Will negative interest rates come to Australia?

Welcome to Finance and Fury, the Say What Wednesday edition. This week’s question comes from Cameron.

“Do you think that negative interest rates will come to Australia?”

Today – look at what would trigger a negative interest rate policy (NIRP) – exchange rates, economic conditions like employment or inflation, then debt levels – at the household level

1. The cash rate was cut to a record-low 0.25% in March and has remained there since.
2. The Reserve Bank board insists it will not increase the cash rate until progress is being made towards full employment and it is confident that inflation will be sustainably within the two per cent to three per cent target band.
3. Negative interest rates are a pretty dramatic financial measure to take –
   1. But lots of drastic measures have been taken recently – those by governments and central banks to help boost the Australian economy
   2. In a quarterly statement on monetary policy the RBA says negative interest rates would be an “extraordinary unlikely” course of action
   3. At this stage – the RBA has again signalled it won’t be moving to negative interest rates – so for now they are ruling it out – but will they still have this same position moving into the future

Current look at the outlook for rates in the short term

1. ASX 30-day interbank cash rate – future implied yield curve – The indicatorcalculates a percentage probability of an RBA interest rate change based on the market determined prices in the ASX 30 Day Interbank Cash Rate Futures – form of financial betting on interest rate movements
   1. 25% is the current – RBA decrease would go to 0%
   2. Up until Feb 2022 – about 50/50 is what the market expects –
   3. In the short term – over the next week – no change – 36% – decrease to 0% is 64%
   4. So the market is expecting a decline in the short term- not 100% accurate – it is a best guess based around all the current information – but this information can change
   5. Next RBA meeting is the 6^th of October – may be a chance that the rates are cut then depending on
2. But the indicators don’t point to anything negative at this stage – so what are the probabilities of it going negative

Exchange rates

4. The Reserve Bank concedes negative interest rates would be a stimulatory benefit by putting downward pressure on the Australian dollar
   1. Covered the exchange rate basics over the last few FF episodes –
   2. The RBA believes the Australian dollar is “broadly in line with its fundamentals”
      1. This means that they think that there is no need to intervene through moving the interest rates to help the exchange rates
   3. However – if the AUD becomes above what they consider to be fair value – they might be more comfortable to move interest rates down to help reduce the exchange rates
   4. So at this stage – Under the current circumstances – the current RBA policy approach is probably not going to be reconsidered – so the exchange rate isn’t going to be what creates a situation for a NIRP

Economic indicators – inflation and employment

5. Employment – It forecasts – in what the RBA calls its baseline case – the unemployment rate will hit a peak of 10 per cent in December, rather than the nine per cent rate predicted three months ago.
   1. Stimulus measures at this stage has kept the unemployment figures lower than originally anticipated – the job keeper payments
   2. The RBA then expects a gradual easing to seven per cent by December 2022
   3. Employment is one contributor to inflation through – and other factors like GDP
6. GDP growth – RBA also expects economic growth will contract by 6% this year
   1. Also expects that the recovery will be slower than previously thought – so GDP growth is slightly lower than the forecasts
   2. Expect that Australia’s economic growth will take several years to return to the trend path expected before the economic downturn
   3. However – this was before the situation in Victoria with the lockdowns – this creates a situation of further reduced growth in the September quarter delay the recovery beyond what was originally forecasted
   4. The government expects as much as well – Finance Minister Mathias Cormann said the situation in Victoria was clearly “having a very bad impact on the economy nationally”.
   5. Outside of Government or RBA forecasts – other economic figures showed the pace of contraction in Australia’s services sector and business was slowing in July – but that was before the situation in Victoria emerged – which will lower the forecasts further
      12. Looking at other indicators – The Australian Industry Group’s Australian performance of services index rose 12.5 points in July
      13. This index with a number of above 50 shows economy expanding – currently sitting at an index of 44.0 points – shows that contraction is at play

• These was some evidence the national economy was stabilising before the Victorian shutdown – but with this occurring – it may slow down the pace of recovery –

1. If it does – and employment doesn’t return by as much – RBA may drop rates – but this alone wouldn’t be justification to go into the negative territory

