The Reserve Bank tapped hard on the accelerator on Tuesday, reducing a range of interest rates, including the cash rate, and announcing a more aggressive approach towards quantitative easing, according to an analysis by St.George chief economist Besa Deda.
The cash rate was reduced from 0.25 per cent to a new record low of 0.10 per cent.
“These days, monetary policy is more than adjusting the cash rate,” Ms Deda said. “The RBA also seeks to influence yields across the yield curve.”
In March, the RBA began setting a target for the three-year government bond yield by buying and selling bonds across the curve (called yield-curve control). The target was set at “around” 0.25 per cent and was reduced to 0.10 per cent on Tuesday.
RBA governor Philip Lowe, in his accompanying press conference, stressed this was the new lower bound and re-asserted that negative rates remained “extraordinarily unlikely”. He did concede, however, that if other major central banks all have negative rates, then the RBA would have to consider them.
“In its effort to support businesses and job creation, the RBA in March also introduced a Term Funding Facility whereby lenders could borrow from this fund to on-lend to clients,” Ms Deda said.
“The borrowing rate from this fund was initially set at 0.25 per cent and was also reduced on Tuesday to 0.10 per cent.”
Another arm of the RBA’s monetary policy is the operation of its Exchange Settlement account. Banks and other authorised deposit institutions (ADIs) hold accounts with the RBA and bank funds can sit there.
The rate on those accounts, prior to the RBA board meeting, was 0.10 per cent. On Tuesday that rate was reduced to zero.
“With a zero rate, there is no incentive for banks to hold funds in these accounts,” Ms Deda said. “The expectation is that banks will seek out better yielding alternatives. When lent out, these funds can assist business activity.”
In a new move, the RBA will introduce a bond-buying program (i.e. quantitative easing) for maturities beyond three years. It now plans to purchase $100 billion of government and state bonds in the five- to 10-year range over the next six months, thus impacting on yields further along the yield curve.
Ms Deda said the RBA now had a price target (for the three-year bond yield) and a quantity target (for its bond buying program for maturities of five to 10-years).
“The new bond-buying program matches the QE programs of other central banks, which the RBA hopes will bring down yields at the longer end of the Australian yield curve and reduce the demand for the Australian dollar (than otherwise would be the case),” she said.
“A more competitive currency would help bolster the trade sector and economic recovery.
“Why is $100 billion the magic number? The governor explained that international experience suggests 5 per cent of gross domestic product (GDP) is what has a meaningful effect on the currency and bond yields. For Australia that is around $100 billion.”
RBA governor Lowe also said that if this amount proved to be wrong, it would adjust the numbers.
Dr Lowe’s speech, following the changes to monetary policy, stressed that the RBA intended to play its part in assisting the recovery and creating jobs.
“The RBA is concerned about the long-lasting effects from the pandemic, especially on jobs, and hopes the delivery of these new stimulus measures will reduce the risk of high unemployment,” Ms Deda said.
“A sharp bounce back in jobs is unlikely but the priority is clearly on job creation.
“Importantly, the governor stated that the RBA board is prepared to do more if necessary. The board will keep the size of the bond purchase program under review, particularly in light of the outlook for jobs and inflation.
“Tuesday’s rate changes, and the forward guidance it has given, reduce the cost and the risk of borrowing. They should also aid recovery via their impact upon business and household balance sheets.
“But will they really work? The RBA is of the view that with lockdown restrictions across the economy lifted, its policies will gain more traction. Recent statistics on home lending, building approvals and consumer sentiment suggest that green shoots are emerging in the economy.
“Tuesday’s announcements will encourage growth.
“The governor’s statement acknowledged that recovery was underway. It also acknowledged that some of its early concerns were not met. Accordingly, it now forecasts that the rate of unemployment will peak a little below 8 per cent rather than the 10 per cent expected some months ago.
“It now also expects the unemployment rate to sit around 6.0 per cent by the end of 2022 (down from 7.0 per cent previously forecast).”
The RBA also upgraded its near-term economic growth forecasts. GDP growth in the year to June 2021 is now anticipated to be 6 per cent, compared with 4 per cent previously.
However, Dr Lowe made it clear that the economy remained in the grips of a recession, although the narrow definition of a technical recession would not be met – with solid growth in the September quarter expected by the RBA.
“Given the slack in the labour market, the RBA notes that wages growth will be weak over the next few years,” Ms Deda said. “This is important for its inflation outlook given that wages are a major business cost.
“With wage growth low, it will take longer for inflation to reach the RBA’s 2-3 per cent per annum inflation target. From this flows the remark made by the governor that ‘the board is not expecting to increase the cash rate for at least three years’.
“The governor explained in his press conference that there was less certainty beyond three years, but he hoped within the next five years, the economy would begin to show signs of recalibrating and policy would begin to normalise.
“Is the RBA out of firepower? The governor says ‘no’ and it has additional policy tools if needed.”
Tuesday’s policy package is designed to work via three channels, Ms Deda said.
Lower lending rates should lift cash flows and so lift spending.
There will be downward pressure on the Australian dollar because of lower bond yields. This will aid export industries and those receiving income from abroad.
Lower yields and access to credit will put upward pressure on asset prices. This will strengthen personal and business balance sheets allowing more scope for spending.
“Together, the RBA policy package and the recent Budget announcements should help create jobs and aid in the recovery of the economy,” she said.