In the ‘old’ days, which is anything pre-COVID-19, forecasting changes in official interest rates was a time consuming pastime.
Each month, ahead of the Reserve Bank of Australia Board meeting which is held on the first Tuesday of each month, there was a ‘will they’, ‘wont they’ raise or cut the official cash rate.
Usually, there were a range of views from the so-called RBA watchers on the probabilities of a rates change. Curiously, markets regularly failed to fully price in the momentum for official rates, particularly over a 3 to 12 month time frame.
To be sure, some did it better than others, but at the end of the day there was usually a strong and well informed debate about the future course for monetary policy changes.
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Dull as can be
In the current era, where official interest rates were cut to 0.25 per cent in March as the COVID-19 pandemic saw the economy dive into a deep recession, the monetary policy debate has faded.
This is partly because the RBA has said it has done all it can in terms of supporting the economy with interest rate changes.
Governor Phillip Lowe has said that it is extremely unlikely that they will follow the example set in the likes of the Eurozone and Japan and implement a strategy of having negative interest rates.
Lowe also said that cutting the cash rate to 0.10 per cent would be inconsequential given the extent of the economic problems the economy is now facing and as a result, it was an unlikely event.
With the RBA targeting 0.25 per cent for the Commonwealth government bond yield, Dr Lowe is indicating that, based on the current outlook, a change in the official cash rate is unlikely before 2023.
What could change?
Three years would be a very long time for official interest rates to remain unchanged and the RBA has been wrong in the past. Recall it was less than two years ago, when the official cash rate was 1.5 per cent that Dr Lowe was saying the next move in rates was more likely to be up than down.
There remains a possibility that Dr Lowe will be forced to change his view.
A cut to 0.10 per cent or to a rate below zero per cent is more likely than the RBA state publicly. Interestingly, Lowe did admit that “if circumstances warranted” the RBA would consider rate cuts towards and even below zero.
If the economic recovery that the RBA is current forecasting falls short in terms of growth, continuing the level of unemployment and inflation, a cut to 0.10 per cent would be sensible as would serious consideration of a move in rates to below zero per cent.
Most of which boils down to the containment or otherwise of COVID-19.
If COVID-19 remains a constraint on business and consumer activity or if the government withdraws some of its stimulus measures too early, the economy will be weaker and RBA interest rate action may be required.
Problems in the global economy would also weigh on the local economy, which could force the RBA to do what it doesn’t want to.
Negative interest rates?
Interest rates in Switzerland, Denmark, Eurozone, Sweden and Japan are negative. While economic conditions in all these countries are poor, the monetary policy response has helped underpin borrowing and with that economic activity.
In other words, economic conditions would have been weaker still if interest rates were higher.
To be sure there are some issues with negative yields. Bank and corporate balance sheets are constrained which impacts profitability. This can be a material issue when the economy is in a deep recession.
It can also create some confusion for householders who would not see negative yields on their borrowing – negative yields have their impact in financial markets but not for retail borrowers.
Don’t rule anything out
For now, everyone, including the RBA, are hoping the economy can pick up as the COVID-19 pandemic is contained.
If it does, then interest rate debates will remain boring for a long time and in a few year’s time, the guessing game on when the first interest rate hike will occur will gain momentum.
Until then, there are risks the RBA will cut official rates if the economy does not pick up as planned.
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