RBA may end QE in April - Capital Economics
Australia & New Zealand Economics

RBA may end QE in April

RBA Watch
Written by Marcel Thieliant
Cancel X

While the Reserve Bank of Australia will present more upbeat forecasts for GDP growth, inflation and the labour market at its meeting on Tuesday 2nd February, we suspect it will still sound dovish. Even so, we think that the rapid recovery in the labour market will convince the Bank to end QE in April.

  • RBA may choose to keep up with large asset purchases by overseas central banks
  • But labour market doing much better than Bank had anticipated
  • Balance of financial stability risks starting to shift as credit growth set to surge

While the Reserve Bank of Australia will present more upbeat forecasts for GDP growth, inflation and the labour market at its meeting on Tuesday 2nd February, we suspect it will still sound dovish. Even so, we think that the rapid recovery in the labour market will convince the Bank to end QE in April.

Case for easing has continued to diminish

The RBA has now bought $48bn in government bonds under its Bond Purchase Program. If it keeps buying $5bn per week, it will hit the $100bn target by the middle of April. As such, the Bank will have to announce whether to extend the programme no later than the meeting on 6th April. The consensus is that the Bank will reduce its weekly asset purchases from $5bn now to less than $2bn from April. We think the Bank may go even further and end QE altogether.

In a recent parliamentary hearing, Governor Lowe laid out three conditions that will determine whether or not the programme will be extended. The first is the actions of other central banks. The Bank argued when it launched QE in November that other central banks had expanded their balance sheets more strongly than the RBA, which meant that long-term interest rates in Australia where higher than elsewhere. That in turn had contributed to the strength of the exchange rate. While we expect the ECB to gradually taper its bond purchases, we expect the Federal Reserve, the Bank of England and the Bank of Japan to keep their purchases broadly unchanged this year. (See Chart 1.) That will keep the RBA under pressure to extend QE, too.

The second factor – liquidity conditions in the bond market – is a bit more ambiguous. The fact that bid-ask spreads are back at pre-virus levels following the surge in the first half of last year suggests that bond markets are working well and are sending clear price signals. (See Chart 2.) That in turn would suggest that additional purchases are no longer needed. On the flipside though, the Bank could argue that because its purchases aren’t distorting the functioning of the bond market, there’s scope for them to be expanded further. We suspect the Bank will take the latter view.

Chart 1: Monthly Change in Central Bank Assets ($bn)

Sources: Refinitiv, Bank of England, Capital Economics

Chart 2: 10-Year Commonwealth Bond Bid-Ask Spread (%)

Source: Refinitiv

The third factor is labour market conditions and it unambiguously points to a scaling down of QE. For a start, the unemployment rate fell from its peak of 7.5% in July to 6.6% in December rather than picking up further as the Bank had anticipated. Across Q4 it averaged 6.8% instead of the Bank’s forecast of 8.0%.

That rebound is underpinned by a strong rebound in activity: we estimate that GDP was down a modest 1.7% y/y in Q4 instead of the Bank’s November forecast of -4%. And the outlook for the coming months has brightened further: Mr Lowe noted in December that the Bank’s central scenario was based on the assumption that a vaccine will be available by the end of this year “at the earliest”. With the government approving the Pfizer/BioNTech vaccine this week, it now looks likely that vaccinations will start as soon as next month.

What’s more, the rebound in hours worked per employee has resulted in the near-complete reversal of last-year’s surge in the underemployment rate. (See Chart 3.) That suggests that the expiry of the JobKeeper wage subsidy in March won’t throw the recovery in the labour market off course. Indeed, job vacancies are now much higher than they were before the virus struck.

Chart 3: Underemployment & Unemployment Rate (% of Labour Force)

Source: Refinitiv

We now expect the unemployment rate to fall to 5.5% by the end of next year. But the Governor noted that the unemployment rate could be as low as 5% instead of the Bank’s current forecast of 6% by end-2022 if vaccines become available quickly. That would bring it below pre-virus levels.

Admittedly, there are other considerations. While unemployment is falling rapidly, there are signs of labour market scarring as long-term unemployment is on the rise. RBA research shows that those who have been unemployed for a prolonged period are far less likely to find a job than those who have been unemployed for shorter periods. That matters because apart from its full employment and inflation mandate, the RBA also needs to contribute to the “economic prosperity and welfare of the Australian people”.

