From CBA’s head of Australian economics, Gareth Aird:
- RBA Deputy Governor Guy Debelle listed four ‘other’ options to ease monetary policy further: (i) purchase bonds further out on the curve (supplementing the three year yield target); (ii) foreign exchange intervention; (iii) cut the current structure of interest rates in the economy without going negative; and (iv) negative rates.
- Purchasing government bonds further out on the curve and/or cutting the current structure of rates in the economy without going negative appear the most likely ‘other’ options to be implemented if the RBA eases policy further.
- We expect the RBA to maintain the current monetary policy structure – but no policy options are ruled out, nor are they ruled in.
Yesterday’s speech by RBA Deputy Governor Debelle was timely and on point. Debelle presented an update on the economic impact of the pandemic as well as an assessment of the effects of monetary policy actions. Most importantly there was a discussion on ‘other’ options for monetary policy.
We focus here on what Deputy Governor Debelle said on the labour market, inflation and monetary policy.
On the labour market Debelle stated that, “hours worked declined by 10% peak to a trough around early May. Since then they have grown by around 6% nationally, though that is being held back by the impact of the lockdown in Victoria. The unemployment rate in August was 6.8 per cent, which was better than expected” (our emphasis in bold).
Stronger than expected growth in hours worked coupled with a lift in our CBA credit and debit card spend over Q3 20 was behind our recent upgrade to our GDP profile for the remainder of 2020 and for 2021.
On inflation Debelle stated that, “I do not see there is any risk of a sustained rise in inflation while there remains considerable spare capacity in the economy. In particular, the high unemployment rate will mean that wage growth, which was not strong pre-pandemic, will remain subdued.”
Our central scenario is for below target underlying inflation over the next three years. But we cannot concur with Debelle that there is no risk of a sustained rise in inflation, even if wages growth is weak. The risk is low, but it is non-trivial. Stagflation is possible and cannot be ruled out. Put simply, we cannot say for certain what the inflationary impact will be of the unprecedented combination of (i) quantitative easing; (ii) massive government deficits; (iii) massive fiscal stimulus that is seeing millions of Australian’s receive sizeable government benefits while not working; and (iv) the temporary closure of entire industries which means a big number of goods and services are not being produced and are not available to be purchased.
Deputy Governor Debelle gave clear forward guidance with regards to what the three yield bond yield target was signalling about the cash rate. Specifically, he stated that, “the three-year yield target is closely aligned with the Board’s guidance about the future direction of the cash rate target ……. under the central scenario, it would be more than three years before sufficient progress was being made towards full employment to be confident that inflation will be sustainably within the target band. In this scenario, it is highly unlikely that the cash rate will be raised over that time horizon.”
Essentially what Debelle has said is that while ever the three-year yield target sits at the same level as the cash rate it implies that the cash rate will not be moved higher. The cash rate, however, could be lowered (more on that below).
On the ‘other’ options for monetary policy, Debelle listed four:
(i) Buy bonds further out along the yield curve, supplementing the three-year yield target. This is essentially additional bond purchases further out the yield curve on a regular basis. This would have the impact of lowering bond yields at longer maturities, although we suspect it would have a pretty negligible impact on the real economy. As Debelle astutely noted, “very few financial instruments in Australia price off these (longer term) yields. This is in contrast to the US where the 10-year Treasury yield is a key pricing benchmark for mortgage rates.”
(ii) Intervention in the foreign exchange market to lower the AUD. Debelle said a “lower exchange rate would definitely be beneficial for the Australian economy”. However, he also points out that because the Australian dollar is broadly aligned with its fundamentals, he doubts intervention would be effective. We agree on both counts.
(iii) Lower the current structure of interest rates in the economy a little more without going into negative territory. Debelle listed the remuneration on ES balances (currently 0.1%), the three-year yield target (0.25% )and the borrowing rate of the TFF (0.25%). He noted, “it is possible to reduce these interest rates”. It was always possible to reduce those rates, but at this stage we do not think the RBA has much appetite to do so.
(iv) Negative interest rates. Debelle noted that, “the empirical evidence on negative rates is mixed”. This is somewhat different to what Governor Lowe has stated in the past where he has said that he believes the cost of negative rates exceeds the benefits. Nonetheless we remain of the view that the RBA has no intention of taking Australian interest rates into negative territory.
Overall we believe the key takeout from today is that the RBA has not ruled out a host of other policy options. That is prudent. But nor have they ruled any of these policy options in. It will be up to the data to make the case to pursue different policy options. And in the interim they still have scope to expand on current policies (further increase the size of the TFF and purchase more Commonwealth and state government bonds).
Fiscal policy looks set to be the major policy support mechanism for the Australian economy in the years ahead with monetary policy playing a more complementary role. We await details in the 6 October Budget, but media report suggest that fiscal policy will be eased further over 2020/21.