Joye: Banks and RBA at war

It should read banks and AFR at war with RBA, via Chris Joye:

With only two or three rate cuts left in the Reserve Bank of Australia’s kitbag, and a best-case scenario involving banks passing on half these changes to borrowers, debate is intensifying around whether the central bank will embrace quantitative easing (QE) more rapidly than markets expect.

A fissure is emerging between bankers who are worried about increasing regulatory interference and the costs associated with the RBA exercising influence over a greater range of interest rates than its overnight target cash rate, and the RBA that has a legislated obligation to reduce the jobless rate to its new “full-employment” level of 4.5 per cent, which is not likely possible with its remaining monetary policy ammunition.

…The problem is that both the RBA and the banks believe lenders are unlikely to pass on any rate cuts below an official cash rate of 0.50 to 0.75 per cent. That means that although the RBA thinks monetary policy has much heavy lifting to do to get the jobless rate back below 4.5 per cent, it only has two to three standard cuts left.

…The RBA believes it has used QE in the past by expanding its current short-term lending operations to banks (carried out by repurchase, or “repo”, arrangements) to 12 month terms during the 2008 crisis. (A repo is simply a secured form of lending where a bank posts collateral with the RBA and then borrows against it.)

…This time around, nobody is talking about a liquidity/funding crisis. The only reason it makes sense for the RBA to expand its policy toolkit is because the official cash rate is approaching its terminal level, which makes it hard for banks to pass through cuts. This is because the banks’ deposit liabilities cannot charge negative interest rates, which means lowering lending rates crushes their net interest margins.

…The RBA is presumably motivated to reduce the cost of all bank loans (including those offered to companies, small businesses, and households), which can only be achieved by focusing on repo financing and/or generic senior bank bonds. (Aussie banks are also unusual globally because they have relatively low deposit funding and a relatively high reliance on sourcing capital via issuing senior debt.)

Some claim these measures should be reserved for a crisis. But it is really just about ensuring monetary policy continues to work effectively in an ultra-low interest rate world. Whether the RBA seeks to manipulate interest rates via its overnight cash rate, term repo lending and/or bond purchases, all these actions are attempting to influence the cost of capital banks pay when they want to borrow money to lend locally.

…And it would be smarter for the RBA to embrace a wider range of interest rate targets sooner rather than later to maximise the pass-through of its remaining cash rate cuts.

No, it wouldn’t. Not unless whatever unconventional policy you adopt also sinks the AUD. Liquidity operations won’t do that. It needs to be open-ended QE or, much better, helicopter money that instead funnels printed money into the real economy, preventing asset price rises and enabling managed deleveraging.

Houses and Holes

David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the fouding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.

He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.

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