7. Inflation – The RBA has released its latest forecasts – expects underlying rate of inflation will remain below 2% until at least December 2022 – so for more than 2 years
   1. Current inflation – gone into the slightly negative territory
   2. Inflation over the past 10 years – has been below the band range – a little below 2% p.a.
   3. Inflation is probably going to be the biggest thing that the RBA is looking at for interest rate policy
   4. Petrified of the deflation materialising

Looking at one of the other biggest indicators IMO for negative interest rates – Household debt levels

1. Looking at the countries with negative interest rates at the moment have two major things in common – 1 and 3 on the list of Household debt to GDP levels – as well as persistently low levels of inflation
   1. Switzerland and Denmark – Household Debt to GDP – 132% and 112% respectively – but Australia is number 2 on the list at 120%
   2. The next down is Norway and Canada with 105% and 102% respectively
   3. Switzerland has a negative cash rate of negative 0.75% – GDP growth forecasts of 1.5% to 2%
   4. Denmark – current cash rate is negative 0.6%
2. In Denmark – the banks have launched the world’s first negative interest rate mortgage
   1. This means they are handing out loans to homeowners where the charge is minus 5%a year Negative interest rates effectively mean that a bank pays a borrower to take money off their hands, so they pay back less than they have been loaned
   2. There is one other country with negative rates – at negative 0.1% – That is Japan – they have relatively low household debt levels though – about 59% – Their level of Government debt is at 237%
3. Debt levels – with negative rates it helps to pay it off
   1. However – the end result of getting inflation is the most important factor here –
   2. Looking at countries with negative interest rates – Household debt to GDP is typically high and inflation is very low – but this has to be so for some time for the RBA or central banks to take the extreme measures
4. Would expect that Australia may see negative interest rates – if out household debt to GDP stays at an elevated rate – and if our inflation rate stays below the 1% level for some time
   1. Would have to be a number of years – 2-3more as an estimate for negative rates
5. When looking at the fixed loan rates for the major banks – like the big 4 – are one pointing factor that an interest rate drop is likely –
6. The household debt to GDP is another – basket of countries with highest household debt
   1. Even though it isn’t a solution – it is seen as the tool that monetary officials have at their disposal to try and get inflation to materialise –
   2. This is done through their Desire to help boost GDP growth at the same time through reducing the cash people spend on mortgage – and instead can spend more in the economy
   3. More money can spend – the more GDP growth should return and the more inflation should come back – but this ignores the supply side to the equation – another story for another day
7. With increasing levels of debt on new loans due to lowering interest rates – even though interest rates are low – means that there is additional household cashflow going to pay back debt –
   1. So less towards economy – less inflation based around the measurements
8. Comparing other countries with negative rates –
   1. Inflation in Denmark – been between1-0% since 2014 – been low for some time
   2. Inflation in Switzerland – been between -1% and 1% since 2010 – so been also low for some time
   3. Inflation in Australia – Has been present – up until recently – the big question will be if this returns as to if we go into the negative rate territory over time
   4. If inflation in Australia starts to lag and our household debt to GDP remains high – on the road towards negative interest rates
9. But plenty of other countries have low to negative inflation rates at the moment – the thing to look out for is persistent low inflation rates – for many years
   1. But negative rates come with costs too. They can cause stresses in the financial system that are harmful to the supply of credit and they can encourage people to save rather than spend
   2. Hurts savers as well – individuals with cash in the bank would start having to pay the bank to store money – With offset accounts
10. Whilst the RBA has said they are ruling out negative interest rates – the current measures may have little long term impact in boosting the economy – due to the high levels of household debt levels
11. Therefore – end result may be that the NIRP may be coming to Australia
12. The RBA would never say this until it was likely to occur – Forward guidance can freak the market out –
    1. At this stage – not likely – but if things don’t improve or deteriorate – especially inflation – then will likely come to Australia
    2. It Wont be exchange rates that cause this – will be lower GDP and Inflation rates not being in line with the RBA economic wishes – so they will take measures to make this happen
    3. The only tool in their arsenal is to keep lowering rates

Thanks for the question

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