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The Reserve Bank of Australia (RBA) has warned that the current historic low interest rates increase the risk of an imminent “sharp correction”.
In a keynote, Marion Kohler, head of the RBA’s domestic market division, told the Australian Securitization Forum that the central bank is keeping an eye on the securities market.
“One area of focus comes from the very low interest rates in history today,” Kohler said. “Low risk-free interest rates raise asset prices. This is part of the monetary transfer mechanism.”
However, this also leads to an increase in “search for yields” behavior, and investors in a low interest rate environment will consider putting more risky assets into their investment portfolio.
“Investors bid on the price of risky assets to the extent that the price of risk may not be appropriate,” said Kohler. “This increases the risk of radical corrections in the future.”
Kohler said stock price volatility and the risk premium on fixed income and equity remained high during the global financial crisis (GFC).
“”[But] Each crisis is different, so we need to be flexible and adapt our tools to the challenges at hand, “she said. “The challenge this time was the very low interest rates at the beginning of the pandemic.”
Australia’s cash rate at the start of COVID-19 was 0.75%, but dropped sharply to 0.5% in March 2020 and then to 0.1% in November 2020.
In contrast, Australia’s cash rate in late 2007, when the global financial crisis (GFC) began, actually began to rise to a peak of 7.25% and fell to 3% in 2009.
She said the economic concerns of COVID-19 led to increased uncertainty and caused short-term but sharp adjustments in securities prices.
“The period of volatility was short,” Caller said. “The risk premium increased much less in the early stages than it did during the global financial crisis and rose in a shorter period of time.”
Shane Oliver, Chief Economist at AMP Capital, said the current increase in money supply and excess household savings are fundamentally different from the post-GFC period.
“A pool of excess savings can boost spending and discourage working (until it runs out), and as the money supply grows, inflation continues to rise beyond the current pandemic-led boost. There is a risk of being injured. ” Oliver said..
He said COVID-19 was most important in the long run, as the financial and fiscal response to the pandemic was likely to have broken the previous disinflationary period, as was the post-WWII expansion policy. He pointed out high inflation as an economic risk.
“This, in turn, means that the tailwinds of inflation and falling interest rates that have led to positive reflexes and boosts in revaluations for growth assets are likely to be behind us,” Oliver said. ..
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