The Reserve Bank Board meets next week on November 3. The Bank will also release its November Statement on Monetary Policy on November 6 where it will provide detailed colour around the policy decisions and print its revised growth forecasts. The Bank has not updated its forecasts since August 7.
Our views on the likely decision by the RBA on November 3 have been clear since our note on September 23:
“All the key policy rates – cash rate; three year target bond rate; and rate on Term Funding Facility will be cut from 25bps to 10bps.
The rate on surplus Exchange Settlement balances will be cut from 10bps to 1bp.
The Board will announce a change in its bond purchase program from ensuring the smooth functioning of the bond market and ensuring that the 3 year bond rate holds at the target rate to a more general role of purchasing Australian government bonds and semi government bonds, across the curve, including maturities in the 5–10 year range”.
We had not envisaged the Board setting a specific quantity target for the bond/semi government purchase program. It is already setting a price target for the 3 year rate. Fixing both price and quantity targets may lead to unexpected difficulties down the track.
Markets seem to differ, expecting a total purchase program, including, ideally, a weekly ‘timetable’ for the purchases and a finish date.
With markets expecting a specific volume target, the announcement of an open ended commitment might cause market disappointment with a potential lift in market yields and the AUD.
A “compromise” approach to the price/quantity issue might be to announce a “minimum” purchase program but that might also disappoint markets if the “minimum” is lower than their expected target.
Our forecast that the ESA rate will be cut to one basis point has not been the consensus view.
The choice of the ESA rate will be important.
If we are wrong and the Board only cuts the ESA rate to five basis points then the effective cash rate will fall to around 7–8bps providing a very slim funding margin to attract investors into a 3 year bond rate of 10bps. Under such circumstances the Bank may have to expend considerable balance sheet to support the 3 year target.
The “downside” with the one basis point ESA rate is that, on particular days of high liquidity, large institutional depositors may be offered negative deposit rates. Banks would need to balance the impact of such policies on the need to maintain solid long term relationships.
From the RBA’s perspective a negative BBSW, which would flow from negative wholesale deposit rates, should not be of much concern. The differential between retail; wholesale; and policy rates would be clear.
To that point, in discussing issues around the use of negative policy rates in Australia we have always argued that negative policy rates would mean negative wholesale rates but not negative retail rates as banks only rely on retail for around 60% of their funding.
Our views on the size and growth rate of the RBA’s balance sheet have been set out in recent notes.
The RBA’s balance sheet ($300bn) is around 15% of GDP – well below the Bank of Canada’s, currently at 20%.
These compare with the Bank of England and Federal Reserve at around 33%, and the ECB well clear of 50%.
Are there any limits to the size of the RBA’s balance sheet? Arguably, not in an absolute sense – but clearly for an inflationtargeting central bank in a world of consistent under performance on inflation we are certainly, in the case of Australia, a fair way away from any upper limit.
To reach the 20% of Bank of Canada, the RBA would need to increase its balance sheet by around $100bn. But remember that there is still $114bn in undrawn capacity in the Term Funding Facility (TFF).
If the TFF rate is cut to 10bps, providing banks and other ADIs with 3 year funding at 10bps, the eventual full draw-down seems highly likely.
It would be prudent to estimate an eventual drawdown in the TFF of a further $150bn, with $114bn qualifying to date.
Accordingly I expect that RBA would factor in a further increase in the balance sheet to, say, $450bn as the TFF is fully drawn down by June next year. Note that increasing the balance sheet to $450bn would represent a 250% increase over the pre COVID level, which compares with the Federal Reserve’s current increase of around 90% since COVID (these calculations assume a steady level of reverse repo facilities, which have been scaled back recently).
This equates with an RBA balance sheet of 23% of GDP – higher than Bank of Canada and RBNZ, and around $200bn below the size that would see ratios on a par with the Federal Reserve and the Bank of England.
While any announcement of a specific purchase volume would be over an extended period, say to June 2021, I doubt whether the RBA would be prepared to rush its balance to Federal Reserve or Bank of England proportions so quickly.
