What happens if the RBA cuts the cash rate in April to 0.25 per cent?

Prime Minister Scott Morrison. Picture: AAP

Possible dividend cuts and sweeping profit downgrades of the major banks after Tuesday’s decline in official interest rates have raised the stakes ahead of the Reserve Bank board’s next meeting in April.

Josh Frydenberg invoked the national interest while pitching the four chief executives for a full pass-through of the rate adjustment. So what does that mean if the RBA again slashes the cash rate in April to 0.25 per cent?

Barring a surprise intervention of common sense, the same pattern of behaviour will be repeated - Scott Morrison or Frydenberg will speed-dial the CEOs and tell them what they can do for their country.

The Prime Minister is locked into a bizarre political narrative that it’s the right thing to do, despite incontrovertible evidence that debt reduction and household deleveraging is consuming the benefit of lower variable mortgage rates.

It’s not only happening with mortgage debt; credit card repayments have also spiked to a record high in a completely rational response to uncertain economic times.

Instead of jawboning the banks after effectively handing over responsibility for economic policy to RBA governor Philip Lowe, the most sensible thing Morrison could do in the face of a March-quarter economic contraction is to conscript the federal budget into the battle.

The “targeted, modest and scaleable” stimulus flagged by the government is nowhere near enough.

The PM’s obsession with the budget surplus - or minimising the deficit - is starting to have serious implications for the banks.

The recent rout in major-bank share prices, precipitated by the global spread of the coronavirus, resumed on Tuesday at 2.31pm after Westpac said it would pass on the RBA rate cut in full.

Of the big four banks’ deposit balances, about 23 per cent, or $400bn, is priced at below 0.25 per cent.

Those deposits are effectively corralled from further cuts to help offset lower lending rates, which means another crunch in industry profit margins already under extreme pressure.

While the major banks are well-funded and comfortably ahead of schedule in their wholesale funding programs, global investors understand the difference between a good credit risk and one with a deteriorating margin profile.

They will have no hesitation in pricing for risk, or passing up the opportunity altogether if a bond issue is mispriced.

That’s the danger in repeatedly forcing the banks to make uncommercial rate decisions.

The news is no better on the equities side.

Macquarie forecast a 5 per cent impact on bank earnings from Tuesday’s events, with UBS predicting a slide in the range of 3-4 per cent from profit forecasts that were already 8 per cent below the market’s consensus.

Macquarie noted that the sector had said after last October’s rate cut that it would no longer be feasible to pass on future cuts in full.

UBS analyst Jon Mott said that with rates near zero for the foreseeable future, the sector’s return on equity was likely to fall towards single digits, putting further pressure on dividends and internal capital generation.

It’s not a pretty picture.