The answer is that although few people were willing to commit to a new mortgage during the lock-down period of May, hordes of people who already had loans, perhaps feeling nervous, rushed to switch banks as lenders slashed their fixed rates to as low as 2.19 per cent.
That refinancing bonanza is in part a result of the Reserve Bank of Australia’s extraordinary effort to drive down the cost of borrowing in March, through the cash rate cut and a range of other “unconventional” measures. While housing is not the economy, of course, it is an important channel through which lower borrowing costs flow into the economy.
This week’s wave of refinancing demonstrates that cheaper credit is indeed flowing: home owners are saving on interest as a result of cut-price interest rates, allowing them to spend more, or pay off debt more quickly.
However, the weakness in new mortgage lending also illustrates how rate cuts alone can’t offset the far bigger problems hanging over the economy, such as job uncertainty. And that reflects a wider limitation of slashing interest rates to support an economy: the RBA can free up household cash flow, but cannot make people lift their spending (or force businesses to invest). And that’s really what the economy needs right now: demand.
Which is why economists are so keen to see Treasurer Josh Frydenberg use the federal budget to support the economy in its hour of need when he delivers a key update in just under two weeks.
First, however, back to all the cheap money that’s sloshing around the financial system and finding its way into household bank accounts. The surge in mortgage refinancing activity is a tangible illustration of how the RBA’s foray into “unconventional” monetary policy has flowed into the “real” economy of household budgets.
As a refresher, back in March the RBA not only cut official interest rates to 0.25 per cent but also unveiled measures to force down bond yields and give banks up to $90 billion in loans at an interest rate of 0.25 per cent. Banks have also been awash with deposits in recent months as nervous households ploughed $40 billion into their bank accounts, and super funds held cash on hand to prepare for emergency withdrawals.
As explained by deputy governor Guy Debelle in a speech last week, the overall effect of the RBA’s various measures has been to bring down the cost of funding for the banking system. The fall in funding costs has been greater than the 0.25 percentage point in the cash rate announced in March. The bank bill swap rate – a gauge of the cost of banks lending to each other – has fallen to just 0.1 per cent.
What are banks doing with the windfall from cheaper funding? Some of it might support their profit margins, but it appears a lot is being passed on to borrowers in the form of low interest rates for new customers, or those who haggle or refinance.
This is reflected in RBA figures that show the average rates on new home loans continuing to fall in recent months to 2.73 per cent and 4 per cent for small business. One small Tasmanian bank is even offering fixed rate mortgages at interest rates of less than 2 per cent.
Given the extent of the economic hit from COVID-19, financial markets are betting that extremely low interest rates are probably here to stay for years to come.
As governor Philip Lowe said after this week’s board meeting, the cash rate will not increase until there is progress being made towards full employment and inflation running sustainably within its 2 per cent to 3 per cent target band. Debelle in his speech said this was “likely to be some years away”.
The challenge, however, is that with a cash rate of just 0.25 per cent, monetary policy is getting closer to the limits of what it can be expected to achieve. The RBA hasn’t exhausted all its options, as a quick look around the world of central banking reveals. Some believe the RBA may act to try to bring down the Australian dollar if it climbs too much higher, and there’s always negative interest rates (though Lowe has said this is “extraordinarily unlikely”.)
But the interest rates lever has been well and truly pulled. The financial system has a huge amount of funding at its disposal, at very low cost, but what the economy needs is stronger demand. Given the uncertainty about future employment and the real worry of a second wave, economists say this requires an ongoing role for the other big arm of economic management: fiscal policy.
Frydenberg has made it clear there will be some further fiscal support in his upcoming economic statement, which might include JobKeeper being extended in some way, or tax cuts being brought forward. With the government’s surplus ambitions long ago blown out of the water, it’s time for fiscal policy to step up to the plate.
Ross Gittins is on leave.
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Clancy Yeates is a business reporter.