• The RBA has indicated a preference to keep rates on hold, but CBA reckons the market has other ideas
  • In the context of global central bank policy, the RBA’s stance could now be considered comparatively ‘hawkish’, CBA said

In the post-COVID economy, emergency monetary policy settings adopted by central banks globally have brought the (once unheard of) idea of negative interest rates into mainstream debate.

Domestically, RBA governor Philip Lowe told parliament as recently as last month that negative rates were ‘extraordinarily unlikely’ in Australia.

And the RBA has been pretty direct in its communication that 0.25 per cent (the current rate) represents the lower bound of interest rate settings.

But according to CBA rates strategists Martin Whetton and Philip Brown, the market “doesn’t seem to agree with the RBA on this point”.


Market mechanics

In a research note on Thursday, the analysts pointed to recent activity in Australia’s interbank (IB) lending market – the rate at which banks provide short-term loans to each other.

The IB rate is partly a function of the official cash rate, and back in August markets were priced for it to hold at around 0.13 per cent through to December 2021.

But on Thursday September 17, markets were pricing for it to fall below 0.10 per cent by March next year.

On the face of it that looks like a tiny difference, but CBA pointed out that a fall below 0.10 per cent is notable.

There is “absolutely no reason” for any bank to lend at less than 0.10 per cent, because that’s the rate they can get anytime by parking cash with the RBA.

What it implies is that markets are pricing for the RBA to lower the cash rate further – either closer to zero or into negative territory, CBA said.

Market pricing for the future direction of interest rates has also moved “lower for longer” over the past month, the analysts said.

Across the Tasman, New Zealand cash rates (also sitting at 0.25 per cent) are now priced to fall well into negative territory next year.

Meanwhile in the UK, the Bank of England opened the door to negative rates in its policy announcement on Thursday night, while the US Fed has put markets on notice that it expects to keep interest rates at zero until 2023.


The art of communication

Taking all that into account, the RBA’s “strong insistence on not allowing negative yields sticks out as an unusual hawkish element, among a sea of dovish communications from the bank”, Whetton and Brown said.

In that context, even a “mere hint” from the RBA that lower rate settings may be considered in the future would materially reduce government bond rates, they added.

The pair also flagged a speech by deputy RBA governor Guy Debelle this Tuesday, as the central bank’s next opportunity to dabble in the dark arts of subtle communication.

Something along the lines of – we’re not going to lower interest rates, but we’re not not going to do it either.

A “few well-chosen words” would be “an awful lot cheaper than the tens of billions the RBA would have to spend” to further intervene in the bond market, CBA said.

Currently, the economics team at UBS assigns a “50/50 probability” the RBA will ramp things up and commence “proper QE (quantitative easing)”.

In UBS’ view, that would entail buying five-year and 10-year government bonds to “lower yields and put downward pressure on the AUD”.

The analysts see “a lower probability of a rate cut, but we can’t rule it out”.


Negative rates on the table

The prospect of negative interest rates was also raised in August by leading Australian economist Bill Evans, who extolled some benefits of further cuts in a research note for Westpac.

Among the positives was that lower rates would help put downward pressure on the Aussie dollar, which would assist Australia’s recovery as a smaller, trade-focused nation.

(Amid broad upward pressure, the Aussie recently climbed above US74c – a two year high).

In additional comments last week, Evans again flagged the AUD but also said the “dominant purpose” of lower rates would be to “further lower fixed-rate private sector borrowing costs”.

For its part, the RBA did make a noteworthy tweak about its thoughts on the currency in the minutes to its September meeting (released last Tuesday).

In August, the bank said the AUD was “broadly in line with its fundamental determinants”, such as stronger commodity prices and rate differentials.

It repeated the same statement this week, but added that “a lower exchange rate would provide more assistance to the Australian economy in its recovery”.

Whatever the outcome – in both rates pricing and currency markets – further communications from the central bank are likely to be well worth watching in the months ahead.