Is this the end of rate cuts? What the RBA is doing instead

At today’s meeting, the Reserve Bank of Australia (RBA) kept the nation’s cash rate on hold at 0.25 per cent. This follows one rate cut at the start of March 2020, and a second out-of-cycle emergency rate cut in March 2020.

With the RBA planning to keep the cash rate on hold at this record low for the foreseeable future, it has turned to other measures to keep the Australian economy’s wheels turning while the nation grapples with the coronavirus pandemic.

What happened

Regarding the decision to keep the cash rate on hold, the RBA governor, Dr Philip Lowe, had this to say: 

"The Board is committed to doing what it can to support jobs, incomes and businesses as Australia deals with the coronavirus. The comprehensive policy package announced last month will also support the expected recovery. The Board will not increase the cash rate target until progress is being made towards full employment and it is confident that inflation will be sustainably within the 2–3 per cent target band."

What does the cash rate mean for interest rates?

Australia’s cash rate is one of many factors that banks and other authorised deposit-taking institutions (ADIs) use to set the interest rates on loans and deposits. Cuts to the cash rate often lead to lower interest rates, meaning borrowers pay less while depositors earn less. And when the cash rate increases, higher interest rates can make loans cost more and deposited savings earn more interest.

According to the RBA, there are no plans (for now) to cut the national cash rate to zero, or to move into negative interest rates as seen elsewhere around the world. A negative interest rate environment could lead to unusual situations where depositors pay money to the banks holding their savings, while borrowers could actually earn money on their loans.

With the RBA governor stating that the cash rate won’t increase until Australia hits employment and inflation targets, the current low interest rate environment for both loans and deposits may be the new normal, for the time being. Other economic factors could affect your interest rates, but the cash rate is unlikely to be one of them.

What is RBA is doing instead of rate cuts? 

Australia’s economy is potentially rolling towards recession due to a combination of economic factors, plus the coronavirus pandemic. This means the RBA has taken some alternative steps to help stimulate Australia’s economy. By allowing banks and the government to access money as cheaply as possible, the RBA can encourage them to keep providing support and relief to the Australian people.

• Want to know which banks are offering coronavirus relief packages? Find out which banks are freezing mortgages, offering relief on credit card repayments, and providing personal loan repayment relief.

A target yield of 0.25 per cent on 3-year Australian Government Bonds

This strategy involves the RBA purchasing three-year bonds in the secondary market (not directly from the government) to help reduce their average yield from around 0.45 per cent to 0.25 per cent.

While this may sound like Quantitative Easing or “printing money”, the RBA has stated that its goal is to provide support for low funding costs across the entire economy, rather than setting certain quantity targets.

Following today’s meeting, it was announced that that the RBA had reached its yield target, and that it would “do what is necessary” to achieve the 3-year yield target, which is expected to remain in place until progress is being made towards the goals for full employment and inflation. 

What does this mean for you?

The national cash rate is just one benchmark used by banks and other ADIs to set their interest rates – the yield on government bonds is another. By buying up these bonds to lower these yields, the RBA may be able to help banks to in turn lower the interest rates on other debt securities, including business loans and home loans.

“By lowering this important benchmark interest rate, we will add to the downward pressure on borrowing costs for financial institutions, households and businesses. We are prepared to transact in whatever quantities are necessary to achieve this objective.”

A term funding facility for the banking system with support for business credit, especially to small and medium-sized businesses

This facility that the RBA has set up allows banks and ADIs to borrow money from the RBA for three years, at a fixed interest rate of 0.25 per cent, which is “substantially below lenders' current funding costs.”

Banks and ADIs will be able to borrow an amount equivalent to 3 per cent of their existing outstanding credit to Australian businesses and households from the RBA. They can then borrow additional funds from the Reserve Bank if they provide large, medium and small businesses with extra access to credit this year. For every extra dollar lent to large business, lenders will have access to an additional dollar of funding from the RBA, and for every extra dollar of loans to small and medium-sized businesses, they will have access to an additional five dollars.

Following today’s RBA meeting, the first drawing are understood have been made from the term funding facility.

What does this mean for you?

The goal of this scheme is to help provide an incentive for lenders to support credit to businesses, especially small and medium-sized businesses. This can help keep small business owners and employees of small and larger businesses from losing their jobs and ending up in financial stress.

“Many small businesses are going to find the coming months very difficult as their sales dry up and they support their staff. Assisting small businesses through this period will help us make that bridge to the other side when the recovery takes place. If Australia has lost lots of otherwise viable businesses through this period, making that recovery will be harder and we will all pay the price for that. So, it is important that we address this.”

While the RBA may not touch the cash rate any time soon, it is instead providing different types of economic support to the government and banks. These, in turn, should be able to more easily provide support and relief to businesses and everyday Australians.

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