The most dovish RBA in history

The most dovish RBA ever by a country mile has tongues wagging. At Westpac:

The Reserve Bank Board decided to extend the current bond purchase program by a further $100 billion. The purchases in the second tranche will begin in mid- April when the current program is set to be completed (that completion date could be as early as April 9).

The new program will be a repeat of the first program – $5 billion of purchases per week at the same mix of 80% Australian Government Securities and 20% semi government issues (although this exact mix is not spelled out in the Governor’s Statement).

Westpac expected that the Bank would extend the $100 billion program although favoured moving the ratio to 70% AGS and 30% semis to provide further relative support for the semis.

We pointed out that the current program could be completed as early as April 9 and therefore any announcement about an extension would need to be made at the February or March Board meetings. With the April meeting being on April 6 delaying the announcement until April would create unnecessary uncertainty for the bond market.

We expected the more likely timing for the announcement would be March when further information would be available but the decision to announce the extension at the February meeting just confirms the Bank’s strong conviction that the policy stimulus needs to be firmly kept in place.

This commitment is also confirmed by the Governor’s revised forecasts for the economy.

Growth is expected at 3.5% in both 2021 and 2022. That compares with 5% and 4% respectively in the November Statement on Monetary Policy which contained the last set of forecasts.

There are a couple of mitigating factors here.

Firstly, the Bank forecast that the Australian economy would contract by 4% in 2020 in the forecasts that were released on November 5 whereas it is now clear that the contraction in 2020 will be around 2%. A less severe contraction is consistent with a more moderate recovery pace.

The currency value which is used in the November forecasts is USD 0.70 compared to the US0.76 which is likely to underpin the new forecast.

The Bank is also much more cautious about the pace of recovery in the labour market in 2021.

In November, based on a forecast of 8% (quarterly average) for the unemployment rate in December the Bank expected the unemployment rate to fall to 6.5% by the end 2021 – a reduction of 1.5 ppt’s.

With the starting point now at 6.8% (for December 2020) the Bank expects a 6% unemployment rate by the end of 2021 (0.8 ppt improvement).

The improvement in the unemployment rate in 2022 is still forecast to be 0.5 ppt’s leaving the end 2022 unemployment forecast at 5.5% compared to 6% in November.

This 5.5% is still expected to be well above the level of the unemployment rate that would generate sufficient wage inflation to allow the Bank to achieve its inflation objective.

These unemployment forecasts are now in line with Westpac’s forecasts – through most of 2020 we argued consistently that the unemployment forecasts of the “official family” – both RBA and Treasury were excessive.

They are also consistent with our expectations in recent notes of the likely forecast changes in this Statement (although we forecast 4% 2021 growth forecast rather than 3.5%).

Consistent with the much slower expected improvement in the unemployment rate in 2021, there has been a “tweak” in the way the Governor describes the timing of his current expectations of the first increase in the cash rate.

In today’s Statement he notes, “The Board will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range…. The Board does not expect these conditions to be met until 2024 at the earliest”. In November and December 2020, he stated “The Board is not expecting to increase the cash rate for at least 3 years”.

Theoretically the latter Statement is consistent with a November/December 2023 tightening – at the earliest. Today’s Statement pushes that timing back to 2024.

With the recent flow of encouraging data particularly around the labour market and housing markets have been speculating about an earlier than previously expected beginning to the tightening cycle. Admittedly at the margin, this Statement, if anything, indicates that the Bank has become somewhat more patient – contrary to market sentiment.

There has been a slight change in the forecast for underlying inflation (described as the “trimmed mean”).

In November, the Bank forecast the trimmed mean to increase by 1% in 2021 and 1.5% in 2022.

The 2021 forecast has been increased to 1.25% while the 2022 forecast remains the same at 1.5%. While there is a little more optimism around the 2021 forecast with 2022 remaining unchanged the implication is that any near-term lift in inflation is not expected to build further over the forecast period.

That leaves the inflation forecasts well below the desired target and, confirming the “2024 at the earliest” sentiment.

This theme of the Bank not getting “carried away” by the recent better than expected data flows is also projected in the observations made by the Governor, “wages are increasing at the slowest rate on record”; and “the unemployment rate remains higher than it has been for the last two decades”.

Appropriately the Governor does discuss “upside and downside” scenarios. The upside scenario is linked to “further positive health outcomes” and the resilience of businesses and households to the tapering of support measures. It also seems likely that the Bank, having maintained its highly stimulatory stance, would like to see the Federal government continuing to provide support for those sectors that are adversely affected by ongoing policies related to the health crisis  with targeted support during that “tapering” stage.

There is little notable consideration of the AUD even though it has lifted significantly since the November and December Board meetings “the exchange rate has appreciated and is in the upper range of recent years”.

