The RBA Governor excluded a key sentence in his Statement which had implied strong support for further QE. This decision now sets a very level playing field for the July decisions on QE and Yield Curve Targeting. With other central banks staying the course and RBA having a much more difficult task to reach its inflation and wages objectives it would be disappointing to see the July decisions beginning the process of tightening.
As expected the Reserve Bank Board kept its policy settings unchanged at the June Board meeting.
The key talking point from the Governor’s Statement was the omission of “The Bank is prepared to undertake further bond purchases to assist with progress towards full employment” when discussing its deliberations for the July Board meeting. At that meeting it will decide on the future of its QE and Yield Curve Target program.
There are at least two ways to interpret this omission. Either the Board felt that the inclusion of the sentence unduly locked them into a commitment to extend QE before the July meeting had even begun or there is a clear intention to dissuade the market from expecting further QE.
Setting a level playing field for market expectations is a reasonable approach but it comes with uncertainty as to how the market responds.
Of course we should also recall a recent speech from Deputy Governor Debelle where he asserted that “It is the total size of purchases that affects bond yields and financial conditions including the exchange rate, rather than how many bonds the central bank is buying each week”.
He did not discuss the rationale behind the assertion but it is important for us to be aware of the thinking of those who are pulling the levers.
This adjustment follows at least two others in the last month which strengthen the case for a hawkish outcome in July.
When discussing the factors that will impact the decisions in July the April minutes referred to “Members would give close attention to the flow of economic data and the outlook for inflation and employment”.
That guidance aligned with our views that the decisions will be largely determined by the Board’s economic forecasts. It is our view that the Board’s latest forecasts are not consistent with the Board expecting to meet its “tightening” conditions until late in 2024 “at the earliest”.
However, surprisingly, the May minutes referred to “the flow of economic data and conditions in financial markets” – no reference to their forecasts of the timing of the likely achievement of their “rate hike” conditions.
And consider the final sentence “This is unlikely to be until 2024 at the earliest”. But even that comment has been “watered down” from the much stronger “The Board does not expect these conditions to be met until 2024 at the earliest”, in the Governor’s April Statement.
Of course this gradual evolution of the Bank’s rhetoric coincides with the falling unemployment rate. At the time of the April statement the unemployment rate stood at 5.8% – never mind that the current 5.5% follows a negative employment number offset by a 0.3 ppt fall in the participation rate.
The one area in the June Statement that attracted some caution was around the re-emergence of the virus- this issue had not been discussed for some time: “an important ongoing source of uncertainty is the possibility of significant outbreaks of the virus, although this should diminish as more of the population is vaccinated”.
No doubt along with the GDP report tomorrow; the confidence measures; and the May employment report the Board will be closely monitoring developments in Victoria . Reasonably, it should also be at least considering risks of ongoing shutdowns in its forecasting process.
On housing the evolution of the investor is the most notable change. In April the Governor noted, “investor credit growth remains subdued”; in May, only owner occupiers and First Home Buyers were assessed as “strong” but in the June Statement, “there has been increased borrowing by investors”.
Conclusion
The Board has surprised the market by excluding the long held positive assessment of QE.
There are at least two ways to interpret this but the market will likely now down play the prospects of a QE extension.
Westpac has long held the view that despite the faster than expected pace of recovery, 2021 is not the year to start tightening policy well before other major central banks.
The Board’s own forecasts and statement of “unlikely before 2024 at the earliest” point to adequate time to, if necessary, err on the side of over stimulus.
Potential imbalances in the housing market can be addressed with macro prudential policies when considered necessary.
The RBA’s underperformance on its inflation target for so many years and the wide gap between actual (annual trimmed mean 1.1%) and target (2.5% sustained) signals a relatively greater need to maintain current highly stimulatory settings than other central banks.
We will not have much time to await the decisions in July and today’s Statement has to be taken very seriously.
