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Why Not Just Cut The Rate To Negative

by Jacob Blanca

The Reserve Bank will reduce interest rates to virtually zero – but what does it mean to borrowers and savers?

Today, the Reserve Bank will determine if its target cash rate is to be reduced to 0.1 percentage point (from 0.25 percentage points).

This puts a negative interest rate really similar to us.


But Australia still has some negative interest rates – if inflation is taken into account.

 

Currently, annual inflation is 0.7 percentage point as calculated by CPI.

 

And as it stands, the cash rate at night is about 0.13 percentage points, which is the interest rate that the Reserve Bank tries to manipulate every month, representing the rate that banks lend to and borrow from each other.

 

Thus, after inflation adjustment, the money banks’ “value” is loaned down by approximately 0.7% annually (at the present level of inflation) while the “return rate” earned by the banks is far below that of approximately 0.13%.

 

The capital of the banks is eroded over time, rather than increasing — the impact of negative real interest rates.

 

Economists claim that this means that the cash rate at present is “really” negative.

Is Cash Rate going to go farther down?

The monthly rating for the RBA is referred to as a “live,” because during its long-term hourly meeting, the bank can very well decide to reduce the cash rate – rather than simply explain its decision during the meeting.

However, all eyes are on the Governor Philip Lowe ‘s following remark. It would be important to see if you can look away from the Melbourne Cup form guide for a moment if it applies to the Bank’s plans for monetary easing.

 


Dr Lowe has to date said that the bank would shift a cash rate to negative territory “extraordinarily impossible.”

 

Then he was equally unambiguous about RBA ‘s chances of joining the cash printing programme and now it has a well developed quantitative easing programme.

How does policy on negative rates work, then?

The major commercial banks have the reserve bank depositing accounts to record the value of their balance sheets. That’s an excellent way to say to the Reserve Bank of commercial banks. Normally, large banks would earn a deposit on their accounts equivalent to a typical customer – the rate is the cash rate alone. The bank directly charges commercial banks for the possession of the money in order to negate the cash rate.

 

Most banks would be terrified by the prospect of paying RBA to retain their cash overnight so that they would try instead to lend it. It is also considered to be an incentive programme — since it is meant to promote lending. Anyway, this is the idea.

Borrowers Getting The Full Benefit Of Cheap Money

Moreover, the truth is that the financial system is very skewed. Banks raise and lend bank deposits. That’s the fundamental model of industry. Logic would suggest that customers would pay for savings accounts and mortgagers would earn money, not lose money on interest if the interest rates turn upside down.

This is exactly right. 
And that is just right. 
Alan Oster, Chief Economist of the National Australia Bank, puts it:

“Certainly if [the RBA] went negative, you would see fixed rates go down, and they’d all probably have a “one” in front of them,” says.

 

“As an empty creditor, to use an extreme example, you will only give the bank back a total of 900 dollars if you have a $1,000 mortgage, when you pay back it.”

 

As regards depositors, most accounts’ interest rates are basically very low. Your money is safer under the mattress once again, adapting to inflation. Most economists argue that banks are unlikely to charge depositors because it would lead, they claim, to mass retirements and might crumple the banks’ capacity for lending.

Circling the Rim of an Economic Catastrophe

Apart from the apparent reluctance of the RBA Governor, Mr Oster says, “It would have meant the economy collapses,” if the programme were to be deployed. This is not an exaggeration. The fear is that under the negative interest rate scenario the banks are losing billion because the money they make from deposits is smaller than the billions lost from the loan downturn.

Yeah, borrowers make money from transactions, but banks are limited by their ability to leverage money and the business model itself begins to fail, with less money.

Business and Investors Watch The Cash Rate With Eagle Eyes

So we have a limbo game — how low is the Reserve Bank going to lower its cash rate target?

At present, the “effective” cash rate hovers between eight basis points and 13 base points (0,13%) because the cash market has lowered the RBA cash rate target by 0,25%. However, the effective cash rate — the rate affecting your hypothecary — can easily be close to null. The bank would do its utmost to reduce long-term interest rates from then on. You can see why the governor of RBA has tried in recent years to turn its attention to what the Federal Government can do. The probable shortcomings of the bank’s arsenal is painfully conscious of Dr Lowe.

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