The Reserve Bank has given its clearest signal yet that the benchmark official cash rate (OCR) could be cut below zero, with a new programme to lend directly to banks at ultra low rates.
Coupled with further advice from governor Adrian Orr that banks should pass on the full benefit of lower funding costs to customers, an unexpectedly dovish stance offers the prospect of materially lower borrowing costs for households and businesses next year.
On Wednesday the Reserve Bank left the OCR at 0.25 per cent, as expected, but increased its quantitative easing programme - sometimes referred to as 'printing money' - by $40 billion to $100b.
After slashing the OCR to its record low in March, for several months the central bank has been purchasing close to $1 billion of bonds a week in a bid to drive down interest rates to help stimulate activity.
While the bank has committed to leaving the OCR unchanged until at least March 2021, Wednesday's monetary policy statement gave a strong signal that beyond that, it is prepared to move lower.
The monetary policy committee "expressed a preference for considering a package of a negative OCR and a 'funding for lending programme'," in addition to its asset purchase programme, a summary of the committee's meeting said.
As well as keeping to its March commitment of an 0.25 per cent OCR, the next moves to add stimulus to the economy would depend on whether the systems of the retail banks were ready to cope with negative rates.
Although the OCR influences borrowing rates, bank funding costs are also dictated by local deposits and wholesale funding costs.
Wednesday's comments about a "funding for lending programme" shows the central bank is considering removing the uncertainty of the international credit market by direct lending.
Assistant governor Christian Hawkesby said the programme was one where banks "are able to get funding directly from us" at near OCR rates.
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"That gives us an assurance that banks will be in a position to lower their funding costs and then pass that on to their household and business customers, in terms of lower lending rates."
The yields on both bonds and interest rate swaps fell on the statement, as bank economists said it raised the odds of further interest rate cuts.
Westpac chief economist Dominick Stephens, who has been forecasting that the OCR will drop to -0.5 per cent in April, said the announcement "is a major shot in the arm for our forecast".
ANZ chief economist Sharon Zollner said the odds of negative interest rates had clearly risen.
"It is hard to imagine a more dovish set of policies and commentary today," Zollner said in a note.
ANZ said a funding for lending programme meant bank funding costs would cost even if other bank funding conditions tightened. But the move could come with strings attached by the central bank.
"Overseas, such programmes have tended to have conditions regarding lending growth attached, often to small and medium sized enterprises]."
The Reserve Bank said in its statement that it believed it was in the long-term interest of banks to "fully pass on the benefits of lower funding costs to their customers".
During the bank's press conference Orr said the pass through of lower rates had been "broadly one-to-one to date" although there had been some timing issues.
"That's not to say we aren't watching incredibly closely around risk appetite, around credit lending criteria and willingness to take on new customers."