Australia / Press Releases
Fit to Print: RBA Plans Negative Rates and Quantitative Easing

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by Jason Aravanis
Oct 09 2019

With stubbornly low wage growth, inflation persistently below the 2-3% target and an unemployment rate resistant to downward pressure, the Reserve Bank of Australia (RBA) is on the verge of implementing unconventional monetary policy. Preceding the cut to a record low cash rate of 0.75% this month, RBA Governor Phillip Lowe revealed that new monetary policy tools may be activated as soon as the cash rate falls below 0.5%. As the global economy shows an increasing number of warning signs, banks, businesses, and homes across Australia will likely need to prepare for negative interest rates and quantitative easing.

The pros and cons of negative rates

IBISWorld expects that a negative interest rate policy (NIRP) would have a major impact on the viability of Australian banks. NIRP has been enacted by the European Central Bank, Japan, Germany, Switzerland, Sweden, and Denmark over the past decade. In a NIRP environment, Australia’s banks would be required to pay interest on the reserves they keep in their accounts at the RBA, rather than receiving interest as usual.

‘NIRP forces banks to lend more funds at any interest rate consumers and businesses are willing to accept, as the alternative is keeping funds at the RBA where a loss is guaranteed. The benefits for households and businesses seeking to borrow are immense, as banks will be eager to get money out the door as much as possible,’ according to IBISWorld Senior Industry Analyst, Jason Aravanis.

To highlight this fact, Denmark’s Jyske Bank launched the world’s first negative interest rate mortgage in August, providing loans to homeowners with an interest rate of negative 0.5% per year.

Although NIRP can stimulate the economy by encouraging lending, the policy can also present a major threat to the National and Regional Commercial Banks industry. Banks generate profit by maintaining a margin between the interest rates paid on deposits and the interest rates earned from lending. If lending interest rates for firms and households become negative, then knock-on effects on bank profitability are inevitable unless negative rates are also imposed on deposits.

‘The capacity for banks to charge interest on deposits is extremely limited, as retail depositors are likely to withdraw funds entirely to preserve their wealth. As a result, NIRP represents a serious threat to the profitability of the big four banks in Australia, which enjoy some of the highest margins in the developed world,’ said Mr Aravanis.

The problems with quantitative easing

Quantitative easing (QE), commonly known as ‘printing money’, has been used by central banks in the United States, Japan, United Kingdom, the Eurozone and Switzerland. QE involves central banks creating new money to purchase government bonds, safe assets such as mortgage-backed securities, and, in some cases, corporate debt and shares. In Australia, this policy may stimulate the economy through three channels. However, IBISWorld expects the effectiveness of QE to be extremely limited in Australia.

‘The RBA has stated that it would consider using a QE-style program to inject more money into the economy. Ideally, the recipients of these funds would use them to make greater investments and generate economic activity. However, the effectiveness of this policy in Australia is likely to be limited, given the existing abundance of money supply,’ said Mr Aravanis.

A QE policy would also increase the price of fixed-income assets, lowering their yield. This measure would push private investors to move funds into more risky investments to maintain the same returns. As a result, funds would move out of risk-free debt assets and transfer into more productive uses, such as corporate debt, which can be used to expand businesses and create employment.

‘However, it is also possible that these funds will flow into the property market instead. Consequently, this measure risks only further inflating housing prices rather than stimulating the economy,’ said Mr Aravanis.

In addition, QE would affect the interest rates on assets denominated in Australian dollars. An increase in the money supply would reduce the attractiveness of Australian debt assets compared with those issued by other economies. As a result, foreign demand for the Australian dollar would decline, as investors seek out alternative investments with higher returns in other economies.

‘By depreciating the currency, the RBA would potentially improve export competitiveness and deliver an increase in inflation by making imported goods more expensive. However, this strategy’s effectiveness is predicated on other central banks not seeking to devalue their own currencies. Given that central banks in most of Australia’s major trading partners have also recently cut their cash rates, it is unlikely that this method would deliver economic stimulus,’ said Mr Aravanis.

An alternative way to stimulate

‘As the RBA has cut rates closer to zero, it has become evident that the capacity for monetary policy to meaningfully stimulate the economy is now marginal at best. In contrast, expansionary fiscal policy is likely to be far more effective in the current economic climate,’ said Mr Aravanis.

Australia currently has significant leeway to stimulate through debt, given our low government debt-to-GDP ratio of 66%. In comparison, in 2018, the United States had a debt-to-GDP ratio of 137% and the United Kingdom had a debt-to-GDP ratio of 113%. The cost of government debt is also at record lows, with the interest rate on 10-year government bonds falling below 1% for the first time in August 2019.

‘Given these conditions, it is an optimal time to ramp up fiscal spending on infrastructure, or offer greater tax breaks to Australian households. With a deteriorating economic climate, it is clear that other policy objectives are more important than simply achieving a budget surplus in 2019-20. If the Federal Government were to conduct fiscal expansion, it would significantly benefit several industries across the economy,’ said Mr Aravanis.

According to IBISWorld, industries that would benefit from expansionary fiscal policy include:


 IBISWorld reports used to develop this release:

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