Soaring oil prices risks causing havoc for Aussie mortgage holders
Bond prices, stocks, US president Donald Trump’s pledge to avoid getting into unnecessary foreign conflicts… everything appears to be sinking at the moment.
Well everything apart from oil prices. As the gulf states brace for impact amid Trump’s Israel-backed war on Iran, crude oil has exploded above US$107 – the highest in nearly four years – with Australian motorists feeling the pain at the pump.
WTI crude oil futures surged as much as 26% in a single day (the largest one-day gain in 38 years) on Monday amid a series of production cuts from major Middle Eastern producers following disruptions in the Strait of Hormuz.
A prolonged oil crisis risks driving up household inflation. This is causing bond yields to rocket higher as the market prices in the likelihood of further interest rate hikes from the Reserve Bank of Australia (RBA).
Australia’s 10-year government bond yield has brushed 5% for the first time in 15 years, adding nearly 80 basis points from a trough in October 2025, while the five-year bond yield has moved above 4.6% (it was just 3.5% five months ago).
The three-year government bond yield – which gives a good indication of where the market expects central bank rates to go – is now above 4.5%, having added 13 basis points in a single day.
With the RBA cast rate sitting at 3.85%, it’s clear that the market is expecting at least two, but probably more, rate hikes in the coming months, following the 25-basis-point hike in February.
Why have yields gone up?
Bond prices (which are inversely correlated to their yield) essentially have to fall when the rate outlook becomes more hawkish.
If the market expects rates to go up, future bond issues will offer higher coupons, making existing bonds with lower coupons suddenly look inferior. To adjust for that, bondholders drop their prices to compete with the higher future rates, hence the sell off.
This latest surge in bond yields “is a combination of expectations for higher cash rates or monetary tightening from the RBA and higher inflationary expectations as a result of the rising petrol prices", says AMP’s chief economist Shane Oliver.
Oliver estimates that a 40% rise in petrol prices will take about 14% out of household budgets a week.
What does it mean for mortgages?
Fixed-rate mortgages are funded from the bond market.
Banks borrow at one‑, three‑ and five‑year maturities at a margin over bond yields. As those bond yields rise, the banks’ cost of funds increases “by a commensurate amount”, said Oliver, putting “more upwards pressure on fixed mortgage rates”, which can also act as a precursor to higher variable rates.
Oliver pointed out that the three-year government yield is now around 30-40 basis points above previous levels, while the five‑year has jumped about 25 basis points from the top of its prior range.
If these higher yields persist, he believes it will become increasingly difficult for banks not to pass the higher funding costs through to borrowers in the form of higher fixed mortgage rates, even though they may delay moves if there is a chance the geopolitical shock and bond sell-off prove short‑lived.
“The banks won’t pass it on straight away, because there’s quite a bit involved in raising rates,” said Oliver. “They don’t want to move too precipitously, because if they hike quickly and markets then reverse, they’d have to cut again.
“If we wake up tomorrow and Donald Trump and the Iranians have struck some big deal to end the war, yields could fall back and this will all look like a two‑week wonder. That’s why banks sometimes hold off for a while.
“But the longer this continues, the harder it will be for them to resist passing those higher funding costs on.”
