Will interest rates go up in a recession?
The widespread economic impact of the coronavirus outbreak continues to put Australia’s economy under strain with the nation recording negative economic growth for the first time in nine years. But what does this mean for our interest rates?
What is a recession?
A recession in Australia is generally defined by contractions in economic growth over two consecutive quarters. Some economists also consider no economic growth over 12 months, or a 1 per cent increase in the unemployment rate increase, as a recession.
Is Australia in recession?
Yes.
The Australian economy has plunged into its first recession in nearly 30 years thanks to the fallout of the global pandemic.
In early September, Australian Bureau Statistics figures showed that the nation’s gross domestic product (GDP) shrank 7 per cent over the June quarter, which represents the biggest fall since records began back in 1959 and the second consecutive quarterly contraction in GDP.
This is the worst economic growth in 61 years, and follows a 0.3 per cent decline in GDP across the March quarter.
"The June quarter saw a significant contraction in household spending on services as households altered their behaviour and restrictions were put in place to contain the spread of the coronavirus,” head of national accounts at the ABS, Michael Smedes, said.
Will interest rates go up in a recession?
In short, no.
Interest rates tend to go down during a recession as governments attempt to stimulate spending in order to slow down any decline in the economy by cutting interest rates.
Low interest rates help to stimulate growth by making it cheaper to borrow money, and less favorable to save which in turn prompts both individuals and businesses to take advantage of low-cost borrowing and the opportunities to make or save money.
For example, during the 1990-1 recession in Australia, the Reserve Bank reduced its official cash rate from 17 per cent to under 5 per cent over 3.5 years in order to stimulate growth.
For the COVID-19 recession, official interest rates were cut to 0.25 per cent in March as the COVID-19 pandemic hit our economy and saw it dive into a once-in-a-lifetime recession.
But while Governor Philip Lowe says the Reserve Bank plans to keep rates at its record-low on hold for the foreseeable future, it is unlikely to follow in the footsteps of the Eurozone and Japan and implement a strategy of having negative interest rates.
With the RBA targeting 0.25 per cent for the Commonwealth government bond yield, Lowe is indicating that, based on the current outlook, a change in the official cash rate is unlikely before 2023.
What are negative interest rates and what do they look like?
Negative interest rates occur when borrowers are credited interest rather than paying interest to lenders. With negative interest rates, banks charge you interest to keep cash with them, rather than paying you interest.
At the moment, interest rates in Switzerland, Denmark, Eurozone, Sweden and Japan are negative. While economic conditions in all these countries are poor, the monetary policy response has helped underpin borrowing and with that economic activity.
While Lowe says this isn’t likely to happen for Australia, economist Stephen Koukoulas points out, three years would be a very long time for official rates to remain unchanged, and the RBA has been wrong in the past.
“Recall it was less than two years ago, when the official cash rate was 1.5 per cent that Lowe was saying the next move in rates was more likely to be up than down,” he said.
“There remains a possibility that Lowe will be forced to change his view.”
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