Lending rates and discounts on mortgage loans have at last parted company, the former inching upwards after a seven-year slide into the red in real, inflation-adjusted terms, and the latter heading downwards as the price war between banks for home loans slides into an uneasy truce. This will be applauded by bank shareholders, who may be tempted to believe that much-improved earnings are now on the cards. However, it will be rued by prospective homeowners, who may fear that their access to easy money is gradually shutting down. Economic policymakers are also apprehensive, concerned that rising interest bills could take the steam out of the fragile economic recovery now under way. As always, there is no such thing as a free lunch. And also as always, hindsight will likely judge that the best and worst expectations held on either side of the unravelling interest rate story overstated the outcomes. Hopes of a profit surge by bank shareholders will be dashed, and fears of a housing boom hose-down will also prove unfounded. Markets will overshoot and markets will correct. But with that caveat in mind, it is safe to say that a tipping point in lending rates and mortgage discounts has been reached after one or two false starts. The retreat in borrowing costs triggered by mass de-leveraging of balance sheets in the wake of the Asian financial crisis took the benchmark best lending rate on offer to Hong Kong borrowers from 10.25 per cent in January 1998 to a low of 5 per cent in November 2002 - where it remained, apart from two brief rallies, until November last year. Since then, however, the trend has been steadily upwards and the rate is now 5.75 per cent. With further rises in US rates on the cards for the rest of the year, the trend is certain to remain in place. At the same time, the discounts to the best lending rate - the prime rate (p) - at which home loans are made, have begun narrowing. Along with cash rebates on offer, the discounts fell to p minus 3 per cent (p-3) in January - for effective home loan rates of just 2 per cent. Homebuyers had never had it so good, and those not left in negative equity by plunging property prices used the opportunity to refinance loans at lower interest rates. Until recently, this meant the rise in new loans being made by lenders was not translating into a notable rise in the aggregate value of loans outstanding. But under the combined influence of cautions from the Hong Kong Monetary Authority and an easing of the mortgage price war as the property market duly recovered, discounts are now floating at about p-2, and effective rates are on the march. That process has already found its way into the latest available mortgage data from the HKMA. The figures show that in May, the share of home loans advanced at a discount of greater than 2.5 per cent had plunged to 52.2 per cent of all loans made that month, from a peak 93.7 per cent in March. Virtually the entire $16.97 billion in new loans drawn down in May found its way into a rise in the total value of outstanding loans, suggesting the refinancing wave is well and truly over. For now, all of the foregoing is unfolding against a healthy background of rising house prices, rising net wealth effects, and improving credit quality. Residential property prices increased 15 per cent between September last year and March, taking the cumulative increase to 60 per cent relative to the trough in July 2003, noted the HKMA. Increases in the prices of commercial properties have been even sharper, rising 19 per cent in the six months to March and 121 per cent since mid-2003. Is it time for bank shareholders to break out the bubbly? Perhaps not. While the prime rate is undoubtedly inching upwards, the Hong Kong interbank offered rate (Hibor) has rocketed ahead in recent months as domestic wholesale rates - or banks' cost of funds - belatedly played catch-up with their US counterparts. Deposit rates, albeit grudgingly, are also headed higher. Banks will undoubtedly respond to these events with further increases in their benchmark lending rates, but until they do, their margins on home loans are being squeezed. Helped higher by refinements unveiled in May to the pegged exchange rate system, three-month Hibor was last at 3.43 per cent - up 336 basis points from a low of 0.07 per cent on January 13. But by comparison, the prime rate has so far risen just 75 basis points, to 5.75 per cent. For the mortgage portfolios acquired by banks in January, this translated into a sharp fall in net interest margins, estimated by the HKMA at 125 basis points for Hibor-financed home loans, 17 basis points for loans funded from time deposits, and seven basis points for 'EDR-financed' loans (EDR: the average interest rates on demand, savings and time deposits weighted by the deposit composition of the entire banking sector - see chart). Bank shareholders, it seems, will have to moderate their expectations, and since the prime rate clearly remains 'sticky', homebuyers may not be in any immediate danger of further sharp rises in their borrowing costs.