Australia’s central bank promises it has not run out of firepower to support the coronavirus-hit economy after cutting interest rates to record lows, ensuring the cost of finance remains low for years to come for home buyers and all borrowers.
The Reserve Bank of Australia cut the official cash rate and other key policy rates to 0.1% on Tuesday in what will be the last rate move for at least three years and likely longer.
The RBA is now relying on unconventional monetary policy to help support the economy through a bumpy and drawn-out recovery from the coronavirus pandemic, the biggest economic shock in more than 100 years.
Unveiling a package of measures to support the Australian economy, RBA governor Philip Lowe said the bank’s major priority was to do what it could to get people back into jobs.
“The Board views addressing the high rate of unemployment as a national priority and it wants to do what it can to support job creation,” Mr Lowe said.
“I’m concerned that we could go a few years with many tens perhaps hundreds of thousands of people not having the employment that they should have. We know that that’s destructive for the economy but it’s also very damaging in people’s lives and for their prospects.”
Mr Lowe said the pandemic had inflicted significant damage on the economy and Australia was in a severe recession, although it was not as bad as was expected earlier.
Realestate.com.au executive manager of economic research Cameron Kusher said the RBA Board clearly felt the need to take action sooner rather than later, given the recession was severe and it would take some time for the economy to recover.
Like some other economists, Mr Kusher said the decision could also be interpreted as the RBA having decided it needed to step in because the federal government’s fiscal stimulus measures were not enough.
“I think also you could read it that fiscal policy hasn’t been big enough and supportive enough that the RBA has had to step in with more monetary stimulus, even though they don’t have many bullets left in the chamber,” Mr Kusher said.
Mr Lowe maintained the RBA’s move was not a judgement on the government’s fiscal policy.
“I think the government’s on the right track and we want to be supportive of their efforts to get the unemployment rate down.”
What did the RBA do?
While the RBA Board cut the cash rate by 15 basis points to 0.1% after its monthly meeting, it also went much further than usual.
“In poker terms, the Reserve Bank Board has gone ‘all in’,” CommSec chief economist Craig James said.
“Monetary stimulus is now at the maximum setting with the RBA hoping that the new measures will provide fresh momentum to the fledgling economic recovery – with the country now completely free of virus lockdowns.”
The RBA’s package of measures involved:
- A cut in the cash rate target, the interest rate on the term funding facility (the rate at which the RBA provides low-cost funding to the banks for three years) and the three-year bond yield target, which were all cut to 0.1% from 0.25%;
- A reduction in the interest rate on exchange settlement balances to zero, from 10 basis points;
- The introduction of a program of government bond purchases, involving the RBA buying $100 billion of government bonds over the next six months.
Mr Lowe said the package would lower the whole structure of interest rates in Australia.
He said the RBA was lowering the cost of finance for everybody, not only the government.
“I should point out that our actions are also lowering the cost of finance for all other borrowers in Australia, whether they are a household buying a home or a business wanting to expand.”
What is the outlook for interest rates?
Official interest rates will not be going up for years, nor does the RBA plan to take them into negative territory.
Mr Lowe said the RBA Board did not expect to increase the cash rate for at least three years.
He said the cash rate would not be lifted until actual inflation was sustainably within the RBA’s 2-3% target range. For that to happen, wage growth would need to be materially higher than it is currently, which required significant gains in employment and a return to a tight labour market.
Mr Kusher said those comments from the RBA were much more definitive than in the past.
“While they’ve said that it’s not going to be increased for at least three years, in reality that could be five years or longer,” he said.
AMP Capital chief economist Dr Shane Oliver said he suspected the RBA would not increase rates until 2024 at the earliest.
“This basically means that borrowers can be confident that the borrowing costs will stay down for several years to come,” he said.
Mr Lowe reiterated that the Board continued to view a negative policy rate in Australia as extraordinarily unlikely, although he would not completely rule it out if major central banks around the world all went negative.
“We have essentially no appetite to go into negative territory,” Mr Lowe said.
“The judgement is that that would not be helpful.”
Mr Lowe said the RBA had done as much as it could on interest rates and the focus now was on the quantity of asset purchases.
Has the RBA used all its firepower?
Mr Lowe was adamant the Reserve Bank was not out of firepower.
“We have additional monetary policy options and we are prepared to use them if the circumstances require,” he said.
“If we need to do more, we can and we will.”
The measures mean the RBA has moved from conventional monetary policy – changing its policy interest rate – to the unconventional or quantitative easing.
“These bond purchases mean that the RBA is now conducting quantitative easing, or QE, similar to that of many other central banks,” Mr Lowe said.
“Monetary policy is now about more than just short-term interest rates – we have returned to a world in which quantities matter too,” he added.
