Nov 08 2020
Following its board meeting on 3 November, the Reserve Bank of Australia announced that it would reduce the cash rate target by 15 basis points, to a historic low of 10 basis points. The reduction was announced as part of a package of measures taken to support the Australian economy as it starts to recover from the COVID-19 pandemic. In addition to the cash rate reduction, the RBA announced that it would reduce the interest rate on exchange settlement balances, which refers to the amount financial institutions have on deposit with the RBA, to zero. The third announced measure is a program of government bond purchases, with the RBA planning to purchase $100 billion worth of federal, state and territory bonds over the next six months. The RBA has said it will purchase these bonds on the to place downward pressure on the yield curve, helping to lower borrowing costs.
The RBA’s announcement also included guidance that it does not expect to increase the cash rate for at least three years. As inflation has consistently remained below the RBA’s target band, RBA Governor Philip Lowe stated that wage growth will have to rise substantially to push inflation to the target level over the long term. Such a level of wage growth would require the unemployment rate to decline, which is forecast to take years as the economy recovers from the COVID-19 pandemic. The RBA has signalled this extended period of historically low interest rates to inspire investor confidence and encourage investment in higher yielding assets, such as equities and corporate debt, to support economic growth.
The reduction in the cash rate has substantial implications for consumers. Interest rates on mortgages will likely fall slightly as banks pass on the rate differential to consumers, reducing interest costs and slightly increasing borrowing capacity. Consequently, mortgage affordability is anticipated to rise slightly as banks lend to consumers at lower rates. Conversely, savers are forecast to face another reduction in interest rates on their savings. Lower interest rates will likely negatively affect retirees and other individuals living off fixed incomes and conservative investment portfolios.
The move to an all-time low cash rate also has implications for the economic recovery. During the global financial crisis, the RBA made significant rate cuts to an ‘emergency low’ of 3.0% in 2009. While the RBA subsequently raised the cash rate back to 4.75% in 2010, it has steadily declined over the past decade, falling to 0.75% before the COVID-19 pandemic arrived on Australian shores. This low rate gave the RBA less ammunition to support an economic recovery, as a lower cash rate can help spur investment and lower the value of the Australian dollar, boosting exports. With the cash rate now set to remain at 0.1% for the next three years, the RBA would need to engage in more unconventional monetary policy to further boost economic growth. Given the narrowing range of available monetary interventions, the Federal Government’s fiscal policy will play an increasingly important role in Australia’s recovery from the pandemic.