While rates are on hold for now – and aren’t expected to rise for years to come – Westpac chief economist Bill Evans has warned that the RBA could be forced to use negative rates, despite Governor Philip Lowe’s well-known dislike of the unconventional policy tool.
“A serious case can be made for the RBA to consider further cuts and entering negative territory for the cash rate if it becomes apparent that the economy is deteriorating even more than is currently expected,” Mr Evans said. “A small open economy with significant foreign liabilities would certainly see a substantial improvement in the competitiveness of the currency with further rate cuts when other major markets are anchored at their effective lower bounds.”
Even late last year a quantitative easing program was considered an outside possibility, one that would only see action in an extremely dire crisis. But Mr Evans warned that the impact on expectations – both inflation and confidence – remained a “powerful argument” against negative rates.
“Do households and business respond to negative interest rates by lowering inflationary expectations, potentially pushing long-run inflation expectations into negative?” Mr Evans said.
Negative interest rates would also distort long-term rates of return, potentially leading to “perverse outcomes” like the rise of premiums, while negative deposit rates could encourage depositors to hoard physical cash. And while precautionary behaviour and lower economic growth will likely lead to calls for the RBA to do more, it’s unlikely they’ll make any rash decisions.
“Both the US Federal Reserve (Fed) and RBA have responded to these developments by largely ruling out the prospect of negative interest rates, with the RBA particularly noting that the cost of such a regime outweighed the benefits,” said Frank Uhlenbruch, Janus Henderson fixed interest investment strategist. “Instead, while they both saw scope for further forward guidance and yield curve control measures, the most powerful policy tool going forward was fiscal policy.”
Last week, governor Lowe also warned that monetary policy could no longer be the main tool for managing the economy in the foreseeable future.
“There’s a limit to what we can do,” governor Lowe told the Senate select committee on COVID-19. “Going forward, fiscal policy will have to play a more significant role in managing the economic cycle than it has in the past.
“For the past 20 years, monetary policy has been the main swing instrument… In the next little while, there’s not going to be very much scope to use monetary policy in that way and so I think fiscal policy will have to be used.”
