RBA enacts emergency rate cut to prop up Australia’s economy

The Reserve Bank has slashed official interest rates to a historic low of just 0.25% in its first out of cycle cut since 1997 and will use a bond buying program to drive interest rates down as low as possible.

The move, which sent the Australian dollar as low as US55c before the announcement, shows the RBA’s determination to do all it can to avert a recession due to the massive economic shock and potential large-scale unemployment from the coronavirus pandemic.

RBA Governor, Dr Philip Lowe, said the bank would also launch a series of actions to boost lending to small and medium sized businesses and to drive down effective interest rates paid by borrowers.

Bond buying and other measures to support liquidity

He said the bank would hold the cash rate at 0.25% “until progress is being made towards full employment and it is confident that inflation will be sustainably within the 2-3% target band”.

He said that while the coronavirus was primarily a public health issue, the closing of borders and social distancing required was having a dramatic economic effect.

“Financial market volatility has been very high. Equity prices have experienced large declines. Government bond yields have declined to historic lows. However, the functioning of major government bond markets has been impaired, which has disrupted other markets given their important role as a financial benchmark. Funding markets are open to only the highest quality borrowers.’’

Among measures the RBA will take to boost business lending and drive down interest rates it will:

• target the interest rate on Australian government 3-year bonds at 0.25%, buying bonds in the secondary market from Friday;
• provide at least $90 billion at 0.25% over three years to banks if they lend that cash to small and medium-sized businesses. The Board will not increase the cash rate target until progress is being made towards full employment and it is confident that inflation will be sustainably within the 2–3% target band;
• a complementary program of support for the non-bank financial sector, small lenders and the securitisation market;
• exchange settlement balances at the Reserve Bank will be remunerated at 10 basis points, rather than zero as would have been the case under the previous arrangements to reduce the cost to the banking system of settlement balances at the Reserve Bank;
• continue providing liquidity to Australian financial markets by conducting one-month and three-month repo operations in its daily market operations until further notice and longer-term repo operations of six-month maturity or longer at least weekly.

Economy and banks in reasonable shape

Dr Lowe said the package would aid the economy and that the “various elements of this package reinforce one another and will help to lower funding costs across the economy and support the provision of credit, especially to small and medium-sized businesses’’.

While not taking away from the unprecedented nature of the emergency rate cut, Dr Lowe said the economy was in a good position to deal with the fallout from the coronavirus.

“The banking system is well capitalised and is in a strong liquidity position,” he said, noting that “substantial financial buffers are available to be drawn down if required to support the economy.’’

“The Reserve Bank is working closely with the other financial regulators and the Australian government to help ensure that Australia’s financial markets continue to operate effectively and that credit is available to households and businesses.”

Low rates add to government spending

Dr Lowe said the actions would complement “welcome” fiscal or spending announcements by Australian governments.

“Together, these measures will support jobs, incomes and businesses through this difficult period and they will also assist the Australian economy in the recovery.

Dr Lowe has previously signalled that 0.25% will be the low point for official interest rates in Australia, following on from the 0.25% cut at the bank’s February meeting.

Rather than cut interest rates below zero, as some other central banks have done, Dr Lowe has said it would be preferable to leave a positive rate in place and instead use other measures such as quantitative easing to ensure the financial system provided credit to businesses and personal customers like home buyers.

Negative rates could be avoided

Overseas negative rates have led to some significant issues with savers not only being heavily penalised on yield but actually being charged by banks to hold their money.

By cutting official interest rates and buying back bonds, the RBA will force the Australian dollar lower, which mitigates some of the worst effects of a recession by making Australian exports competitive.

Lower dollar to support economy

However, a lower dollar will increase the cost of imports and feed into some inflation, which the RBA would not mind either.

In the long run though, a lower Australian dollar reduces the purchasing power and global net worth of all Australians.

Some economists have tipped unemployment to climb as high as 7.8% – an extra 300,000 people – in response to coronavirus containment measures and for the economy to enter a recession due to a lack of demand.