Savers Face Negative Interest Rates
Last week, the Reserve Bank of Australia delivered a historic, 25 basis point cut to the cash rate. This record low is a blow to millions of households that heavily rely on interest rates, through which, a million households will see a dip in their capital.
Some lenders such as Westpac and ANZ cut rate in term deposits leading up to the RBA’s announcement. This move will push savers to seek out riskier investment options such as stocks to achieve better results as negative interest rates will have a big impact on housing investments. All eyes are now on the big banks to see if they will go ahead with full cuts. ANZ chose to keep 7 of the 25 basis points to itself, while Westpac kept 5. The Commonwealth Bank and NAB however have passed through the full cut. The Reserve Bank governor, Phillip Lowe reiterated that all big banks need to cut rates. Even though lower interest rates will benefit borrowers heavily, increasing consumer sentiment, there is no doubt that the lower the cash rate falls, the more it will affect the net interest margins further.
The reduction in cash rate will equate to a reduction in shareholder equity of $750 billion float of free funding. As interest rates move towards zero, the margin on this free funding is tainted as banks cannot cut deposit rates in order to make up for lost profits. The RBA has said it took this decision to support growth in employment and provide confidence that inflation will be consistent with targets. Consumers with mortgages will be better off from this rate cut as this also coincides with the federal income tax cuts announced in the April federal budget. An example was given by Australian Treasurer, Josh Frydenberg, where a two-income family earning a combined income of $120,000 a year with a $400,000 mortgage will be almost $3,000 better off as a result of these rate cuts.
Easing of Monetary Policy
The Australian Treasurer believes that the economy is sound and that the rate cut will not make a big dent in housing investment. The loosening or easing of monetary policy occurs when the money supply is expanded and is easily accessible to consumers to encourage economic growth. A decrease in interest rates is a result of monetary easing as the government and central bank aim to boost the economy through investment and spending. A lower interest rate will mean an increase in spending with consumers more likely to try and take advantage of the interest rate and obtain loans for housing investments. The RBA’s statement gave a subtle sign of further easing suggesting that it would “continue to monitor developments in the labour market closely and adjust monetary policy to support sustainable growth”.
An increase in housing investment may be a positive economic factor however this record low cash rate will have negative impacts on the equity market as current housing investors will see their capital decrease. The RBA downgraded its economic growth forecast from 3% to 2.75% which further questions if the monetary stimulus was required at this stage.
The governor of the Reserve Bank stated that too many people are relying on interest to support their income and acknowledged that this would be a difficult time for those people however argued that this will be in the interest of the overall economy.
Analysts in the banking sector, however, have argued that this cut in cash rate will result in reigniting the housing bubble. There are already very high household debt levels and a lowered interest rate will only add to that as people will now look to borrow more. Professor Holden from the University of New South Wales has warned that a record low cash rate and house prices could encourage people with cash to buy property in search for higher returns. Analysts from investment bank Morgan Stanley believe that tighter controls and record levels of household debt means a property boom that occurred earlier will not be repeated.
How the economy will react
The economy is stable as the monetary stimulus provides more harm than good. That said, there are many pros and cons of the cut in the cash rate, depending on current living situation. The record low cash rate will force banks to cut interest rates which will be beneficial for home buyers who have enough savings to obtain a mortgage. On the contrary, low interest rates can bait consumers to obtain a mortgage without having enough savings or ability to pay off their debt. The lowered cash rate will be detrimental for investors as they will not make any great returns on their housing investments as property prices continue to drop. It is yet to be seen how this monetary easing will affect the economy.
By Rizwan Sayeed
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