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Analyst report
Cash injection won’t help liquidity crisis
December 5, 2007
Brendon Lau, ShareAnalysis
One of the factors hammering global equities is the sudden and sharp withdrawal of investor funds from the markets. Central banks around the world, including Australia, have responded by injecting unprecedented amounts of money into their respective domestic markets to ease the liquidity crisis. So how does the Reserve Bank of Australia (RBA) boost liquidity and how does this affect you?
The most obvious way the RBA tries to control liquidity in the banking system is by adjusting the cash rate target (this is the interest rate that caused John Howard grief this election past). The cash rate is the interest rate charged on overnight loans between financial intermediaries and it is often the benchmark used to price other financial instruments, especially short-term loans and bank bills. However, since the onset of the credit crisis, overnight and short-term interest rates have risen well above the RBA's target cash rate (left at 6.75% by the RBA today).
This has made the job of the Domestic Markets Department (DMD) in the RBA a lot more challenging. This department is responsible for maintaining conditions in the money market so as to keep the overnight cash rate at or near the target decided by the RBA board.
The DMD does this by controlling the supply of funds that banks use to settle transactions among themselves. Since banks are required to deposit funds in their exchange settlement accounts held by the RBA, the DMD can choose to release more or less funds to influence the short-term yields on the money market.
For example, if the RBA releases more exchange settlement funds than the commercial banks wish to hold, the banks will try to shed funds by lending more in the cash market, resulting in a tendency for the cash rate to fall.
This operation, sometimes called 'open market operations', is hardly exact. While the RBA's initial intervention has helped to calm financial markets, the spreads between the 90- and 180-day bank bill rates and the cash rate are still wider than they have been historically. The RBA is a potent balancing force in our economy, but there are limits on its influence over our financial markets.
Consumers may be already feeling the pinch, as interest rates on some types of consumer loans have risen out-of-step with the RBA's target cash rate. Non-bank lenders have also raised mortgage rates recently by more than the 0.25% rate hike early this month, and the Big Four banks are threatening to follow suit.
Since the Australian economy is growing so strongly (hence the threat of more interest rate hikes in the coming months), the good news is most consumers should be able to wear these rate hikes with only minor discomfort.
Brendon Lau is the editor of ShareAnalysis, a premium retail investment service offered by Aegis Equities Research. Click here for your free trial.
More articles from this edition of CompareShares:
Investing: How to make money from new energy plays
Stocks: Stocks for the Long Haul – QBE and Leighton Holdings
Resident Trader: A frustrating foray into forex
Trading: The ultimate guide to trading shares for beginners - part 4
Markets: Cash injection won't help liquidity crisis
Economics: Inflation pressures just “tommy rot”
Outlook: The impact of commodities prices on mining companies
Rates: RBA leaves rates on hold
IPOs: Surge of IPOs deliver scant returns
Markets: ECB, US officials downbeat on recovery
Please note that CompareShares.com.au simply publishes analyst reports on this page. The publication of these reports does not in any way constitute a recommendation on the part of CompareShares.com.au. You should seek professional advice before making any investment decisions. |
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