(Reuters) - Australian no.2 mortgage lender Westpac's first-half profit missed expectations on Monday as margins contracted, and it warned shifting global trade policies were rattling markets and may raise funding costs, knocking its shares down 3%.

"Geopolitical uncertainty is a key risk that's as high as it has been for a very long time," said Anthony Miller, who took the helm as chief executive in December.

"Business confidence has also weakened. This could lead to softer consumer spending and business activity. Funding spreads have widened since the end of the first half and volatility may push funding costs higher," he told reporters on a conference call.

Westpac posted a 1% drop in net profit for the six months ended March to A$3.32 billion ($2.14 billion), missing a Visible Alpha consensus estimate of A$3.43 billion.

A 6% rise in the bank's operating costs due to investments in technology and its UNITE simplification program offset growth in home, business and institutional lending volumes.

Westpac's net interest margin (NIM) - the difference between interest earned from lending and paid for deposits - fell one basis point from last year to 1.88%. 

Its core net interest margin stood at 1.80%, narrowing by three basis points as loan spreads tightened in an intensely competitive mortgage market and as customers shifted toward lower-margin savings accounts.

The bank's shares initially fell 3.8% and were down 2.7% as of 0104 GMT, underperforming a 0.4% fall in the broader market.

"While management are pivoting lending growth to business and institutional, the challenge appears to have stemmed from funding that growth in a competitive environment," analysts at Citi said in a note.

"We expect the market will be questioning the sustainability of this growth, particularly as rate cuts present incremental imposts and the replicating portfolio converges on spot, reducing a key lever of support for the NIM."

Westpac said mortgage delinquencies and impairment charges remain low, with repayments on home loans in Australia more than 90 days late as a proportion of total loans falling to 0.86% as of the end of March from 1.12% six months earlier.

The result comes two days after the Australian Labor Party secured a historic second consecutive term, in an election in which soaring housing costs were a key issue.

Miller said he's eager to work with the government on a range of issues, "including providing more housing, guaranteeing access to cash with a sustainable long-term model and challenging ourselves as to how we compete as a nation going forward."

Westpac declared an interim dividend of 76 Australian cents, up 1 cent from a year earlier.

($1 = 1.5513 Australian dollars)