In deciding to announce the extension of the QE program in February rather than March the RBA is emphasising its confidence in the need to maintain a very stimulatory policy despite the recent faster than expected recovery. The Bank’s forecasts are now in line with the Westpac forecasts which are consistent with further QE extensions and maintenance of Yield Curve Control through 2021.
The Reserve Bank Board decided to extend the current bond purchase program by a further $100 billion. The purchases in the second tranche will begin in mid- April when the current program is set to be completed (that completion date could be as early as April 9).
The new program will be a repeat of the first program – $5 billion of purchases per week at the same mix of 80% Australian Government Securities and 20% semi government issues (although this exact mix is not spelled out in the Governor’s Statement).
Westpac expected that the Bank would extend the $100 billion program although favoured moving the ratio to 70% AGS and 30% semis to provide further relative support for the semis.
We pointed out that the current program could be completed as early as April 9 and therefore any announcement about an extension would need to be made at the February or March Board meetings. With the April meeting being on April 6 delaying the announcement until April would create unnecessary uncertainty for the bond market.
We expected the more likely timing for the announcement would be March when further information would be available but the decision to announce the extension at the February meeting just confirms the Bank’s strong conviction that the policy stimulus needs to be firmly kept in place.
This commitment is also confirmed by the Governor’s revised forecasts for the economy.
Growth is expected at 3.5% in both 2021 and 2022. That compares with 5% and 4% respectively in the November Statement on Monetary Policy which contained the last set of forecasts.
There are a couple of mitigating factors here.
Firstly, the Bank forecast that the Australian economy would contract by 4% in 2020 in the forecasts that were released on November 5 whereas it is now clear that the contraction in 2020 will be around 2%. A less severe contraction is consistent with a more moderate recovery pace.
The currency value which is used in the November forecasts is USD 0.70 compared to the US0.76 which is likely to underpin the new forecast.
The Bank is also much more cautious about the pace of recovery in the labour market in 2021.
In November, based on a forecast of 8% (quarterly average) for the unemployment rate in December the Bank expected the unemployment rate to fall to 6.5% by the end 2021 – a reduction of 1.5 ppt’s.
With the starting point now at 6.8% (for December 2020) the Bank expects a 6% unemployment rate by the end of 2021 (0.8 ppt improvement).
The improvement in the unemployment rate in 2022 is still forecast to be 0.5 ppt’s leaving the end 2022 unemployment forecast at 5.5% compared to 6% in November.
This 5.5% is still expected to be well above the level of the unemployment rate that would generate sufficient wage inflation to allow the Bank to achieve its inflation objective.
These unemployment forecasts are now in line with Westpac’s forecasts – through most of 2020 we argued consistently that the unemployment forecasts of the “official family” – both RBA and Treasury were excessive.
They are also consistent with our expectations in recent notes of the likely forecast changes in this Statement (although we forecast 4% 2021 growth forecast rather than 3.5%).
Consistent with the much slower expected improvement in the unemployment rate in 2021, there has been a “tweak” in the way the Governor describes the timing of his current expectations of the first increase in the cash rate.
In today’s Statement he notes, “The Board will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range…. The Board does not expect these conditions to be met until 2024 at the earliest”. In November and December 2020, he stated “The Board is not expecting to increase the cash rate for at least 3 years”.
Theoretically the latter Statement is consistent with a November/December 2023 tightening – at the earliest. Today’s Statement pushes that timing back to 2024.
With the recent flow of encouraging data particularly around the labour market and housing markets have been speculating about an earlier than previously expected beginning to the tightening cycle. Admittedly at the margin, this Statement, if anything, indicates that the Bank has become somewhat more patient – contrary to market sentiment.
There has been a slight change in the forecast for underlying inflation (described as the “trimmed mean”).
In November, the Bank forecast the trimmed mean to increase by 1% in 2021 and 1.5% in 2022.
The 2021 forecast has been increased to 1.25% while the 2022 forecast remains the same at 1.5%. While there is a little more optimism around the 2021 forecast with 2022 remaining unchanged the implication is that any near-term lift in inflation is not expected to build further over the forecast period.
That leaves the inflation forecasts well below the desired target and, confirming the “2024 at the earliest” sentiment.
This theme of the Bank not getting “carried away” by the recent better than expected data flows is also projected in the observations made by the Governor, “wages are increasing at the slowest rate on record”; and “the unemployment rate remains higher than it has been for the last two decades”.
Appropriately the Governor does discuss “upside and downside” scenarios. The upside scenario is linked to “further positive health outcomes” and the resilience of businesses and households to the tapering of support measures. It also seems likely that the Bank, having maintained its highly stimulatory stance, would like to see the Federal government continuing to provide support for those sectors that are adversely affected by ongoing policies related to the health crisis with targeted support during that “tapering” stage.
There is little notable consideration of the AUD even though it has lifted significantly since the November and December Board meetings “the exchange rate has appreciated and is in the upper range of recent years”.
Conclusion
Markets were surprisingly nervous that the Bank would begin tapering the QE program. That may explain why AUD bond yields have recently underperformed global markets.
Westpac was strongly of the view that there would be an extension of the $100 billion program.
And we do not expect that the new program will see the end of QE with two further tranches of $50 billion likely in October and next April.
However, we do expect the Term Funding Facility to be wound down from June providing further “room” on its balance sheet for the RBA to support QE.
There is also likely to be considerable market speculation in 2021 about an early end to the Yield Curve Control policy. Clearly, from today’s Statement, the Bank is not expecting that to happen in 2021.
Westpac concurs with that view while recognising that the Bank will need to allow the three-year rates to edge up in 2022.
Our inflation and growth forecasts are surprisingly in line with the Bank’s revised forecasts.
However, as the Governor points out, there is a possible much stronger upside scenario, and that is why 2021 is likely to be a very active year in markets despite the cash rate being anchored at 0.1%.
