RBA probably won’t extend QE any further next year - Capital Economics
Australia & New Zealand Economics

RBA probably won’t extend QE any further next year

RBA Watch
Written by Marcel Thieliant
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The Reserve Bank of Australia won’t make any policy changes at its meeting on 1st December. And with the labour market improving much faster than the Bank had anticipated and the prospect of a vaccine lifting the outlook, we think won’t extend quantitative easing in April.

  • Vaccine may be available by Q2 2020, allowing full reopening of the economy
  • Labour market doing much better than Bank had anticipated
  • Case for additional stimulus is diminishing

The Reserve Bank of Australia won’t make any policy changes at its meeting on 1st December. And with the labour market improving much faster than the Bank had anticipated and the prospect of a vaccine lifting the outlook, we think won’t extend quantitative easing in April.

Case for additional easing has diminished

We’ve been forecasting since May that the RBA would eventually launch quantitative easing (QE) and the Bank finally did so at its November meeting. It also lowered its interest rate targets, with the 0.0% rate paid on Exchange Settlement balances setting the floor for interbank rates. Given that the Bank reiterated its stance that negative interest rates are extraordinarily unlikely, that means that interest rates are now as low as they will get.

In the three weeks since its November meeting, the Bank has bought $14bn in government bonds, leaving it on track to hit its $100bn target by mid-March. The Bank may then own around 17% of outstanding government bonds, which would still be rather small compared to other central banks that have launched QE. As such, there’s certainly scope for a further extension. (See Chart 1.)

Chart 1: Central Bank Holdings of Government Bonds (% of Total Outstanding)

Sources: ABS, Refinitiv, Treasury, Capital Economics

Admittedly, hopes that QE would result in lower government bond yields and a weaker Australian dollar haven’t materialised. (See Chart 2.) But that partly reflects positive news about a vaccine.

Chart 2: 10-year Government Bond Yield & US$/Aus$

Source: Refinitiv

We think that optimism is justified and believe that a vaccine should be available in Australia and other advanced economies by Q2 2020. While it’s unclear if sufficient doses will be available to vaccinate all Australians by then, we think that at least health care workers, the elderly and those with pre-existing conditions will get a shot. That should allow a full reopening of the economy by mid-2020, including the opening of the border. As a result, GDP growth should be much stronger than the average 3% rise across 2021 the Bank is predicting. While our current forecast is 4%, we think it could be a larger 4.5% once we factor in the tailwind from a vaccine.

The counterargument is that the pandemic has generated a large amount of slack that will keep inflation and wage growth weak for years. While the subdued 0.1% q/q rise in the wage price index in Q3 was partly due to this year’s low and staggered minimum wage hike, annual wage growth reached a record-low of 1.4% and we think it could be as low as 0.7% by early next year.

But it’s becoming increasingly clear that the Bank’s outlook for the labour market is too pessimistic. Employment rose by a large 1.4% m/m in October even as the JobKeeper wage subsidy was scaled back. And while an equally strong rise in the labour force lifted the unemployment rate slightly to 7.0%, that’s well below its July peak of 7.5%.

Jobkeeper will be scaled back further from 1st January but the reduction in payments won’t be any larger than the one on 1st October. What’s more, the share of people working zero hours for economic reasons has fallen sharply since April. (See Chart 3.) And nearly all of the remaining gap in the number of people working zero hours relative to pre-virus levels is due to Victoria, which is opening up again after its draconian lockdown. As such, the further scaling back of Jobkeeper is unlikely to derail the recovery in employment.

Chart 3: Broader Measure of Unemployment (%)

Sources: Refinitiv, ABS, Capital Economics

Meanwhile, the labour force was 0.3% above its March level in October as the participation rate was back at pre-virus levels. And due to the collapse in net migration, the population is rising at a subdued annualised pace of just 0.5%. As such, the labour force will probably rise only marginally over the coming months. With employment in Victoria set to bounce back, unemployment is set to fall sharply

While the RBA, the Treasury and many other forecasters had expected the unemployment rate to rise to 8% by the end of the year, we’ve been saying for a while that the 7.5% reached in July will mark the peak. We reiterate our forecast that the unemployment rate will fall to 6.5% by December. And we still expect the unemployment rate to fall to 5.5% by end-2022, well below the RBA’s forecast of 6% and not far above its pre-virus level of 5.2%.

With output and the labour market set to rebound strongly, the Bank’s assessment of financial stability risks may change. The Bank has declared fighting high rates of unemployment an “important financial priority”. And it has argued that loose monetary policy will lower financial stability risks by improving balance sheets and preventing loan losses.

But it’s worth emphasising that as recently as February, concerns about fuelling another housing bubble prevented the Bank from responding to below-target inflation by cutting interest rates. Indeed, if the unemployment rate falls as rapidly as we anticipate and the full reopening of the economy keeps a lid on loan losses, the balance of the argument could shift quite rapidly. The recent downturn in the housing market has already come to an end and several leading indicators, including our sales-to-listings ratio as well as lending commitments, suggest that the housing market will soon be running red-hot. (See Chart 4.)

Chart 4: Lending Commitments & House Prices
(% y/y)

Sources: Refinitiv, CoreLogic, Capital

All told, the case for additional stimulus is diminishing. Given that the Bank’s monthly bond purchases are equivalent to a rather large 1% of the outstanding stock, we wouldn’t rule out a small extension of the Bank’s asset purchases, perhaps by $50bn for another six months. But we suspect that the economic outlook will have improved sufficiently for the Bank to end its purchases altogether in April. Either way, it seems likely that monetary stimulus will be withdrawn next year, which is one reason why we expect the Australian dollar to rally further from US$0.73 today to $0.80 by end-2022.

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

No major policy changes

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