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Why the RBA is depressing ASX shares and lifting the Aussie this afternoon

The S&P/ASX 200 Index (Index:^AXJO) traded at an intraday low after the Reserve Bank of Australia (RBA) released its interest rate decision.

While the top 200 stock benchmark fell 1.6% to 5,202 on the news, reversing its morning gains, the Australian dollar hung on to its 0.9% increase to trade at US61.4 cents.

But it isn’t interest rates that were moving ASX shares and the Aussie battler. The RBA is left with no more room to cut the record low cash rate, which sits at 0.25%.

Coronavirus and QE

Attention is instead on its unprecedented quantitative easing (QE) program to drive down borrowing costs. Our central bank said it was sticking with this program, in which the central bank buys government bonds to drive down yields.

The fact that it wasn’t taking a more aggressive stance or talking about expanding its QE measures are the likely reasons why equities are moving in the opposite direction to our dollar.

QE increases the amount of cash in our financial system. This tends to lift demand for risk assets while depressing the value of the Aussie.

Good news for ASX banks

The RBA intends on keeping the cash rate and the three-year Australian government bond yield at 0.25% until we have full employment and inflation.

That’s good news for ASX banks. Many of them, including National Australia Bank Ltd. (ASX: NAB) and Westpac Banking Corp (ASX: WBC) have moved to offer three-year fixed mortgages at record low rates of around 2.29%.

Our big banks, which are essentially back-stopped by the federal government, can borrow at rates that are only a little above the RBA’s target of 0.25%.

The banks will be hoping that more borrowers opt for the lock in as that will protect their precious but pressured net interest margin during these volatile times.

Don’t bet on a bigger QE

“Since this target was introduced, the Bank has bought around $36 billion of government bonds in secondary markets, including bonds issued by the states and territories,” said RBA governor Philip Lowe.

“The Bank will continue to promote the smooth functioning of these important markets. If conditions continue to improve, though, it is likely that smaller and less frequent purchases of government bonds will be required.”

It almost sounds like the RBA is ready to take its foot off the QE accelerator!

Record low rates here to stay

But it will be a long time before the RBA lifts the cash rate. The fact is, we should get used to low rates for a long time.

While the coronavirus growth curve is flattening, the jobless rate won’t be going back to the low 5% level till long after the pandemic is over.

This is because job losses happen a lot quicker than rehiring. We were already struggling with low wage growth before the global COVID-19 outbreak, remember?

So, inflation isn’t likely to be much of an issue until the demand for labour materially exceeds supply.

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Motley Fool contributor Brendon Lau owns shares of Westpac Banking and National Australia Bank Ltd. The Motley Fool Australia owns shares of National Australia Bank Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.