And UBS:

RBA held rate at 0.1%, as expected; but adds $100bn QE (after current $100bn)

The RBA’s February meeting, as widely expected, held interest rates at 0.1%, for the cash rate, 3-year bond yield (YCC) targets, and the TFF. However, the debate was if the RBA would extend easing ( UBS view at the dovish end of consensus), or taper. Overall, we see the RBA’s decision today as ‘maximum dovish’, given the easing occurred now, despite materially stronger than expected data. Specifically, the RBA announced an additional $100bn of QE, purchasing Government bonds (after the current $100bn program completes in mid-April). While they didn’t specify details, the wording implies no change to existing parameters of duration or split (80/20) across the Australian Government and States. That said, also on the dovish side, the RBA pre-committed the pace of purchases to continue at the ‘auto-pilot’ $5bn/week (implying a total of $200bn by Sep-21). This likely reflects the RBA increased concern about the AUD, highlighting it “has appreciated and is in the upper end of the range of recent years”.

‘Committed to maintaining highly supportive conditions until goals achieved’

The RBA’s forward guidance remains extremely dovish. The only arguably hawkish change removed “the Board is prepared to do more [QE] if necessary”. But, they replaced this by adding they “remain[] committed to maintaining highly supportive monetary conditions until its goals are achieved”. The RBA conditions to hike interest rates in the future were reiterated. Namely, “actual inflation is sustainably within the 2 to 3% target range”, which requires wages growth “materially higher than it is currently”, and “significant gains in employment & a return to a tight labour market”.

‘No rate hike until 2024 at the earliest’… implies YCC extension as well

In December, the RBA removed their explicit commitment to YCC purchases. So today’s factual comment that they have “not purchased bonds in support of the 3-year yield target since early December” should not be seen as a policy change. Rather, they have not needed to make purchases, because their commitment to YCC is deemed as credible enough by the markets. Furthermore, the RBA (implicitly) extended YCC as well today, given their (previously explicit) linkage between the outlook for the cash rate and their YCC target point. Specifically, the RBA now note they do not expect to see the conditions for a cash rate hike “to be met until 2024 at the earliest”. This is a shift to a calendar based forward guidance (that we expected), and now allows YCC to ‘decay’ over time (if they wish). This differs from the previous guidance of “at least 3 years”.

RBA materially upgrade economy, but ‘reaction function’ now remains dovish

As we expected, the RBA materially upgraded its economic outlook to around its ‘upside scenario’ in their Nov-20 SOMP (with details in Friday’s Feb-21 SOMP). Specifically, they now expect GDP growth of 3½% y/y in both Q4-2020 and Q4-2021 (while UBS remains more bullish at ~4% y/y). They now see unemployment around 6% at the end of 2020, and 5½% end 2022 (in line with UBS). Meanwhile, underlying inflation is now seen rising to 1½% y/y over 2022 (with UBS modestly higher), so remains below their target band over the entire forecast profile. Indeed, we continue to argue the RBA’s ‘reaction function’ – to a stronger flow of incoming data and forecast upgrades – has changed to be more dovish since late last year, amid COVID. Looking ahead, Governor Lowe’s speech tomorrow, and his testimony on Friday (and the SOMP), will give further details on the new easing. We also look for 1) any comments on the AUD amid global central bank easing; and 2) if there is any shift in their reluctance to use macro-prudential tightening, given the ‘up-crash’ in housing.

Yep. MP will be the first cab off the rank which helps explain why the RBA is confident to push out any rate hike so far.

As usual, the key factor on whether the bank can reach its higher wage and inflation forecast isn’t mentioned by anybody. If mass immigration resumes then the permanent labour supply shock will prevent the RBA from getting anywhere near thresholds for higher rates.

If mass immigration does not resume then we’ll probably get there much sooner than the RBA expects.

But hey, don’t mention the war.

David Llewellyn-Smith

Comments

    • Jumping jack flash

      On track to becoming a yearly (maybe bi-annual, but we will see) COVID flu shot.

      There wasn’t any other alternative in my opinion. Hopefully their computer models can predict SARS2 mutations better than they can the regular flu, because those predictions are just woeful.

  1. happy valleyMEMBER

    The RBA happy clappies have decimated savers and depositors and that gives the clappies a thrill.

  2. happy valleyMEMBER

    “If mass immigration does not resume then we’ll probably get there much sooner than the RBA expects.”

    The only inflation that the RBA is interested in is housing prices and they don’t even show up in the CPI as Howard (?) stripped out of the measure in the early 2000s.

  3. Jumping jack flash

    “As usual, the key factor on whether the bank can reach its higher wage and inflation forecast isn’t mentioned by anybody.”

    That’s because the RBA only manages debt, and wages and inflation depend on a truckload of debt, but after that the animal spirits and planetary alignments are needed to then kick off CPI and then wage inflation, in that order.

    Phil will need to don his loincloth and dance and wave his shaman stick on the boardroom table.

    We have a truckload of debt, but as yet we haven’t got much by way of CPI, therefore it would be really very strange if we got enough wage inflation in that environment.

    Fortunately we have COVID stimulus, and trillions of dollars to support some CPI rises. If the animal spirits agree, and if the planets align, then CPI will rise enough to flow into wage inflation. Once that happens it should become self-sustaining (like it was in 2007) and debt will boom.

    And after it does, hopefully our leaders are smart enough to not start shouting about inflation being a problem like they did back in 2007.