The RBA Governor has opened up the prospect of further QE having already decided on a policy which is more aggressive than expected.
As expected the Reserve Bank Board decided to cut the cash rate target from 0.25% to 0.1%; cut the target yield on the 3 year bond from 0.25% to “around” 0.1%; cut the rate on new drawings under the Term Funding Facility from 0.25% to 0.1%; and cut the rate Exchange Settlement balances from 0.1% to zero.
A five year yield target was considered but five years was considered to be too far out to be confident that rates would not be increased over the period.
The Board has also committed to purchases of government bonds of maturities of around 5 to 10 years over the next six months. Those purchases will be issued by the Australian Government and the states and territories with an expected 80/20 split. The bonds will be bought in the secondary market through regular auctions with weekly purchases of around $ 5 billion.
The Governor indicated the RBA had not ruled out buying bonds outside that maturity spectrum.
The Governor confirmed the objective of lowering the Australian dollar through a lower long term bond rate – dissuading foreign investors of purchasing AGS with reducing a resulting upward pressure on the exchange rate.
Purchases of AGS will be conducted on Mondays (5 to 7 years); and Thursdays (7 to 10 years) while semi purchases will be conducted on Wednesdays.
The size of the initial purchases of AGS will be around $2 billion and $1 billion for the semi’s.
In addition, the Bank is prepared to purchase bonds in whatever quantity is required to achieve the 3 year yield target. These purchases will not form part of the $100 billion program.
Market Consensus was a purchase program of $100 billion (across all maturities) so by complementing that $100 billion with the 3 year open ended program this announcement represents a more aggressive approach than expected, in particular restricting the $100 billion to the longer term maturities.
The Governor indicated that the choice of $100 billion (5% of GDP) was based on observations of other central banks where around 5% of GDP had a meaningful impact on markets and policy objectives.
While we respected market Consensus our preferred approach would have been to retain more flexibility so it is not surprising that this announcement has lowered bond rates.
The Board will “keep the size of the bond purchase program under review and “is prepared to do more if necessary”.
As we have discussed in earlier notes this Consensus view of the likely bond purchase program would see the RBA’s balance sheet increase to around $550 billion – $ 300 billion currently plus, say, $140 billion for the TFF (entities have access to a further $104 billion and the facility may increase before final drawdown in June 2021) plus $100 billion in the new facility. In addition, we should allocate some balance sheet to defend the 3 year bond rate target of 0.1% (say $10 billion).
That would lift the balance sheet to, say, $550 billion or 27.5% of GDP. That growth will see the RBA increasing its balance sheet which was $180 billion before COVID by a stunning 300%.
In contrast the Federal Reserve has increased its balance sheet since COVID from $3.8 trillion to $7.05 trillion – an increase of 85%. The FED’s balance sheet is now around 33% of GDP.
The RBA will be very rapidly closing in on the FED from a “standing start”!
We had been concerned about the issue for the RBA of setting a price (the three year bond rate target) and a quantity. The RBA has neatly got around that issue by restricting the purchase program to the 5 year plus maturity part of the curve and leaving the volume of purchases necessary to achieve the three year target open ended.
The decision to set the rate on Exchange Settlement balances at zero is a surprise. Arguably, Consensus was that the rate would be set at five basis points to ensure that short term private rates remained positive. Our view was that it was likely to be set at one basis point. We speculated that such a decision would open up the possibility of negative short term (not policy) rates since banks would not be motivated to take wholesale deposits at positive rates if the alternative use of the funds was ESA investment at one basis point.
Under a zero ESA rate the decision to offer a positive deposit rate will be even more difficult. Of course, banks will need to weigh that issue against long term relationships.
However, the Governor confirmed the Board’s view that a negative policy rate is “extraordinarily unlikely” – the main issue being the impact of negative rates on the supply of credit.
The most likely reason why this might change is if “the biggest central banks in the world” went negative – presumably that means the Federal Reserve given that the ECB and BOJ are already negative.
The Governor has also released the Bank’s revised forecasts for growth; unemployment; and inflation.
Last week we forecast that the RBA would revise down their forecast for the unemployment rate from 10% by December to 8% and to 6.5% by end 2022.
The Governor announced that the forecast is now just below 8% in December 2020 and 6% by end 2022 – slightly more optimistic than we had anticipated.
We expected that the RBA’s GDP growth forecast for 2020; 2021; and 2022 would be –4%;3.5%; and 3.75%.
The Governor announced growth forecasts of 6% (year to June 2021) and 4% (year to June 2022). Our -4% estimate for 2020 implies an assumption of around 3.5% growth in 2020 H2 and we expected around a 2% assumption for 2021 H1 meaning around 5.5% for June 2021 – a little lower than the Governor’s 6% forecast.
Our forecasts would have implied a June 2022 growth rate of 3.5%, once again slightly lower than the RBA’s forecast.
The Bank’s inflation forecasts are in line with general expectations.
Conclusion
These moves are more aggressive than we had expected and the Governor has certainly left open the possibility for further QE.
On the other hand, while the decision on the ESA zero rate opens up the possibility of negative short term private rates a choice of a negative policy rate is still “extraordinarily unlikely”.
This analysis has been based on the official Statement from the Governor and his one hour press conference.
