Analysis: Cash Rate Returning to Normal Attributes, Thanks to RBA

By Sophia Rodrigues

For seven days in a row, Australia’s interbank overnight cash rate was the same as the highest and lowest rate of the day, marking a return of the long regime where the Reserve Bank ensured the cash rate displayed such characteristics.

There is one difference -- the cash rate now is 12bps below the RBA’s target whereas in the past it was exactly equal to the target.

And there is one similarity – like in the past, the cash rate has been guided to its level by the RBA.

It is no coincidence that the cash rate, including the highest and the lowest rate, has been at 0.13% since June 15 when the RBA set the cash rate at that level.

On that day the RBA, instead of publishing the cash rate based on the previous day’s rate, decided to determine a rate that reflects the interest rate relevant to unsecured overnight funds for cash market participants, based on expert judgement and market conditions.

In some ways, on that day the RBA guided the cash rate to a level where it wants it to be. In other words, it was like setting a cash rate target.

The RBA could have gone as low as 10bps but didn’t because at that level there is no incentive for anyone to lend in the overnight market because it remunerates Exchange Settlement balances at 10bps.

The rate could probably go to 0.12% or 0.11%, but the RBA likely sees 3bps as a good spread to encourage some interbank activity, knowing fully well that activity could easily drop to zero for a long period if liquidity increases significantly.

So far, the record low volume has been A$42 million on May 12.

(Stay tuned for part two of this article where I discuss the RBA’s strategy on the cash rate, going ahead).