What's next after rate cuts?

By Gerv Tacadena | 23 Mar 2020

The Reserve Bank of Australia has lowered the cash rate for the second time in the month to a historic-low of 0.25% — does it still have further ammunition to boost the economy in case the two consecutive cuts are not enough? 

The central bank has taken an emergency route in response to growing global and local economic concerns due to the COVID-19 outbreak. Tim Lawless, head of research at CoreLogic, said the rate will remain at its current level until labour markets are moving towards full employment and inflation is tracking to be within the target range of 2%-3%. 

"The announcement from the RBA was driven by economic necessity. It is aimed at keeping the Australian dollar low, ensuring borrowing costs are stimulatory for businesses and households, and helping to stabilise and capitalise credit markets. However, it is the same economic weakness and uncertainty that is likely to keep consumer spirits low," he said. 

In a speech late last year, the RBA Governor Philip Lowe dismissed the possibility of a negative-rate scenario, saying 0.25% is the effective lower bound. The negative rate policy is common in European countries, including Denmark, Sweden and Switzerland. Outside of the European region, only Japan has tried to go below zero rates. 

"It has become increasingly apparent that negative rates create strains in parts of the banking system that can impair the ability of some banks to provide credit. Negative interest rates also create problems for pension funds that need to fund long-term liabilities," Lowe said.  

In a think piece in The Conversation, Isaac Gross, a lecturer at Monash University, said the RBA initially hinted of adopting a quantitative easing strategy. However, as market conditions continue to go against the bank's favour, it started to shift its focus on a strategy called yield curve control. 

"Yield curve control would involve the bank announcing targets for long-term yields on government debt instruments such as the five or 10-year bond, and then intervening in debt markets to buy until the target rates are achieved," Gross said. 

While quantitative easing and yield curve control use the same basic tactic of creating money to buy bonds, the latter is targeted to achieving a certain level for interest rates.  

Gross said yield curve control works similarly to a conventional monetary policy, unlike quantitative easing which is aimed to boost the stock money in the economy.  

"Previous work by the bank has calculated that adjusting the 10-year nominal interest rate is 40 times as effective at lowering firms' cost of capital as a similarly sized cut in the cash rate. This leaves the bank with plenty of ammunition after short-term rates hit the effective lower bound and can no longer be adjusted," he said.  

Furthermore, this strategy would require fewer bonds to be held by the central bank. This will keep government debt down and help maintain stability in the financial markets.  

However, Gross said yield curve control might not be sufficient on its own.  

"The interest rate on 10-year bonds are already low — at about 1% — and so even there, there isn't much room to cut," Gross said. "Ultimately, if it needs to do more than get bond rates to near zero per cent, it'll need to come up with something new, but yield curve control will buy it time." 

Top Suburbs : toowong , mt colah , the basin , chermside , west wodonga

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