cent in the days following the RBA's February 7 policy announcement.

National Australia Bank added 9 basis points to 7.31 per cent, Westpac Banking boosted the cost by 10 basis points to 7.46 per cent, while ANZ Bank added 6 basis points to 7.36 per cent.

Treasurer Wayne Swan condemned the actions, urging customers to switch lenders.

Australia's four largest banks have raised A$10.2 billion in bonds in the domestic market this year, up 62 per cent from the same period of last year, Bloomberg data show.

Fitch Ratings downgraded Westpac, Commonwealth Bank and National Australia to AA- from AA on February 24, citing their vulnerability because of the banks' dependence on wholesale funding markets. About 40 per cent of the lenders' funding comes from bond investors, with about 60 per cent of that from overseas, according to Fitch.

National Australia Bank's chief executive Cameron Clyne reported earnings were buffeted by narrower lending margins, in a statement on February 7.

"It's costing banks more to borrow in the wholesale markets at the present time and that means to protect their return on capital they need to reflect that and it's a key driver of how they set their loan rates," said Glenn Feben, head of fixed interest at Perennial Investment Partners.

Australian home prices fell 4.8 per cent in 2011, the biggest drop on record, as the European debt crisis kept a lid on demand, the statistics bureau said. Credit for home buyers rose 5.4 per cent in December from a year earlier, the smallest annual increase since 1977, when central bank data begins.

Australian household debt as a proportion of disposable income tripled over the past 20 years to 150.3 per cent in the quarter to September 30, central bank data shows. That compares with 133 per cent in the US at the height of the sub-prime-mortgage boom.

- Bloomberg