A commitment to $100bn, which seems to be a ‘market favourite’, would see an implied commitment to boost the balance sheet to $550bn or 28.5% of GDP – well clear of the current ratios of the Bank of Canada and RBNZ.
That balance sheet would see a 300% increase on pre COVID levels – certainly a strong signal but a signal the market is requiring.
That ‘market favourite’ may well be acceptable to the RBA.
Personally, given that it is already committed to a yield target, I would opt for a more open commitment but can certainly see that a $100bn target would be manageable without forcing the RBA to abruptly lift its balance sheet to Federal Reserve and Bank of England proportions.
The Growth Forecasts
In its most recent Statement on Monetary Policy (August 7) the RBA forecast GDP growth for 2020 at –6%; 2021 at 5%; and 2022 at 4% (on a through the year basis).
The forecast unemployment rate in December 2020 was 10%; December 2021, 8.5% and December 2022, 7%.
Westpac’s equivalent unemployment rate forecasts on August 7 were: 8.6% for 2020; 7.4%, 2021; and 6.5%, 2022.
Recall that the RBA’s forecasts were released in the aftermath of the announcement that Victoria was entering a Stage 4 lockdown.
In fact, as a result of that announcement we lowered our own growth forecast for 2020 from -4.2% to -4.7% with no changes to forecast growth in 2021 at 3.0% and 2.7% in 2022.
Since August 7; partial data has shown that the contraction in Victoria has been more mild than initially anticipated; the labour market has been more resilient; and outside Victoria, the reopening of the economy and containment of the virus has been much more successful than expected; while the Federal Budget on October 6 also boosted the growth outlook.
Accordingly, on October 9, we revised our growth forecasts to –3.5% for 2020; 2.8%, 2021; and 3.5%, 2022.
Our unemployment forecasts are 7.5% for December 2020; 7.5%, December 2021; and 6.6% at December 2022.
We can get a guide as to how “official” growth forecasts may have evolved since early August by comparing the Budget forecasts, which are on a fiscal “year average” basis with the RBA’s comparable forecasts back in August.
Back in August the RBA was forecasting 2020/21 year average growth at –3% and 2021/22 at 5%.
In the October 6 Budget the government forecast year average growth in 2020/21 at –1.5% and 2021/22 at 4.75%.
It also forecast the unemployment rate in June 2021 at 7.25% and 6.5% in June 2022.
That compared with the RBA’s unemployment forecasts in August at 9% June 2021 and 7.5% for June 2022.
Westpac’s current forecasts on the year average basis are: –1.4% (2020/21) and 3.4% (2021/22).
On the basis of these comparisons we expect that the RBA will forecast –1.75% (upgraded from –3%) for 2020/21 year average growth.
That would be reasonably close to the current Westpac forecast although incorporates a more cautious near-term outlook, (3.5% rather than 4% growth over the second half of 2020).
Recent commentary from the RBA Deputy Governor that the September quarter will now be positive, ending the technical recession, suggests the RBA might revise it’s through the year 2020 growth number to around –4.0% (compared to Westpac’s –3.5%), upgraded from –6.0% in August.
For the 2021/22 financial year, we doubt whether the RBA would “go all the way” with the government’s 4.75% (year average), possibly opting for 4% (downgraded from 5% in August).
These likely RBA forecasts for 2020/21 and 2021/22 of -1.75% and +4.0% year average imply a through the year rate of around 3.5% for 2021. They also imply a through the year growth rate of around 3.75% in 2022, near the August forecast of 4.0% and reasonably close to Westpac’s 3.5%.
As discussed, the RBA was forecasting the unemployment rate at 9% for June 2021 and 7.5% for June 2022 in August.
That compares with the Budget forecasts of 7.25% and 6.5% respectively.
Note that the Budget forecasts for employment growth to June 2021 and June 2022 respectively were 2.75% and 1.75%.
That compares with the RBA’s employment growth forecasts in August of 0% and 4%!
The RBA is likely to make some very significant changes to its unemployment forecasts with December 2021 being revised down from 8.5% to 7.0%.
The Table below contrasts our forecasts for the RBA’s key revisions which will be released on November 6 with our own forecasts.
