Banks to pass on full rate cut

Home owners are expected to rejoice in lower interest rates with the banks tipped to pass on any rate cut in full.

Investors are expecting the Reserve Bank of Australia (RBA) to cut the official cash rate by 0.25% later today, with the banks expected to pass on the full cut to mortgage customers. Analysts expect the banks to avoid making themselves political targets, in the face of a looming election, and won’t want to hold back any part of official rate cuts at a time of record profits.

Doing so could see the government take further steps to ‘tax’ the banks’ profits, much like the proposed deposit guarantee levy floated last week.

The usual reason for the banks not passing on rate cuts in full has been the cost of funding, including paying relatively high interest rates on deposits. Those deposits now represent more than 60% of the banks’ funding. In September last year, banks were paying 0.9% above the cash rate for term deposits, that has now slipped to 0.6%, as banks look for other ways of cutting costs, as credit growth struggles.

Earlier this year in May following the 0.25% official rate cut, ANZ Bank (ASX:ANZ) cut by 0.27%, while Commonwealth Bank (ASX:CBA), National Australia Bank (ASX:NAB) and Westpac Banking Corporation (ASX:WBC) all cut rates by 0.25%.

Wholesale funding costs are closing on four-year lows reached earlier this year, suggesting the banks can afford to pass on any interest rate cut in full.

Of course, there’s no certainty that the Reserve Bank will cut interest rates today, with one or two economists expecting a rate cut next month rather than this month. They are the exception though, with many analysts tipping a 0.25% rate cut today, and some have gone so far as to tip a 0.5% cut.

Foolish takeaway

We could see the official cash rate hit a record low of 2.5% today, and an even lower rate by Christmas. Economic activity especially in the construction sector has been poor, and the Australian dollar is seen as still too high to have a more positive impact on the economy. Should the banks cut their rates in full too, we could see consumers spending again.

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Motley Fool writer/analyst Mike King doesn’t own shares in any companies mentioned.

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