The RBA could take Australia into uncharted territory with a 0% interest rate. This is what it would mean
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It’s happening. After years of interest rates being on hold, the Reserve Bank of Australia (RBA) has thrown caution to the wind and looks to be cutting the cash rate towards 0%.
The man ultimately responsible for it is RBA Governor Philip Lowe. In his most recent cut, Lowe confirmed for the first time that the top priority of the RBA is achieving full employment — considered an unemployment level of 4.5%.
“[We are] prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time,” Lowe said.
The problem with that is further interest rate cuts are pretty unlikely to get Australia there with unemployment currently sitting at 5.3%. While cuts may have helped support strong job growth, unemployment has just kept ticking up despite them.
If the RBA goes on cutting, then, to find full employment, it is quite possible it will hit 0% and still be looking. Indeed, Lowe has flagged that very possibility before.
“It’s possible we end up at the zero lower bound although I think it’s unlikely,” Lowe told the Federal government back in August.
“We are prepared to do unconventional things if the circumstances warranted it,” he said.
“I hope we can avoid that.”
Fast-forward a couple of months, though, and that last sentiment looks like wishful thinking. Tuesday’s rate cut brought the official cash rate in Australia to 0.75%.
So what happens if it keeps cutting?
The official interest rate is the one the RBA charges your bank to borrow money which it then loans to you.
As it cuts the rate, it effectively makes money cheaper, with the banks expected — but not required — to pass on the changes to you, their customers. This affects you in two major ways.
Firstly, the lower the interest rate goes, the less interest you earn on your savings. Before the last cut, all the big four banks were already paying little interest on deposits at all. As more cuts are made, savings will struggle to grow. In fact, after you consider inflation, savings are far more likely to actually shrink in real terms as the cost of living rises.
If a 0% interest rate is implemented, the bank is unlikely to pay you at all for having your money with them, leaving you with less incentive to save.
The other big impact is on mortgages. As rates go lower, banks tend to slash their own rates. However as the official rate nears zero it becomes less likely those cuts are passed on, even partially because banks’ profit margins start to suffer. That was evident in October’s cut, with the big four only passing on around half of the cut.
As 0% draws closer, it’s unlikely Australians will even receive that. Instead, interest rates are likely to plateau sooner rather than later.
There’s serious concern about where the Australian economy is headed and for proof, you need not look any further than the falling rate, currently at 0.75%.
At the start of June, it was twice that — 1.5%. In fact, the RBA’s June cut was the central bank’s first in almost three years and gave Australia its lowest cash rate in history.
That record didn’t last long. It’s been slashed twice more since, with the October cut bringing it below 1% for the first time ever. The consensus is now that the RBA will cut again, either at its November meeting or, more likely, in February to 0.5%.
While Lowe has suggested negative interest rates could be implemented, it remains more probable that the RBA will stop before that.
If it did cut into negative territory, things start to go a little topsy turvy.
Lowe has signalled it doesn’t want to cut, but without the government increasing its spending it has no choice but to stimulate the economy.
“Quite simply, the economy requires more stimulus. Ideally, the federal government would rise to the occasion. Fiscal policy can be better targeted in the current environment and could stimulate the economy without pushing house prices and debt higher,” Indeed Asia-Pacific economist Callam Pickering said in a note issued to Business Insider Australia.
“Unfortunately, a budget surplus has been placed ahead of jobs and growth. The RBA will have to make do with their imperfect policy tool.”
Cutting rates is an “imperfect” tool because by making borrowing cheaper, it increases the amount of money that flows into the real estate market. The RBA has warned repeatedly that it fears creating a housing bubble by doing so.
If rates go to 0% and the economy is still faltering, then the RBA could choose to use another unconventional tool known as quantitative easing, or QE.
Essentially, it involves the RBA buying government bonds and increasing the amount of money in circulation. Despite being used overseas, in the US, Japan, and Europe, the jury is still out on just how effective it is in helping the economy grow.
Lowe has indicated he would be reluctant to use it but would consider doing so if required.
“Bank officials are reluctant to discuss quantitative easing but it becomes a real possibility the closer we come to a cash rate of 0%,” Pickering said. “In the absence of meaningful fiscal stimulus, quantitative easing may soon be inevitable.”
In other words, unless the economy suddenly improves, Lowe might not have a choice.