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COVID-19 and its economic impact

18/03/2020

Why the Reserve Bank cut the cash rate to a new historic low.

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The Reserve Bank of Australia's (RBA) decision this month to cut the official cash rate to a record low of 0.5 per cent highlights its concern of a "significant" fall-out on the global and Australian economy from the coronavirus outbreak.

Coronavirus is likely to have a large and immediate negative impact on the global economy.

The Australian economy was underperforming before the outbreak, with gross domestic product in the March quarter expected to contract as a result of much weaker tourism and education sectors, the effects on other parts of the domestic economy and disruptions to the global supply chain.

The government has unveiled a $17.6 billion stimulus package to be spread over several years. This is likely to have material positive impact on the Australian economy, however, it will not prevent economic slowdown given the large negative impact on global and domestic economies from the coronavirus.

At the weekend, the central banks of Canada, England, Japan, Switzerland, Europe and the US took further coordinated action to enhance liquidity in global markets in an attempt to mitigate the consequences of coronavirus.

On Monday, the US Federal Reserve cut rates by 100 basis points to near zero and announced a comprehensive package, including buying government bonds to alleviate pressure on financial markets.

This is the second Federal Reserve emergency rate cut this month.

All eyes are on the RBA with the market expecting a 25bp cut at an emergency meeting on Thursday. This would take the official cash rate to 25bp - the RBA stated floor.

The market is also expecting the RBA will announce an asset purchase program (quantitative easing) that will involve the RBA buying Australian government bonds to lower interest rates across the economy.

It is likely there will be more targeted government relief in the May budget.

On balance, Australia is most likely facing a prolonged period of very low interest rates similar to what is being experienced in Europe and Japan.

The lower for longer rate environment will have a direct impact on banking profitability with returns to shareholders and self-funded retirees set to move lower over time.

Borrowers are likely to benefit from a cheaper cost of funds, while the current environment maintains the theme of lower rates for deposit holders.

This article is intended to provide general information of an educational nature only. This information has been prepared without taking into account your objectives, financial situation or needs. Information in this article is current as at the date of publication.

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