I bet ex-Reserve Bank governors must look at the interest rates of today and marvel. What else could they do?
Not in a million years would they have thought that they would see a cash rate of 1.5%. Nor, as seems likely, about to head lower.
But that is exactly what the market is predicting today. The RBA Governor said as much in the minutes from the last meeting.
Will the RBA will lower the cash rate today?
In fact, you are unlikely to find anyone who doesn’t think the RBA will lower the cash rate today.
Though, as consumer spending raged out of control back in the late 1980s — along with inflation — the RBA at that time raised the cash rate a full 7% in less than two years. 7%!
Only in early 1990 — back when the RBA used to meet in January — did the RBA start to trim rates. In January 1990, they cut rates by 0.5–1%.
And even after that cut, the official cash rate target was still 17–17.5%. It is a number that seems incomprehensible compared to today.
But that was how high the RBA had to push rates, to try and get on top of the inflation genie.
Those eye-watering interest rates had a devastating impact on many businesses, which simply had to close their doors.
And pity the then mortgage holder. If rates increased by even 1% today, you could only guess at the havoc it would cause.
The consolation being, that when the dust finally settled after such a tumultuous time, Australia embarked on a quarter-century (and counting) period of growth.
Of course, interest rates are not a single sided coin. Whilst a borrower feels the pain of a rate rise, someone else is enjoying a benefit. Those that have money in interest-bearing investments will enjoy some extra cash in their pockets.
On the flip side, when rates are falling, it puts extra pressure on those investing in cash.
If the RBA does cut the cash rate today, the banks have to make a tough decision. And you can already guess how the commentary will play out.
With the Royal Commission still very much current in people’s minds, any decision not to pass a rate cut on in full will only generate another bout of grief. And that is the very thing the banks want to avoid.
Yet, the banks have to balance their books…and expectations.
The margin — the difference between the rates banks borrow and lend at — is at the core of their profitability.
If banks drop interest rates on term deposits to match lower mortgage rates, depositors could pull their money out and put it elsewhere.
To try and appease depositors, banks won’t want to cut rates on their term deposits by too much. If they try to please both lenders and borrowers, the banks will be the losers as their margins shrink. Because of that, banks will have to make a choice. That is, between its own best interests, versus the huge potential backlash if they don’t cut rates in full.
It is not hard to imagine where the banks’ priorities will be
After the huge amount of grief the banks received last year, it is not hard to imagine where their priorities will be.
They are only in the early stages of rebuilding their reputations. They won’t want to do anything that throws all that off course.
Also, although the property market has shown positive signs since election night, it is still way too early to call the next bull cycle.
In the meantime, banks will be competing even harder to keep their own customers. Plus, trying to poach those of their rivals.
The reason why mortgage holders will win out over depositors is, however, not only political, it also has to do with pump priming the economy.
With interest rates lower, the theory is that businesses will borrow more to invest. And in turn, that will lead to lower unemployment — something that ticked up a fraction last month. And in turn, more consumer spending.
On balance, happy mortgage holders and better employment numbers trump the poor old depositor. Meaning that the saver once again bears the brunt of monetary policy.
Unfortunately for them, with anemic inflation, rates are unlikely to rise anytime soon. What they would give for rates to be even half that of what they were a generation ago.
All the best,
Editor, Options Trader