It seems that the taper decision at the Board’s July meeting was a close run affair. Respectable arguments are set out for both sides. There is also less confidence about 2024 as the timing for the first rate hike while Covid disruptions are seen as temporary.
The Minutes of the Reserve Bank Board meeting on July 6 highlight that the decision to taper the Bank’s purchases of bonds from $5 billion to $4 billion was subject to a healthy discussion.
The Minutes note that “Members acknowledged that an argument could be made to retain the pace of bond purchases at $5 billion per week, given that economic outcomes were still well short of the Bank’s goals for inflation and employment”….. but “In light of these improvements (economic outcomes) and the agreed decision making framework, members decided to adjust the weekly purchases …”
As with the Governor’s speech the Minutes note that “members agreed that there should be flexibility to increase or reduce weekly bond purchases.”
In a note we have released today revising our forecast for GDP growth in the September quarter to -0.7% we have suggested that an appropriate response from the Board would be to not only delay the decision to taper but to actually temporarily lift purchases from $5 billion to $6 billion over the September to November period to recognise this flexibility and to support the recovery we anticipate for the December quarter.
Such a decision should only be communicated once the Board had sufficient information around the impact of the current lock downs, which would be the September Board meeting.
The minutes go into more detail on the decision not to extend the yield target to the November 2024 bonds. Two key points are emphasised- firstly that the conditions necessary for a rate hike will be “not met until 2024”, excluding the previously used “at the earliest” and secondly “the faster than expected recovery…had widened the range of alternative plausible scenarios.” That latter comment seems to be central bank talk for a much higher degree of uncertainty around the 2024 forecast.
As I have noted in the past, because the Bank is committed to purchasing April 2024 bonds at the current cash rate it will find it very difficult to describe a central scenario that excludes 2024 as the likely timing of the first rate increase.
The Board meeting was held on July 6, following the reopening of the Victorian economy after the snap lockdown in late May/early June and in the early stage of the “lock down lite” NSW developments which were introduced on June 24.
In the Minutes the Board seems relaxed, “Recent COVID 19 outbreaks in many parts of the country, and associated restrictions, were considered to weigh on household consumption through the middle of the year. However, as observed following earlier lock downs spending was expected to rebound when containment measures were eased. “Of course these minutes predate the extensions and tightening, including the closure of building sites, other NSW restrictions and the recent lockdown in Victoria which has just been extended for another week. The comments also do not take into account that the governments’ current relief packages are not as generous or effective as the earlier packages, which included JobKeeper.
The Board also conducted a detailed discussion on wages growth. It was agreed that spare capacity appeared likely to decline and there were some signs that wages growth was picking up from low levels during the pandemic. The Bank’s liaison indicated that firms were not planning to fully compensate for wage freezes; while a flat outlook for public sector wages and new enterprise bargaining agreements pointed to wages growth being stuck at pre pandemic levels.
One area of interest was a lift in bonuses and non wage incentives “to attract and retain labour.”
Conclusion
The flexible use of bond purchases may become a more active tool than has been recognised so far, despite clear statements in the Minutes and by the Governor.
If by the September board meeting, Westpac’s forecasts for a 0.7% contraction in GDP in the September quarter appear to be on track a case can be made for a temporary lift in bond purchases in recognition of this newly flexible policy tool.
