By Mr. Propwise

Many people are concerned that the current low interest rate environment in Singapore could end by the end of this year, driving up the cost of mortgages and putting pressure on the property market. In this article we take a look at how interest rates in Singapore are determined, and where they are likely to head for the rest of the year and beyond.

How are interest rates determined?

In a 1999 paper titled “Interbank Interest Rate Determination in Singapore and its Linkages to Deposit and Prime Rates”, staff of the Monetary Authority of Singapore (MAS), the central bank, found that “only changes in US interest rates or market expectations of future movements in the exchange rate have a significant impact on the domestic interbank rate.”

But other analysts have found that the SIBOR has historically been positively correlated to the movement of the bank loan to deposit ratio, even after controlling for the impact of US interest rates. This means that if bank loans grow faster than deposits, SIBOR tends to head upwards.

So to summarize, exactly how interest rates in Singapore are determined is a controversial topic and there is no simple formula! But we know there are three significant factors that will influence it: 1) US interest rates 2) Market expectations of the Singapore Dollar exchange rate (will it appreciate or depreciate?) and 3) Demand and supply for loans and deposits in Singapore.

So where are interest rates heading?

Hong Kong mortgage rates have already risen by as much as 1% over the past three months, driven by tight liquidity in the banking system as the growth of loans have outpaced the growth of deposits. Will interest rates in Singapore also head upwards due to the demand-supply dynamics in the local banking system, even if US interest rates stay low for now?

In a similar situation to Hong Kong, loans have been growing faster than deposits, with loan growth till April of 21.9% versus deposit growth of 12.7%. If the gap between the growth of loans and deposits continues, this will increase the bargaining power of local banks and increase the probability of a higher SIBOR and also interest rate spread above SIBOR for mortgages.

But Hong Kong has its own specific dynamics – there has been a growing shift into Renminbi from Hong Kong Dollar deposits, which has been absent in Singapore as the MAS has let the Singapore Dollar appreciate against the US dollar, whereas the Hong Kong Dollar is pegged to it. In fact, the Singapore Dollar has even appreciated against the Renminbi over the last two years! But if the MAS decides to slow the appreciation of the Singapore Dollar, we could start to see higher interest rates.

Also, the Singapore government’s recent moves to dampen speculation in the property sector could lead to both fewer transactions and thus mortgage volume, and also a lower mortgage per transaction (as the Loan To Valuation limit has been lowered for investment properties). This means that loan growth might start to weaken, while deposit growth remains healthy despite the low rates as people prefer to park their money in a “strong” currency.

As for where US interest rates are headed, it is anybody’s guess. But Singapore’s Asian neighbours China and India have already been raising rates in an effort to combat rising inflation. If inflation starts becoming an issue in the US, and policymakers have confidence in the strength of the economy, then interest rate hikes could come sooner than expected.

While we do not expect a large spike in interest rates anytime soon, they certainly can’t go much lower, and borrowers should be prepared for scenarios where they start moving higher. For homebuyers, this means that you should not assume that interest rates will always remain this low, and to plan your finances so that you will still be able to meet your mortgage payments even if interest rates rise.

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