Australia is in the midst of a COVID-19
third wave, and according to health experts, things are going to get worse
before they get better. Along with the obvious toll on people's health and
livelihoods, the pandemic and lockdown response is likely to affect interest
rate decisions in the weeks and months ahead. Along with the lockdown, sky-high
property prices, unsustainable global stimulus, and a looming economic slowdown
in China are all causing concern among policy makers.
Prior to Sydney's protracted lockdown,
futures markets were pricing in multiple rate hikes over the next few years.
The situation has changed, however, with the lockdown placing an entirely
different kind of pressure on decision makers. At the start of the lockdown,
banking regulator APRA started to raise the potential of negative interest
rates with the banks. This noise became louder as the lockdown continued, with
negative rates now a very real possibility.
According to Commonwealth Bank (CBA)
predictions, Australia's economy is expected to contract by 2.7% in the
September quarter alone. While that may not sound like much, it is an entire
percentage point higher than the fall experienced during the 1990s recession,
where GDP fell by just 1.7%. Politicians and bankers will need to make tough
decisions going forward, and they are already expecting the worst. CBA are now
predicting a rate hike in May 2023, which is a long way, and many decisions by
the Reserve Bank, away.
While negative interest rates are very
foreign to Australians, Japan, Denmark, and Switzerland have been dipping into
negative territory for years. Negative interest rates have also become likely
in England, with the Bank of England giving UK banks six months to prepare back
in February. This should not really be a surprise, as unsustainable debt levels
reach into lofty new realms. Even back in February, the collective borrowings
of world governments, households, and businesses had increased by a massive
US$24 trillion since the pandemic began.
The economic situation in China will also
affect Australian interest rates in the months ahead. Despite trade falling off
in some areas over the last year, the health of the Australian economy is still
largely dependent on China. Massive stimulus in the Middle Kingdom has greatly
eroded confidence, as commodity prices sit near record highs and Beijing
attempts to put on the brakes. While yet another large-scale construction
program will help somewhat, it risks sending commodity prices even higher while
putting additional pressure on inflation.
The other factor sure to play a role in the
RBA's decision is the domestic residential housing market. With property prices
already sky-high, a negative cash rate would only send prices higher. Existing
mortgage holders could gain trillions of dollars’ worth of collective equity if
this happened, but prospective first-home buyers would face even more hurdles
trying to get into the market. While negative rates are far from certain, just
talking about them is a sign that we have entered brand new territory.