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Australian Banks to Get Hurt as RBA Cuts Interest Rates

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In a bid to lift the economy from a recession mainly due to the coronavirus pandemic and support growth, the Reserve Bank of Australia (RBA) has announced a reduction in its yield-curve target and bank lending facility rate to 0.1% from 0.25%, the lowest in history. Additionally, the RBA chief, Philip Lowe, announced a “quantitative easing” policy, under which it has pledged to purchase longer-term debt.

The central bank has planned to buy A$100 billion ($70.4 billion) of Federal and State debt with a 5-10-year maturity period over the next six months.

Lowe stated, “The combination of the RBA’s bond purchases and lower interest rates across the yield curve will assist the recovery by: lowering financing costs for borrowers; contributing to a lower exchange rate than otherwise; and supporting asset prices and balance sheets.”

Notably, following the announcement, the Australian dollar eased and yields on sovereign bonds fell to historic lows yesterday.

In fact, the main motive behind the longer-term bond-purchase program is to facilitate a significant increase in the demand for those bonds, which will result in a decline in interest rates. When interest rates on bonds decline, governments are able to borrow at cheaper rates over longer periods. And, when interest rates across the economy are low, the overall cost of borrowing declines.

Most importantly, with lower cost of finance, the economic recovery becomes swift, which is the ultimate aim, given the coronavirus-induced economic slowdown.

Notably, given Australia’s progress in containing the spread of the novel coronavirus, the RBA has slightly upgraded its outlook for economic growth. Lowe stated, “it now appears probable that GDP increased solidly in the September quarter despite the lockdown in Victoria.”

How Will Lower Interest Rates Impact Australian Banks?

While lower interest rates mean reduced cost of borrowing, which is good news for businesses and households, for banks it is bad news.

This is because interest rate declines negatively impact banks’ interest income. Moreover, lower rates mean lower net interest margins for banks (which is the main indicator of their profitability). Overall, with a decline in interest rates, banks’ top lines get hampered to an extent.

Currently, banks across the globe have already been witnessing pressure on their top lines because of the prevailing low-interest rate environment. Several developed and developing economies resorted to similar actions as the RBA amid the pandemic and the resulting slowdown.

Banks in the United States are grappling with the near-zero rate environment, which is expected to continue at least until 2023, as signaled by the Federal Reserve. Notably, the Bank of England is contemplating the use of negative interest rates, thus taking the borrowing costs below zero.

Similarly, with interest rates declining further in Australia, banks within the region will see their top lines getting hurt. A few of the many Australian banks that are expected to witness revenue growth pressures due to this recent move by the central bank are Australia and New Zealand Banking Group Limited (ANZBY - Free Report) , Commonwealth Bank of Australia (CMWAY - Free Report) , Westpac Banking Corporation (WBK - Free Report) and National Australia Bank Limited (NABZY - Free Report) .

Of these, Australia and New Zealand Banking Group and Commonwealth Bank of Australia currently carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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