March 21, 2020 08:54:11
Australia’s main interest rate was cut to 0.25 per cent this week, the lowest in history.
The unprecedented decision by the Reserve Bank was part of an emergency package to prevent the financial system melting down as large parts of the economy are boarded up to stop the coronavirus spreading.
Does it mean Australia’s interest rate may soon hit 0 per cent? Is there a possibility we could see negative interest rates?
Well, according to the RBA, it’s already offering zero rates anyway, for practical purposes. And it’s extremely unlikely Australia will see negative rates.
What happens in a world of negative interest rates?
Negative interest rates are a strange phenomenon.
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They’re intended to incentivise banks to lend more freely during periods of extreme economic uncertainty or financial market dislocation.
But they have economic consequences, in a topsy-turvy way.
Theoretically, when rates turn negative, depositors can be charged a storage fee to keep their savings in a bank rather than receiving interest, and borrowers can be credited with interest rather than being charged interest for taking out a loan.
Last year, the Jyske Bank in Denmark made headlines by launching the world’s first negative interest mortgage, offering borrowers a 10-year deal at -0.5 per cent.
It said when its borrowers made their monthly repayments, their debt would be reduced by more than they paid on their mortgage each month (although after fees, the effective interest rate was just in positive territory).
The bizarre arrangement was possible because the interest rates in Europe’s money markets dropped to extraordinary levels and Jyske Bank could borrow from institutional investors at a negative rate and pass it on to customers.
However, Jyske’s savers faced a zero per cent interest rate when they deposited money in a savings account.
Negative interest rates are far more common in money markets
It’s extremely rare for consumer products like home loans and savings accounts to face negative interest rates.
According to Canstar’s database, in the last two decades there have never been negative interest rates on such products in Australia.
They’re far more likely to occur in money markets where central banks lend to retail banks and institutional investors.
Last year, the entire Swiss Government nominal bond yield curve [ie bond interest rate curve] was in negative territory and the Swiss government could borrow for 30 years at an interest rate of -0.2 per cent.
Most of the German, Dutch, French and Japanese yield curves were in negative territory too.
It’s not just governments that can borrow at negative rates. In recent times, corporations including Coca-Cola, Orange and Siemens have issued unsecured bonds with zero coupons and negative yields.
In October last year, there were $US14 trillion ($23.9 trillion) of bonds trading at negative yields around the world and around a quarter of all government bonds globally were trading at negative yields.
Why are we talking about negative interest rates in Australia?
The conversation about negative interest rates began in earnest last year when the RBA kicked off its recent rate-cutting cycle.
In mid-2019, faced with a weakening economy — before the summer’s bushfires and coronavirus pandemic — the RBA cut rates from 1.5 per cent to 1 per cent over two successive months.
Then, in August, RBA governor Philip Lowe told Parliament all options were on the table to stimulate the economy, potentially even cutting interest rates to zero.
In October, the RBA cut rates again to 0.75 per cent.
It fuelled speculation that Australia was heading towards zero or negative rates, and the speculation became too large for the central bank to ignore.
So, a few weeks later, in late October, Dr Lowe delivered a speech in Canberra to say it was “extraordinarily unlikely that we will see negative interest rates in Australia”.
In the Q&A afterwards, he warned negative interest rates were having a “pernicious” effect on the functioning of the financial system and pension system in Europe, and Australian businesses should stop waiting for negative interest rates and start investing.
In November, he then gave another speech explaining why he thought negative rates were a bad idea for Australia.
He said negative interest rates were largely a European phenomenon and the evidence suggested the experiment had not been a success.
“While negative rates have put downward pressure on exchange rates and long-term bond yields, they have come with other effects too,” Dr Lowe said.
“It has become increasingly apparent that negative rates create strains in parts of the banking system that can impair the ability of some banks to provide credit.
“Negative interest rates also create problems for pension funds that need to fund long-term liabilities.
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“In addition, there is evidence that they can encourage households to save more and spend less, especially when people are concerned about the possibility of lower income in retirement.
“A move to negative interest rates can also damage confidence in the general economic outlook and make people more cautious.”
He argued if Australia’s official cash rate was reduced to 0.25 per cent it would effectively be a zero per cent interest rate anyway.
Why? Because the rate the RBA would pay on bank reserves would be less than 0.25 per cent, and in most other countries you’d call that zero interest rates.
He was adamant Australia’s main interest rate would not be lowered below 0.25 per cent.
“Our appetite, as you could probably tell from my remarks, for a zero cash rate and hence, negative interest rates on central bank reserves, is very, very limited and I don’t think we’re going to go there,” Dr Lowe said.
Fast forward a few months — to March 2020 — and the RBA has now had to cut rates to 0.25 per cent anyway, in response to the summer’s catastrophic bushfires and the outbreak of the coronavirus locally.
But Dr Lowe reiterated his point this week that he would not cut rates below 0.25 per cent.
March 21, 2020 06:11:26