At its meeting on March 3rd, the RBA decided to cut the cash rate to a new historic low of 0.5%. The cut is intended to support the economy in response to the coronavirus outbreak which has disrupted supply chains and stagnated global growth. The RBA’s decision follows that of American Federal Reserve’s 0.50% rate cut – to bring the Fed Funds rate to 1 – 1.25%.
The cash rate cut has prompted many to believe that monetary policy may be heading into the Quantitative Easing (QE) zone. The RBA has previously signalled that it will consider using QE if the cash rate is cut to 0.25%. With significant uncertainty around the impact and length of the coronavirus outbreak, another rate cut may be on the horizon.
As the interest rate approaches zero, conventional monetary policy becomes less effective. The current rate cut has meant that there are now even fewer bullets in the chamber to deal with a wider recessionary event. For example, during the 2008 Global Financial Crisis, the cash rate dropped from 7.25% to 3% - a 4% reduction. The alternative is QE where the central bank purchases government securities (treasury bonds) from the market (private sector) to increase the money supply and encourage lending and investment. QE was widely used around the world during the 2008 financial crisis. In fact, the European Central Bank has been running a QE program since 2015 to support the sluggish EU economy.
The rate cut will further weaken the Australian dollar which is currently at 0.66USD – its lowest level in many years. The dollar was 0.70USD in January 2020. While this depreciation will help to increase the competitiveness of Australian exports, it is unlikely to completely offset the loss of income experienced by the tourism and education sectors from slowing Chinese demand.
In response to the rate cut, all major banks have announced that they would pass on the full cut to borrowers. With a significant number of Australian households holding a mortgage, this will reduce the amount they have to pay in interest expense and increase disposable incomes. The RBA hopes this interest saving will spur consumption and future aggregate demand.