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RBA rate cuts and stimulus

Written and accurate as at: Nov 11, 2020 Current Stats & Facts

On Melbourne Cup day last week, the RBA announced its largest and broadest ranging monetary stimulus program ever, reducing the overnight cash rate, as well as the yield on the 3-year Australian Government bond and The Term Funding Facility (TFF) rate (i.e., the rate at which the RBA provides cheap funding to the banks for three years) to 0.1%. This takes the cash rate to a new record low, aligning Australia’s official interest rate with comparable countries around zero.

The Reserve Bank also announced a ramped-up Quantitative Easing program where they will use newly printed money to fund $100 billion of government bond purchases over approximately 6 months, focusing on bonds with maturities of around 5 to 10 years.

This came as the RBA remains concerned about the economic outlook in the medium term specifically regarding unemployment and not meeting their inflation targets. The RBA stated, "Given the outlook for both employment and inflation, monetary and fiscal support will be required for some time... the Board is not expecting to increase the cash rate for at least three years." 

What does this mean?

The impact of decreasing interest rates (lending, deposit and investment rates), can encourage consumers and businesses to borrow more and save less. This helps the economy to grow through a boost to retail and capital spending (including new home demand)  This will ultimately lead to declining unemployment and asset price inflation (i.e. higher equity markets and property prices) thereby achieving more progress towards the inflation target. 

Through Quantitative Easing, more cash is injected into the economy, increasing the supply of Australian dollars (liquidity). This will make it easier for the Government to finance its $214bn budget deficit as the RBA will be indirectly buying the equivalent of nearly half the value of bonds to be issued to finance it. 

Further rate cuts and an increase in the supply of Australian dollars due to expanded quantitative easing, will help keep the Australian dollar lower to help our exporters and companies competing with imports to help our economic recovery. If global recovery continues and pushes up commodity prices, the dollar will likely rise again.

As ultra-low interest rates will likely be with us for several more years, bank deposit rates will remain unattractive. Hence, it’s important for investors traditionally investing in bank deposits to assess alternative options. Investors will need to consider whether getting a decent income from their investment or stability in the capital value of that investment is more important to them.

Conclusion

While the economic boost from monetary policy will be small compared to that provided by the recent Budget stimulus, the RBA believes these measures will help support the economy by lowering borrowing costs, contributing to a lower exchange rate than otherwise, supporting asset prices and reducing unemployment.

This extended period of low-interest rates will help in reducing unemployment, supporting sustainable growth and achieve progress towards the inflation target.

 

 

 

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