The RBA’s Minutes of the February Board meeting contain a robust defence of the bond buying policy – we can certainly expect a continuation of that policy beyond October. The Board’s concerns about achieving its wages and inflation targets resonate supporting our view that the Yield Curve Control policy will extend beyond 2021.
There were no surprises in the Reserve Bank Board’s Minutes of the February 2 Board meeting.
Since the Board meeting, we have seen the Governor’s speech to the National Press Club; his appearance at the House of Representatives Standing Committee on Economics and the February Statement on Monetary Policy.
For me the key global theme is that while economies are now recovering and in many cases (including Australia and the US) the level of activity will return to pre pandemic levels during 2021 it will be years (beyond the mid 2024 forecast period in the case of Australia) before economies restore activity to the levels expected prior to the pandemic. That indicates ongoing spare capacity that weighs on wages growth and investment activity.
In our recent notes we have discussed the cautious forecast for wages growth which is described in the Minutes as “both wages growth and underlying inflation were expected to remain below 2% over the forecast period, reflecting ongoing spare capacity in the economy.”
Clearly the Bank is concerned about the current “starting point” for wages growth, “Liaison contacts had suggested it could be some time before wage freezes were lifted”.
Lack of confidence in prospects for higher wages growth and inflation was also emphasised with the forecasts in the “upside” scenario – even though the unemployment rate is forecast to fall below 5% by end 2021 (central scenario forecasts 6%) inflation was still expected to be below 2% (“approach”) by the end of the forecast period (June 2023).
So it is in this context that we assess the nuances around the policy outlook in the Minutes.
The key policy change that was announced following the February 2 Board meeting was to extend the bond purchase program by a further $100 billion in exactly the same format as the program that was to expire in mid- April. ($5 billion per week- $4 billion in Australian Government bonds and $1 billion in bonds issued by the states and territories).
The decision to extend was justified by: a number of central banks had announced extensions to their programs and due to widespread market anticipation of an extension ceasing purchases would lead to “unwelcome significant upward pressure on the exchange rate.”
The decision “would ensure a continuation of the Bank’s monetary support for the Australian economy”. In further strong commitment to this policy “it would be premature to consider withdrawing monetary stimulus” and “members observed that the size of the Bank’s balance sheet relative to GDP remained lower than that of most other advanced economy central banks.”
Whenever central banks make a policy change they will always emphasise the benefits of the policy but these sentiments certainly indicate a very strong conviction of the benefits of the bond purchase program.
As discussed below, in early December when markets were questioning the continuation of the program beyond April Westpac supported a full $100 billion continuation but forecast a scaling back of the program from October.
The sentiment in today’s Minutes warrant ongoing scrutiny of the scaling back assumption.
Prospects for continuing the Term Funding facility are low. With an extension only likely if “there was a marked deterioration in funding and credit conditions” – an extremely unlikely prospect.
Markets continue to speculate on the timing of the adjustment to the Yield Curve control policy. The Minutes confirmed that “later in the year the Board would consider whether to shift the focus of the yield curve target from the April 2024 bond to the November 2024 bond”. Not shifting to the November maturity would question whether the Board is prepared to continue signalling it expects (does not pledge) to keep the cash rate on hold for at least 3 years. That decision will be dependent on “the flow of economic data and the outlook for inflation and employment.”
The Board will be aware of the potential impact on the yield curve of a decision to “shorten” the expected period before the first rate hike.
One reason why markets are strongly speculating around an early adjustment to the YCC policy is around asset markets.
For now, the Board has concluded that “there are greater benefits for financial stability from a stronger economy, while acknowledging the importance of closely monitoring risks in asset markets”.
In that regard the Minutes noted that the national house price index had returned to highs of four years earlier; there were few signs of a deterioration in lending standards; and new loan commitments for owner occupiers were above the previous high of 2017; although investor loan commitments remained “well below earlier peaks”.
Those comments are consistent with our views that any targeted tightening of housing lending through the Council of Financial Regulation (known as macro prudential policies) is some way off – most likely not before mid-2022.
Conclusion
Back in early December Westpac forecast a $100 billion extension of the bond buying program (to be followed in October by a further $100 billion at half the current purchase pace); a termination of the TFF facility in June (although an extension of the program specifically tied to small business lending was likely); and a continuation of the Three Year Yield Curve Control policy until 2022, when the policy would need to be reviewed.
We remain comfortable with those forecasts.
The most uncertain aspect of those forecasts is that Bank would lower the weekly purchase pace from October. The Minutes strongly support the effectiveness of the bond buying program pointing out its benefits in lowering the AUD; constraining any lift in bond rates while not causing any disfunction in the bond market.
