RBA Rate cut to 0.25 Per Cent

Interest Rate Update – Emergency Meeting March 2020

Updated March 25th 2020

RBA cuts rates to lowest level, introduces ‘unconventional’ measures: what does this mean?

At an emergency board meeting on today the Reserve Bank cut the official interest rate to 0.25 per cent, which is the lowest level the cash rate can go. The cash rate cut was just one part of a “comprehensive package to support the Australian economy through this challenging period”.

The RBA also announced it is implementing “yield curve control” and “forward guidance” to provide further stimulus to the economy. The RBA will target a three-year bond rate of 0.25 per cent (yield curve control) and “will not increase the cash rate target until progress is being made towards full employment and it is confident that inflation will be sustainable within the 2–3 per cent target band” (forward guidance).

The RBA will also set up a funding facility for the banking system, with a focus on credit supply to small and medium-sized businesses and increase the interest rate on banks’ deposits held with the RBA.

These measures will take effect immediately.

Will the RBA’s actions be enough to stop a recession?

The RBA’s actions in isolation won’t be enough to stop a recession. The COVID-19 virus could cause the biggest economic downturn since the global financial crisis, and potentially since the Great Depression.

Large parts of the economy need to shut down to slow the spread of the virus and save lives. Businesses will close, jobs will be lost and people will work fewer hours. In 1991, it was a recession we didn’t need to have. Now, unfortunately, this is a recession we have to have.

The government will need to soften the economic impact by supporting households and businesses through the economic slump. This could be through loans or funding to businesses to keep staff and cash payments or tax refunds to households. The government will need to spend much more, maybe five times more, than the $17.6 billion stimulus package announced last week. The government should be shifting from talking about stimulus to talking about support.

What will the rate cut and yield curve control mean for the property market?

The RBA’s actions will provide some support to the property market in the short term. However, the impact of the COVID-19 virus will overwhelm the RBA’s stimulus. There is likely to be a significant drop-off in property sales over the next few weeks and over the Easter period due to social distancing.

The extent and length of the property market downturn will depend on how many businesses close and how many people lose jobs or have their hours cut.

If people can’t afford to pay off their mortgage then forced property sales will push prices down, though many people are currently ahead on their mortgage repayments.

People will also become more wary of taking out a loan to purchase a home, which will weigh on demand. Significant government support will limit the impact on jobs and businesses and will support the property market.

Once the economy recovers, we are likely to see a rebound in property sales and price growth.

There will be a catch-up in transactions from those who were unable to purchase a property during the social distancing period. Very low interest rates, and the expectation of very low rates for an extended period, will also push prices up.

What are the downsides to the RBA’s “unconventional” actions?

There could be some downsides to the RBA’s unconventional monetary policy measures.

If some “zombie firms” solely survive due to low interest rates, this could drag on productivity and long-term economic growth.

Lower interest rates will increase wealth inequality. In property and equity markets, there is a larger proportion of ownership held among higher socioeconomic households. When the value of these assets increase, this will widen wealth inequality within Australia.. Lower rates via yield curve control may will add to already high demand

But this rise in inequality is a necessary trade off to save jobs and businesses and help Australia avoid a large slump. Overall living standards will be higher with low rates, but at a cost of higher wealth inequality.

What else can the RBA do to support the economy through the downturn?

The RBA has intervened in financial markets in recent days to ensure they operate smoothly.

Ensuring Australia’s financial system remain resilient during this downturn is another crucial part of the RBA’s job.

In combination with the banking regulator, APRA, the RBA has worked to make sure banks can withstand an economic slowdown. In a worst-case scenario, the government and the RBA may need to step in to support financial institutions if large numbers of households and businesses can’t meet loan repayments.