RBA Minutes – Strong Support for the States

The Minutes of the September meeting of the Reserve Bank Board provided one key insight into the conclusion “It ( the Board) agreed to maintain highly accommodative settings as long as required and to continue to consider how further monetary measures could support the recovery.”

That insight is around a more accommodative approach to semi government borrowers rather than any move to cut the cash rate to 0.1%.

When I wrote last Friday in a note “Next Steps for the RBA” I concluded that a move to a cash rate of 10 basis points from the current 25 basis points would have been consistent with that concept of “further monetary measures” but there appeared to be no urgency.

Arguably, if there had been some urgency then the wording in the section “Considerations for Monetary Policy” would have provided a clear signal that such a development was under consideration.

There was a surprising change in attitude towards the AUD – “ While members noted that the Australian dollar was broadly aligned with its fundamental determinants, a lower exchange rate would provide more assistance to the Australian economy in its recovery.”

I do not believe that this statement is any more than jaw boning and not a precursor to an imminent policy move to lower the AUD- such as a rate cut partly because a modest rate cut (see above) would be seen to be unlikely to succeed given that the key driver of the attractive fundamentals is commodity prices.

This statement is certainly insufficient evidence to suggest the Board is close to adopting more radical policies such as exchange rate intervention or negative rates.

Another important change in the Board’s rhetoric is around the commitment to further purchases of government securities.

For the first time in the “Considerations” section of the Minutes the Board note – “ Members noted that public sector balance sheets in Australia were strong which allowed for the provision of continued support.”

In the discussion on the domestic economy further support to the causes of the State and Territory governments was outlined, “Members noted that state and territory governments had played an important role in complementing income transfers …by increasing direct spending on goods and services and job creation….accounted for a larger share of public demand than the Australian government… debt levels relative to the size of the economy were low for Australian and state governments.”

This indication of support for the state governments is clear even though the official policy target is restricted to the three year AGS.

But bear in mind the comment the “Bank stood ready to purchase AGS and semi-government securities in the event of a recurrence of market disfunction.” Arguably, “market disfunction” could include any unusual changes in semi government borrowing margins given the clear vote of confidence which the Board gives the states in these Minutes.

As we discussed in last week’s note support for the semi’s will also be coming indirectly as the banks may utilise the increased TFF facilities (increased by $57 billion to $210 billion) and the likely reduction in the Committed Loan Facility (currently around $240 billion) which the RBA has extended to the banks in favour of holding more AGS and semi’s.

The debate about a move to a 10 basis point cash rate is not developed in the Minutes. The Board acknowledges that the effective cash rate has held at around 13 basis points and “investors expected it to remain at that level for some time.”

That expectation is a function of continuing easy liquidity as the banks are prepared to borrow and lend at the rate they receive on their Exchange Settlement balances at the RBA, which is 10 basis points.

If the RBA lowered the cash rate to 10 basis points it would be obliged to lower the ESA rate, triggering a lower effective cash rate, although in an environment where the RBA is expected to significantly lift its purchases of AGS and semi’s the resulting surge in ESA balances would be a significant shock to bank profitability.

On this argument the RBA could lower the effective cash rate by lowering the ESA rate without adjusting the cash rate and complicating the signalling around the three year target bond rate.

Comments on the domestic economy were inciteful without being anything really new:

• the downturn had not been as severe as earlier expected.
• the outlook for capital expenditure continued to be weak overall
• household consumption was still expected to increase in the September quarter (despite Victoria) but only partly reverse the contraction seen earlier in the year
• housing rental markets remained weak although, while prices had fallen in Melbourne and Sydney, markets had been mixed elsewhere
• the July increase in employment had been stronger than expected but more timely payroll data had indicated that jobs had declined a little – even outside Victoria, jobs growth had slowed
• wages growth has slowed to record lows; liaison highlighted firms were more likely to have instituted wage freezes than in the past.

We calculate that for the RBA to achieve its 10% unemployment rate forecast by December there will need to be a further loss of jobs near 300,000 – way above our forecast unemployment rate of 7.8%.

Conclusion

There is insufficient evidence from these minutes to change the view from last week, “I do not see such a move as imminent” around the prospect of a cut in the cash rate to 0.1%.

However it seems reasonably clear that the RBA is committed to supporting the semi government sector’s borrowing requirements as it encourages states to lift their spending.

That will happen indirectly through the TFF and the wind down of the CLF, although I expect there will be a significant lift in direct purchases of semi’s by the RBA as we move into the next stages of the budget deficit funding processes.

The jaw boning on the AUD is not a new strategy. The approach has been proven in the past to be ineffective unless there is a sustained policy pivot – I do not think the RBA is even close to such a move which would likely require intervention or negative rates.

That debate is more likely to emerge in 2021.