Reserve Bank of Australia
An office worker walks past the Reserve Bank of Australia (RBA) building in central Sydney, Australia, March 1, 2016. Reuters/David Gray

All eyes are on the Reserve Bank of Australia (RBA) as the monetary board of the central bank meets on Tuesday, Aug 2, to decide on the key lending rate. Given recent inflation data, majority of economists believe the RBA would cut interest rate which spells bad news for Australian banks.

The Australian Financial Review cites a Friday survey of economists by Reuters that places a 64 percent chance of the RBA cutting interest rate based on response of 36 out of 47 economists surveyed. But NAB believes otherwise based on the bank’s belief that market price reaction would be greater if the central bank leaves the rate untouched at 1.75 percent.

NAB based its prediction on the RBA’s growth and inflation forecasts have not been materially altered since the board’s last meeting in July and the last set of published RBA forecasts released in May. It adds that market conditions and international factors hint new downside risks of a rate cut.

In a Sydney Morning Herald comment, Clancy Yeates says that rate cuts spell bad news for Australian banks. He notes that reports on RBA rate cut decisions always focus on the interest rates that borrowers would pay and not on the impact of the decision on bank depositors.

Yeates cites experience of banks overseas that there are limits on how low central banks could set deposit rates which continue to squeeze the lenders’ profits. He stresses that ultra-low interest rates drag bank profits and Yeates believes it would soon become apparent on the big four.

If the RBA would cut rates, Yeates says the big banks would be deeply reluctant to pass on any future cuts in the key lending rate to home loan customers. He notes falling interest rates cause fewer borrowers to default on their loans. But while it is good for banks, customers pay back their debt more quickly, resulting in banks competing more fiercely for loan growth.

Yeates adds despite some Australian banks offering special rates of 2.5 percent, the lenders would still reach a point when customers would think the rate would not be worth the trouble of locking their money with the bank. He cites that based on RBA figures, the most competitive special interest rates on term deposits have gone down by 0.15 percentage points, lower than the 0.25 percent cut in average lending rates since May 2015.

CommSec chief economist Craig James explains in the video below why he believes the RBA would cut the interest rate to 1.5 percent.

VIDEO: RBA Preview 1 Aug 16: Expect RBA to cut the cash rate to 1.5%

Source: CommSecTV

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