Central Banks

BTIM warns Reserve Bank of Australia may adopt negative interest rates on weak inflation

Reserve Bank of Australia may adopt negative interest rates
Reserve Bank of Australia may adopt negative interest rates

The Reserve Bank of Australia (RBA) could be the next central bank to embrace negative interest rates, according to BT Investment Management (BTIM).

In a Tuesday note, the Sydney-based firm cited weak inflation and consumption to justify its bold call.

"The RBA still has scope to ease to help inflation recover and it's quite clear to us that the RBA will be easing to 1 percent, with a move to 0 percent or lower a distinct possibility," BTIM said.

Consumer price inflation slid 0.2 percent during the January-March quarter, the worst quarterly drop since 2008.

Following the dismal data, the RBA slashed its benchmark cash rate to a record low of 1.75 percent from 2 percent last week in an effort to combat deflation and took a knife to its inflation forecasts. It now anticipates underlying inflation between 1-2 percent for 2016, versus previous estimates of 2-3 percent.

"Add to this the effect of the recent rally in the Australian dollar caused by bouncing iron ore prices, which has lifted our terms of trade temporarily and this has only had more of a deflationary effect on prices," BTIM explained.

The local currency has appreciated nearly 4 percent against the greenback over the past three months and is currently trading at $0.7347 U.S. cents on Wednesday.

Pointing to longer-term inflation swaps, BTIM says that Australia's 10-year breakeven rates are now below the bottom of the RBA's band (2 percent) and still falling.

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Moreover, a look at recent gross domestic product (GDP) data "reveal a lack of sustainability," BTIM continued. While the country's 2015 report card revealed a 3 percent expansion for 2015, beating RBA expectations, that trend won't continue for much longer, BTIM noted, warning of lower iron ore exports in the future.

Central banks such as the European Central Bank, the Bank of Japan (BOJ) and Riksbank have all introduced negative rates during periods of tepid consumer price growth in an effort kick start their respective economies. But many strategists have questioned their efficacy and warned of dangers underlining the move, including the risk of consumers withdrawing money from banks to store at home instead of spending the cash.

"The question is will they [the RBA] be successful?" echoed BTIM.

The firm pointed to market reactions to recent BOJ meetings as proof of the doubts behind negative rates. The BOJ implemented negative rates at the end of January, a move that should have caused the yen to depreciate but instead, the currency has rallied in the months following the decision.

"The theory says yes, but in practice it's unclear as RBA monetary policy has no influence over commodity prices or overcapacity in Chinese and Japanese markets. This takes us back to the question of central bank credibility in being able to deliver on their objectives."

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