Central banks use unconventional monetary policy tools such as QE to stimulate the economy when interest rates are already at near-zero levels.
Dr Oliver said central banks had shown since the global financial crisis that there was much they could do outside of interest rate cuts.
“The RBA has now hit the bottom of the barrel in terms of conventional interest rate cuts, but as other major central banks have shown since the GFC, there is still plenty it can do in terms of ongoing quantitative easing.”
Will lenders pass on the rate cuts?
Mr Lowe said he expected, and hoped, the interest rate reductions get passed through to all borrowers.
But he noted that over the past year, many banks had left their standard variable rates unchanged and the cuts were being passed on through borrowers renegotiating with their bank at a lower rate or in some cases switching lenders.
“I think the best outcome would be for standard variable rates to be lowered but if that doesn’t occur, I’m confident that there will be pass-through occurring through people renegotiating and switching,” Mr Lowe said.
The RBA governor encouraged borrowers to ask their bank for a better deal. “Ask them and if they don’t give it to you, switch to a bank that will.”
As major lenders started to act on Wednesday, the Commonwealth Bank of Australia, Westpac, National Australia Bank and ANZ cut fixed home loan rates and reduced rates on a number of business loans by varying amounts. But they left their variable home loan rates untouched.
Richard Burton, the acting chief executive of Westpac’s consumer division, said the bank recognised it had been a tough time for many Australian households.
“However, we are in an extraordinary period with the official cash rate at a historical low and unconventional monetary policy measures in place,” Mr Burton said.
“It is critical we carefully manage interest rate changes, while continuing to do our part in supporting customers and the economy.”
Dr Oliver said passing on the full 15 basis points rate reduction would put some downward pressure on bank profit margins as a significant chunk of deposits were already at or near zero rates.
But he believed the banks would pass on most of the official rate cuts, under pressure from the RBA and the government.
“If they don’t they will face a public backlash,” he added.
“One way around it is to cut their standard variable rates by say 0.1% and then cut their fixed rates by say 0.2%, as the latter only benefits new customers but gains publicity brownie points (made possible by lower funding costs on the back of lower bond yields due to RBA bond buying).”
Smartline Mortgage Advisers CEO Sam Boer said the RBA was supporting banks and other lenders through its term funding facility, a source of low-cost funding which essentially helped lenders afford to cut their funding rates.
“The RBA’s decision to cut the interest rate on new drawings under the TFF to 0.1% will hopefully see more lenders pass on more of the latest rate cut to their consumers,” he said.
“It will also facilitate an ongoing supply of credit to the economy and help to generate more business investment – things the economy desperately needs.”
What do lower rates mean for home owners and buyers?
Lower interest rates generally mean lower mortgage repayments and increased borrowing power.
Comparison site RateCity.com.au said the average mortgage holder with a $400,000 loan could see their minimum monthly mortgage repayments fall by $33 per month – almost $400 a year – if their lender passes on the rate cut in full.
Real Estate Institute of Australia president Adrian Kelly said the interest rate cut would add to buyer interest and, if passed on in full, would improve housing affordability.
“The RBA is obviously throwing the kitchen sink at this pandemic and (the) decision will definitely benefit home buyers,” Mr Kelly said.
Mr Boer expected there would be a further rise in refinancing activity as borrowers try to reduce the cost of their loans, while others may look at fixing their rates.
“The bottom line is that the RBA is making sure cheap term funding is available to the banks so we can expect to see even lower fixed rates available on one to three year terms,” Mr Boer said.
“Certainly, when fixed rates start to drop below the standard variable rates, it’s attractive for borrowers to lock in those savings in case rates start to rise again.”
What is the impact on the housing market?
Mr Kusher said lower rates, assuming they are passed on to mortgage holders, would increase housing demand and push prices higher.
CBA’s head of Australian Economics Gareth Aird said any further reduction in mortgage rates will put further upward pressure on dwelling prices.
“Indeed, dwelling prices could accelerate quite quickly as the economic recovery continues to gain traction.”
Mr Lowe said in the past he would have been worried that lower interest rates would encourage people to borrow more and push up housing prices, but the dynamics of the housing market had changed.
“Population growth is slower, investors are seeing rents fall at the fastest rate we’ve ever seen, the vacancy rate is quite high,” Mr Lowe said.
“At the moment I’m not particularly worried about causing excesses in the housing market, although I’d have to keep that under review.”
Mr Boer said the rate cut would help some struggling mortgage holders to keep their homes, as lower repayments should reduce the likelihood of mortgage defaults.
“This in turn should reduce the number of distressed property sales, which devalues property markets.”
Mr Boer said lower rates would also help businesses by reducing expenditure, which should contribute to job creation.
“Since a solid income is generally essential for making mortgage repayments, the creation of jobs will filter through the economy and help to keep the property market afloat.”