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November 30, 2020

Going Negative…..What if?

Image source: Mortgage Business

In the minutes of the November 2020 Statement on Monetary Policy, Philip Lowe, the Governor of the RBA stated: “The Board considers that there is little to be gained from short-term interest rates moving into negative territory and continues to view a negative policy rate as extraordinarily unlikely”.

Plenty has happened in 2020 which would have been considered as ‘extraordinarily unlikely’!  So, with the overnight cash rate at an historic low of 0.1%, another unforeseen economic shock could create such an environment that necessitates interest rates going negative.

The purpose of going negative is to stimulate the economy by reducing borrowing costs, increasing the money supply to trigger spending and consumption, and to achieve the inflation target and full employment.  

1. The RBA is not a one trick pony and can increase money supply by other mechanisms – quantitative easing.  It has embarked on the purchase of $100 billion of government bonds of maturities of around 5 to 10 years over the next six months. The aim is to lower the whole structure of interest rates in Australia, making it cheaper for governments, companies and households to invest and borrow, while discouraging saving, and to lower the value of the Australian dollar to support economic growth.

2. Should a decision be taken to go negative, expect some interesting outcomes, as this is unchartered territory for the Australian economy.  Low or negative rates on Australian debt will deter foreign investors, thereby weakening demand for the Australian Dollar, and depreciating the currency relative to other currencies. This is advantageous to exporters, not so for importers.  A weaker dollar should stimulate demand for exports and encourage businesses to expand; local production and employment will pick up and along with that comes an increased government tax take from GST, PAYG and company profits.  Going negative would be a temporary state of play and a short run effect on the exchange rate.

3.  As interest rates fall, investors in search of real returns will find cash deposits and government bonds unattractive thereby directing money into the sharemarket causing prices to increase.

But, it’s a double edge sword.  Going negative to stimulate in theory is grand, but it can have a psychological and behavioural effect on business and households.   Lower interest rates, in a pandemic created recession, are not consistent with sustained growth and consumer confidence and participants may go into preservation mode, undermining the strategy.

4. Negative rates could invert rates on deposits, meaning that a depositor would pay for the privilege of storing currency in a bank account, rather than earn interest income.  If rates go deep into negative a borrower could conceivably be credited with more than their principal repayment.  It’s happened….but not in Australia!

5. There is an inherent risk that borrowers could overextend themselves during periods of hyper low or negative rates.  When the economy eventually bounces back, and rates increase, many will find themselves unable to service their loans and be at risk of default.

Written by Mark Bouw Group CFO, Andrew Pittard.

For more support and information , contact the Mark Bouw Group.

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