With only one more interest cut in its back pocket, the RBA could begin increasing the money supply in Australia 'within months'

• Having cut the cash rate to 0.5% on Tuesday, the Reserve Bank of Australia (RBA) is for the first time near the limitations of monetary policy.

• Economists now expect it to cut once more to 0.25%, its own declared 'lower bound', before considering quantitative easing, or QE.

• QE is the controversial process by which a central bank increases the money supply, artificially inflating asset prices in an effort to stimulate the economy.

• Visit Business Insider Australia’s homepage for more stories.

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The RBA is almost out of ammunition.

Having been forced to cut the official cash rate to a record low 0.5%, the Reserve Bank of Australia (RBA) doesn't really have much more room to move. Governor Phillip Lowe and his board may cut once more but have indicated interest rates of 0.25% would be at the "lower bound" with really nowhere to go from there.

While the government has promised it has a stimulus package on the way – the details of which are still emerging – the central bank has to this point been doing all the heavy lifting. Economists expect the RBA may have more to do.

"Our economists expect a follow up 25 basis points [of] easing in April. It is possible that only meaningful fiscal stimulus could prevent this from happening," JP Morgan banking analysts Andrew Triggs and Nicholas Dalton said in a research note issued to Business Insider Australia.

But there's more.

"Given the RBA’s effective lower bound is said to be 0.25%, this raises the possibility of quantitative easing."

Quantitative easing, or QE, is a controversial policy by which a central bank buys government bonds to increase the money supply and, hopefully, stimulate the economy. While it has never been tested in Australia, we've seen it unleashed in Japan, the US and Europe in the last two decades to varying degrees of success.

"It can work. It's obviously controversial but it has worked overseas," Domain economist Trent Wiltshire told Business Insider Australia. "It works by pushing down longer-term interest rates, lower interest rates on home loans and business loans, and that means more money in the hands of people, more money flowing through the economy."

In doing so, QE typically increases asset prices, including house prices, to create a positive wealth effect. Theoretically, this emboldens homeowners and lenders alike, and encourages greater spending, stimulating the economy.

The RBA admits it would only implement quantitative easing if it needs to

However, while QE is more likely than it has been in the past, the RBA wouldn't take the decision lightly. In August, Lowe briefed the Australian government on its views on such unorthodox stimulus measures, saying "we are prepared to do unconventional things if the circumstances warranted it... [but] I hope we can avoid that."

But it's certainly something the RBA has been looking at, despite the potential negatives.. Lowe even went so far as to publish an international paper in October that lauded the net positives QE had produced overseas, and then deliver a similarly themed speech a month later to some of the country's economists.

So while Lowe may have hoped to avoid it, he's certainly laid the groundwork to prepare Australia for QE should it come to that.

"It would be a big step and the RBA would need to see a more significant downturn to move to QE," Wiltshire said.

The coronavirus could bring a QE program forward to be implemented 'within months'

So what would it take? Well, a coronavirus-driven downturn could again be what forces the RBA's hand. Spiking unemployment, which last month ticked up to 5.3%, could be the smoking gun.

"As the virus starts to spread, we think that people will become more reluctant to go job-hunting. What’s more, uncertainty about the impact of the disease should encourage firms to restrain hiring," Capital Economics ANZ senior economist Marcel Thieliant said. "As such, we now expect the unemployment rate to climb to 5.7% over the coming months. That would further weigh on wage growth and increases the chance that the RBA will eventually have to resort to quantitative easing."

Indeed Asia-Pacific economist Callam Pickering maintains it could come sooner than we expect.

"Quantitative easing has become more probable and, depending on the persistent impact of COVID-19, could begin within months," Pickering said.

Of course, at this stage, it's uncertain how much hurt the coronavirus will inflict both locally and globally. It's also possible a well-targeted and effective fiscal stimulus package could avert the need for a QE program. The government is expected to hand it down next week but appears to be ruling out large-scale spending in an effort to project fiscal responsibility at all costs.

It may be what Lowe needs to pull the trigger, writing late last year that QE and other unconventional tools "are most effective when used together with a broader set of policies, like fiscal and prudential measures".

If he chooses to cut again next month, then QE looks like a very real possibility.

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READ MORE:

Quantitative easing – also known as printing money – is an economic solution for uncertain times The RBA has just revealed what it needs to unleash quantitative easing and negative interest rates in Australia for the first time Speculation is rife Australia is about to start printing money, as RBA governor Philip Lowe prepares to speak on quantitative easing