The last few weeks have been very eventful in relation to the outlook for interest rates and monetary policy.
Last week, the Reserve Bank lowered its economic growth forecast for 2019 from 2.75 per cent to 2.5 per cent. According to Westpac’s economic forecasts, we think that's still too high and is more likely to be at 2.25 per cent.
Next year, however, looks to be a better year, and while the Reserve Bank has forecast the economy to grow at 2.75 per cent in 2020, we think it’s more likely to be about 2.5 per cent.
We were given more perspective on the interest rate story when Reserve Bank Governor Philip Lowe addressed a House of Representatives Standing Committee on Economics. He told the Committee the possibility of lower interest rates remains on the table and the Reserve Bank board is prepared to ease monetary policy further. Indeed, he noted that “there is scope to lower the cash rate at least a couple of times.”
When asked whether he could push interest rates down to zero, he said that might only happen if the whole world goes to zero, which we don't think is a likely prospect.
This context has given us further comfort to stay with our current view that there will be two more interest rate cuts from the current 1 per cent – one in October and again in February next year, ultimately pushing the cash rate down to a new low of 0.5 per cent.
This terminal rate is lower than the other majors are predicting. We are comfortable with that given that Westpac’s record in this cycle has been well ahead of the other majors.
In addition, we have also raised the prospect of the Reserve Bank embracing some form of quantitative easing – or QE – like other central banks overseas since the GFC, rather than cutting rates below the terminal rate, although the issue would be a very difficult one for them to consider.
This prospect has been widely discussed in recent times. On a trip to visit institutional investors, money managers and hedge funds in Europe and London in June, there was considerable interest in what action the Reserve Bank could ultimately take. Opinions varied, including around the practicality and unknown costs of QE policies.
When the Bank of England cut the “Bank Rate” from 0.5 per cent to 0.25 per cent following the Brexit vote in June 2016, it supported the economy through a four pronged strategy that included a Term Funding Scheme designed to “encourage banks to pass on cuts in Bank Rate to customers” (and boost household demand). Banks and building societies could borrow from the BoE on a secured basis at the new official rate.
Adopting a package of instruments at the same time ensured the effectiveness of the rate cut (in time, banks passed on 24 basis points of cuts to variable mortgage rates) and avoided the confidence drag from adopting an “emergency measure” later on. Banks found that the alternative costs of funding – wholesale and term retail funding – were considerably more expensive than the drawdown costs of the BoE program.
Of course, the details of any domestic package would need to be best suited to Australia’s financial system.
When asked at last week’s Parliamentary Committee about potential QE policies, such as negative interest rates or cheap loans to banks, the Reserve Bank governor said at this stage, although it was unlikely, if it was to occur, it would be through the government buying government bonds.
My view is that a much more effective policy would be a series of direct loans to the banks which would be able to be passed on a lot more effectively to other borrowers.
While the environment remains in flux, we're feeling reasonably comfortable with our view that the most likely outlook is for two more rate cuts – one in October, and again in February, at which point additional unconventional policies might be considered.
This material contains general commentary, and market colour. This material does not constitute investment advice. This information has been prepared without taking account of your objectives, financial situation or needs. We recommend that you seek your own independent legal or financial advice before proceeding with any investment decision. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The ultimate outcomes may differ substantially from these forecasts. Except where contrary to law, Westpac and its related entities intend by this notice to exclude liability for this information.