The RBA Board kept rates on hold at its meeting today. The recent earlier than expected opening up of the economy has raised the possibility with the Board that the depth of the economic downturn might be less than previously expected.
As expected the Reserve Bank Board kept the cash rate and three year bond rate target on hold at its June meeting.
The Governor notes that declining infection rates (in many countries) and some easing of restrictions which, if that were to continue, would get the recovery in the global economy underway.
For Australia, the Governor notes that “it is possible that the depth of the downturn will be less than earlier expected”, with ”some restrictions have been eased earlier than previously thought likely”. Hours worked have stabilised and there has been a pick up in some forms of consumer spending.
However the Governor rightly observes that the outlook remains highly uncertain with the pandemic likely to have long lasting effects on the economy.
He points out that it is likely that fiscal and monetary support will be required for some time.
The guidance around the two forms of monetary support for the economy remains consistent. For the three year bond rate target of 0.25% the Governor notes that, “the target will remain in place until progress is being made towards the goals of full employment and inflation”; for the cash rate target the comment is “will not increase until progress is being made towards full employment and it is confident that inflation will be sustainably within the 2–3 per cent target band”.
It is our forecast that the three year target will hold until 2022 and then the rate will be lifted. Presumably, the somewhat different language around the two targets implies that the three year target could be changed even if the inflation rate had not established ( or even reached) the 2–3 per cent range whereas the cash rate would only be lifted if the inflation had been firmly established near the middle of the 2–3 per cent range.
The Bank’s own forecasts which were released on May 8, with the Statement on Monetary Policy, are for the unemployment rate to still be well above the full employment level (4.5%), at 6.5%, at June 2022 with the inflation below the bottom of the band at 1.5%.
On May 29 I published a note titled “Why Negative Rates should figure in the Policy Debate”. The Governor has stated that a negative cash rate is “extraordinarily unlikely”. As a small open economy with a strong banking system and limited reliance on retail deposits, a negative cash rate is likely to provide a considerable boost to Australia’s international competitiveness through exerting downward pressure on the AUD; incentivise institutions and corporates to invest and employ; boost asset prices; and lift disposable incomes. This could be achieved without the need to impose negative rates right across the yield curve. Such a policy may also ease the need to weigh down the central bank’s balance sheet with an excessive volume of government and, potentially, private sector securities as we have seen in the US
I also concurred that the impact on confidence of negative rates would be the major hurdle for going in that direction. However, once households realised that retail deposit rates and mortgage rates would not go negative and the negative rates would be restricted to the wholesale sector confidence concerns might ease. Certainly from the markets’ perspective the willingness to take the cash rate into negative territory would strengthen the RBA’s commitment to achieving its objectives.
In the note I pointed out that the RBA’s current forecasts are broadly in line with our own . We need to heed the strong views of the decision makers and, accordingly, our base case is still for the cash rate to remain at 0.25% beyond the end of 2023.
Today’s statement from the Governor implies that the Board may be seeing upside risks to their forecasts which would allow further time to assess the situation.
However, as discussed in the note on May 29, “Until we get more clarity around the way in which the economy develops the current policy is appropriate. However a serious case can be made for the RBA to consider further cuts and entering negative territory for the cash rate if it becomes apparent that the economy is deteriorating even more than is currently expected”.
