RBA makes rainy day rate cut

Photo: David Clarke on Unsplash
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THE Reserve Bank has responded to the coronavirus by slashing interest rates to a new record low of 0.25% and will facilitate $90 billion (4.5% of GDP) to banks on the proviso they increase lending to small and medium-sized businesses.

This is the first time the RBA has cut rates outside of its regular monthly meeting since 1997 and comes just a fortnight after reducing rates from 0.75% to 0.50%.

The RBA also signalled that it will not raise interest rates “for some years” until it is satisfied progress is being made towards full employment which is around 4.5%.

The latest Australian Bureau of Statistics show the current unemployment rate is sitting at 5.1%.

RBA governor Philip Lowe said the coronavirus has had a very major impact on the economy and the financial system.

“As the virus has spread, countries have restricted the movement of people across borders and have implemented social distancing measures, including restricting movements within countries and within cities. The result has been major disruptions to economic activity across the world. This is likely to remain the case for some time yet as efforts continue to contain the virus.

“At some point, the virus will be contained and the Australian economy will recover. In the interim, a priority for the Reserve Bank is to support jobs, incomes and businesses, so that when the health crisis recedes, the country is well placed to recover strongly,” Lowe said.

The RBA indicated that rates would remain low for some time.

Lowe said the board will not increase rates until progress is being made towards full employment and it is confident that inflation will be sustainably within the 2–3% target band.

“It is also consistent with the board’s expectation that the cash rate will remain at its current level for some years, but not forever,”

At the same time, the RBA has launched quantitative easing by purchasing government bonds in the secondary market.

Furthermore, it will provide a new funding facility for the banking system, to support credit to small and medium-sized businesses.

The RBA will provide at least a $90 billion, three-year, 0.25% fixed rate funding facility to banks which will be able to obtain initial funding of up to 3% of their existing outstanding credit, if they increase lending to small and medium-sized businesses.

“For every extra dollar lent to large business, lenders will have access to an additional dollar of funding from the Reserve Bank.

“For every extra dollar of loans to small and medium-sized businesses they will have access to an additional $5. These funds can be drawn upon up until the end of March next year. There is no extra borrowing allowance for additional housing loans,”

Lowe said these measures will complement the government’s program of support for the non-bank financial sector, small lenders and the securitisation market.

“The various elements of this package reinforce one another and will help to lower funding costs across the economy and support the provision of credit, especially to small and medium-sized businesses,” the governor reiterated.

Lowe also reassured the market that Australia is well placed to respond to the covid-19 pandemic.

“Australia’s financial system is resilient and well placed to deal with the effects of the coronavirus. The banking system is well capitalised and is in a strong liquidity position. Substantial financial buffers are available to be drawn down if required to support the economy. The Reserve Bank is working closely with the other financial regulators and the Australian Government to help ensure that Australia’s financial markets continue to operate effectively and that credit is available to households and businesses.” Lowe concluded.

Capital Economics’ senior economist Marcel Thieliant said the RBA may have to expand asset purchases further.

“The RBA has previously stated in November that it has “no appetite” to buy private sector assets. But Governor Lowe hinted that this could change if markets become dysfunctional. With the spread between US-dollar three-month Libor and overnight rates now the highest since the GFC, there’s a risk that funding costs of Australian banks rise further.

“As such, the Bank may eventually decide to buy bank bonds or mortgage-backed securities. And while the RBA has previously ruled out launching negative interest rates, that assessment could change as underlying inflation falls further below target and bank lending rates remain high.” Thieliant said.

AMP Capital chief economist Shane Oliver said the extraordinary measures by the RBA won’t stop the virus, the hit to the economy from the shutdowns and the associated recession, but they should help minimise the fall out in terms of jobs, incomes and businesses such that we can recover more quickly once the virus comes under control.

“Its likely though that more action will be needed and until we get clear evidence that the virus is coming under control its too early to say that share markets and the Australian dollar have bottomed.” Oliver said.