And the surge in the Australian dollar will make it more difficult to meet the Bank’s 2-3% inflation target. Given that retail sales volumes were around 6% above pre-virus levels, goods inflation climbed to a 20-year high of 3.4% in Q4. But as the economy opens up and spending shifts back from goods towards services, that downward pressure may yet filter through more clearly. Finally, the Bank will probably stick to its line that additional loosening is lowering financial stability risks. While banks’ non-performing loans started to decline in Q3, around 3% of deferred mortgage loans had yet to restart payments in November.

But services inflation has now started to pick up, too. Indeed, trimmed mean inflation held steady at 1.2% in Q4 rather than falling to 1.0% as the RBA had anticipated. Meanwhile, the balance on financial stability risks is starting to shift. Housing finance commitments were up 24% y/y in November and consistent with annual housing credit growth of 7%. (See Chart 4.) Even if wage growth picks up a bit over the coming quarters, that means that the ratio of household debt to incomes could hit a fresh record-high by the middle of this year.

Chart 4: Lending Commitments & Housing Credit

Sources: Refinitiv, ABS. Capital Economics

All told, it’s clear that the labour market has done much better than the Bank had anticipated. Whether that’s sufficient for the Bank to end its asset purchases altogether remains to be seen. It’s possible that the RBA will want to see clear evidence that the phasing out of JobKeeper isn’t derailing the recovery, which it will only know with the release of the April labour force survey in mid-May. Next week’s Statement on Monetary Policy and Governor Lowe’s speech on Wednesday will show whether our forecast that the RBA will end QE in April is too optimistic.

Table 1: RBA Monetary Policy Background Information

Interest Rate Meetings

The Board meets 11 times a year, at 9.00 am on the first Tuesday of the month. There is no meeting in January. Rate decisions are released in a statement at 2.30 pm.

Release of Minutes

Two weeks after each meeting.

Other Publications

The Statement on Monetary Policy sets out the Bank’s assessment of current economic conditions and the outlook. It is published four times a year, on the Friday after the policy meetings in February, May, August and November.

Disclosure of Voting

No, the votes and views of individual members are not identified in either the policy statements or the minutes of the meetings.

Inflation Target

The Board targets CPI inflation of between 2% and 3% over the medium-term. This is an average rather than a rate to be achieved at all times.

Policy Framework

The Reserve Bank Act gives the Board a duty “to maintain price stability, full employment, and the economic prosperity and welfare of the Australian people.”

Membership of Board

The Board comprises the Governor, Deputy Governor, six other non-executive Bank members and the Secretary to the Treasury. The Governor and Deputy Governor serve terms of up to seven years and are eligible for re-appointment. The non-executive members are appointed for terms of up to five years. There is no limit to the number of terms they may serve.

Governor

Philip Lowe

Deputy Governor

Guy Debelle

Other members of the

Mark Barnaba

Carol Schwartz

Reserve Bank Board

Allan Moss

Catherine Tanna

Ian Harper

Steven Kennedy, (Secretary to the Treasury)

Wendy Craik

Meetings

Date

Outcome/Forecast

Date

Outcome/Forecast

* Denotes release of

4th Feb 2020*

Cash rate cut 0.75%

2nd Feb 2021*

No major policy changes

The Statement on Monetary Policy later that week

3rd Mar 2020

Cash rate cut to 0.50%

2nd Mar 2021

No major policy changes

19th Mar 2020

Cash rate cut to 0.25%, launch of 0.25% target for 3-year government bonds & launch of Term Funding Facility (TFF)

6th Apr 2021

Bank to announce end to QE programme

7th Apr 2020

No major policy changes

4th May 2021*

No major policy changes

5th May 2020*

No major policy changes

1st June 2021

No major policy changes

2nd June 2020

No major policy changes

6th July 2021

No major policy changes

7th July 2020

No major policy changes

3rd Aug 2021*

No major policy changes

4th Aug 2020*

No major policy changes

7th Sep 2021

No major policy changes

1st Sep 2020

Increase in size of TFF

5th Oct 2021

No major policy changes

6th Oct 2020

No major policy changes

2nd Nov 2021*

No major policy changes

3rd Nov 2020*

Cash rate target, 3-year yield target & Rate on TFF cut to 0.10%; $100bn in government bond purchases.

7th Dec 2021

No major policy changes

1st Dec 2020

No major policy changes

Sources: RBA, Capital Economics


Marcel Thieliant, Senior Australia & New Zealand Economist, +65 6595 1514, marcel.thieliant@capitaleconomics.com