By Jukka Viljanmaa, Senior Investment Manager, TPT Wealth

The Reserve Bank of Australia (RBA) sets a target for the cash rate, which is the interest rate on unsecured overnight loans between banks. It is considered the risk-free benchmark rate for the Australian dollar. The RBA last reduced the target for the cash rate twice in March 2020 to the all-time low level 0.25%. In comparison, during the Global Financial Crisis the RBA lowered the cash rate target to 3.00% and kept it there for 6 months before raising it up to 4.75%.

On 1 July the overnight cash rate was set at 0.14%. This rate is the actual rate that banks lend unsecured funds to each other overnight. Typically the cash rate target and the overnight cash rate do not differ.

The current discrepancy arises from the liquidity being injected into the financial system by the RBA’s asset purchase programs and the 0.10% that banks earn on Exchange Settlement balances, which is essentially excess liquidity held with the RBA. Currently the Exchange Settlement balance is around $40 billion, whereas historically the balance is approximately $2 to $3 billion.

Due to the excess liquidity within the financial system the overnight cash rate is gravitating towards the 0.10% earned on Exchange Settlement balances. In this environment this is a significant discount which is flowing through to reference rates used to set the yield on short term money market securities, known as the bank bill swap rate or BBSW.

As conditions normalise expect the BBSW and the overnight cash rate to move towards the cash rate target. This would be the first indication that the RBA is looking to raise rates. The RBA has stated that negative interest rates are “extraordinarily unlikely” pegging the three-year bond rate to 0.25%, indicating the cash rate will remain at 0.25% for some time.

As an asset manager, TPT Wealth consider the value on offer across the term structure and credit spread through every economic cycle. With these currently low interest rates we consider not only the compensation we receive for longer term investments but also the value we receive for our short term investments. We actively monitor our Funds’ investments and investment guidelines with the aim to keep them appropriate for each stage of the business cycle as we look to produce risk adjusted returns for our investors. Contact us or read our Managed Investment section to learn more about our Cash and Income Funds, the risks, returns, warnings and redemption periods.

The views and opinions expressed are presented for informational purposes only and are a reflection of TPT Wealth’s Investment Management’s best judgment at the time the content was compiled.