The RBA has clearly signalled the overriding importance of the labour market and the evolution of the pandemic to policy outcomes.
The minutes of the Reserve Bank Board meeting for November contain no new insights. That is not surprising given that we have seen the Governor’s post meeting Statement, including a one-hour press conference; the November Statement on Monetary Policy and a speech which the Governor delivered to CEDA last night.
The minutes highlight the Board’s view on the effectiveness of lower interest rates, working through lower financing costs for borrowers; contributing to a lower exchange rate; and supporting asset prices, which strengthen balance sheets.
The minutes also highlight the link between targeting the 3 year bond rate and “forward guidance”. The bond rate policy commits the Board to clear forward guidance that the cash rate is expected to remain on hold for “at least 3 years”. Accordingly, a decision to target the 5 year bond rate would have implied an unrealistic level of confidence about an unchanged cash rate for 5 years “beyond that (3 years) members have less confidence about the path of interest rates”.
Markets will now be focussed on whether the Board is likely to continue its QE program beyond the $100 billion of purchases which are scheduled to be completed by June next year.
The important concluding paragraph in the minute’s notes that “the effects of the bond purchases on the economy and market functioning …” and “The Board is prepared to do more if necessary”.
In his speech last night, the Governor neatly set out the four ways in which monetary policy had changed.
- The nature of forward guidance – “we have now moved to place much more weight on actual outcomes rather than forecast outcomes“; a reasonable interpretation here is that particularly due to the combination of globalisation and technology the functioning of labour markets has changed and the need to be pre-emptive with policy has dissipated. It is now appropriate to wait to see inflation firmly within the 2–3% band AND high wages growth, requiring a return to a tight labour market. Arguably he is making the “tight labour market” a necessary condition so, if for example a spike in inflation resulted from a supply shock then that would be an insufficient condition to raise rates.
- Consistent with the above view he emphasises the RBA’s mandate – price stability; full employment; and economic welfare. He confirms the sentiment in 1) by emphasising the need to reduce spare capacity in the labour market – jobs are the central focus and success with jobs will lead to progress on the inflation front.
- He discusses “the gravitational pull of low global interest rates” – if that pull, which reflects the global excess of savings over investment, is overlooked developments around the exchange rate and the economy would be adverse. However, in the Q and A he again describes negative rates as “extraordinarily unlikely” since they make it “harder for banks to lend” although he does accept that the gravitational pull represented by a decision of the US Federal Reserve to go negative would cause a rethink.
- We are now in the world where quantities, not just prices, matter. The RBA’s QE program affects the economy through boosting the liquidity of the banking system, lowering rates, and forcing a reallocation of private sector portfolios away from bonds to other private assets- boosting asset prices. By lowering rates, foreign investors are discouraged from buying AUD assets, lowering the value of the exchange rate.
So, the themes are consistent – the elevation of the labour market over the inflation priority; sensitivity to a rising exchange rate; and the benefits of rising asset prices.
In the Q and A he was asked about excessive froth in the housing market – his own view is that it is unlikely given the collapse in population growth; rising vacancy rates in Sydney and Melbourne; and falling rents. However, he made it clear that the authorities have a successful track record in cooling housing markets through macro prudential policies as we particularly saw in 2015 and 2017/18. There would certainly be no need to direct interest rates at any asset bubbles.
Conclusion
The global outlook which is so closely tied to health outcomes is decidedly uncertain.
Record new caseloads in US and Europe are confronting.
However, the emergence, since the November Board meeting, of two potentially successful vaccines will be watched closely by markets.
From the perspective of the RBA the issue is clearly around the unemployment rate. The minutes refer to an “upside” and “ downside” scenario, although we are given no details except: “ In the downside and upside scenarios the unemployment rate could be significantly higher or lower than projected in the baseline forecast (6% by end 2022), depending largely on the evolution of the pandemic”.
US yields have lifted recently (0.75% to 0.90% in the ten years) partly in response to the news around the vaccines; markets will be closely watching the progress of the vaccines
Markets like to be moving.
Further positive news, on the vaccine front, which might engineer a “reverse gravitational pull” for rates could see the market test the RBA’s commitment to its three year forward guidance.
