As was well flagged, the RBA eased policy yesterday with more aggressive changes than the market expected. This followed on from recent RBA speeches which prepared the market for yesterday’s moves. The RBA in attempting to fulfil its mandate, is leaving no stone unturned from a monetary policy perspective. While they (as always) don’t wish to do more, they can still ease via additional QE, or, they can cross the Rubicon to negative rates if needed but they remain very reluctant to make this move.
The RBA should also be applauded for their additional communication via a press conference from the Governor - hopefully this now becomes a regular feature on policy days. In that additional press release the Governor set out what he saw as the four main questions that arose from yesterday's decision.
Why make these changes now? “This is an understandable question, especially given that we are easing monetary policy further today at the same time as we are upgrading the near-term outlook for the economy.” For me, their focus hasn’t changed. It’s all about employment, wages and growth, and despite their improved forecasts, the unemployment rate is forecast at 6% at the end of 2022. This is where the charter of the RBA kicks in.
Is the RBA now financing the Government? “The answer is a simple no. Today's decision does not change the long-standing separation of monetary policy and fiscal financing in Australia. The RBA is not financing government spending.” Yea, nah, maybe… if I buy a corporate bond in the secondary market, am I financing that company? Yes, although not directly. If I pre-announce that I will buy a set volume of a certain piece of corporate debt in the secondary market, am I financing that firm? Not directly, but that decision would change the financing choices of the firm, so technically no but yes. Does it matter? Yes, as direct financing changes the debt decisions of a borrower, in this case the Government, and this way they are still ensuring government debt will be financed at low rates.
Why have a price and quantity target? This is more technical, and is really just a judgement call from the RBA on the most effective way to execute.
Is the RBA now out of firepower? “The short answer here again is no. The Reserve Bank is not out of firepower. We have additional monetary policy options and we are prepared to use them if the circumstances require.” I quote Dr Lowe from 2019, "monetary policy has become less effective at the margin" and that people were changing the way they used interest rate cuts. “Once upon a time, when we lowered interest rates, people would run off to the bank to borrow to kind of go on a holiday or buy furniture or kind of do some spending, they don't do that anymore." Just over a week later the RBA cut rates, and now just over a year later, we have a big bang easing with rates cuts and QE. Does that mean they have had to do more to be effective? Yes. Will they be effective? Probably albeit might take some time.
There is substantial global debate of the efficacy and impact of QE, but from those that study it the most, Central Banks, it's clear they believe it works because almost every developed market Central Bank, is or has, implemented QE. Its impact on demand, employment and asset prices depend on the starting point but perhaps most importantly the structure of the economy in question.
At the end of the Q+A, Dr Lowe responding to a question, saying the effect of the moves should 1. Lower lending rates 2. Remove some upward pressure on the exchange rate, and 3. Lead to higher asset prices which should have a positive impact on balance sheets.
True, but will it make a difference? The starting point for rates pre Covid was already at record lows (75 bps) from the October 2019 cut, and credit growth and business investment were subdued and in decline (the pink line below). Previous rate cuts had not engineered credit growth or business investment so why will it be different this time? Time will tell. As I have previously mentioned this is why business and consumer confidence are so important as is time.
Reduce upward pressure on the exchange rate. We will have to wait and see but the exchange rate isn’t overvalued so the impact will be muted and the one day price action (which is irrelevant for the RBA) isn’t supportive. This game has only just begun but the opposition (Higher AUD) just scored an early goal.
Higher asset prices. The common criticism of QE that it impacts asset prices rather than final demand and employment but studies have shown differing impact depending on the country and the timing of QE. Most think of the US as an example but the unemployment rate did fall to record lows post QE. Charts shows US housing prices (purple) and the S+P 500 and the lower chart is the US unemployment rate. The initial QE programs began at the low point for asset markets.
But Australia is at a very different starting point for QE in terms of asset prices, we are not starting as the US did with lower asset prices. House prices have been in a multiyear uptrend and the equity market is closer to all-time highs than its 2008 low. Does this mean asset prices wont be a beneficiary? No. Does this increase the risk of asset prices bubbles? Maybe given the starting point.
Source ABS, Beckon Capital
Differing stage of QE US vs Australia mapped against the ASX
I never really met a bond market vigilante (vigilant on inflation) but given the multiyear down trend in inflation most have long left the industry, now the ongoing health of the bond market and its role as a signal on the economy are both under pressure. The RBA stated rates will likely stay low for 3 years but hopes not 5 years and as QE and YCC have a significant signaling effect we can assume the same possible time frame. There is little doubt the RBA would prefer to end the longer end QE well before that but exiting these programs has proved problematic globally. For now the exit is tomorrows story but the subdued volatility of the bond market is todays.
“Neither a borrower nor a lender be, for loan oft loses both itself and friend, and borrowing dulls the edge of husbandry.”
The Government and the RBA are ignoring Shakespeare’s advice, let’s hope they stay friends.
The RBA has now played most of its cards and after weighing up those negatively impacted they have moved in favour of what they define as the collective good. Lower unemployment and its impact on society.
David “Bushy” Nolan
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