RBA to launch quantitative easing in earnest - Capital Economics
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RBA to launch quantitative easing in earnest

RBA Watch
Written by Marcel Thieliant
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We suspect that the Reserve Bank of Australia will keep policy settings unchanged at the meeting on 2nd June. But with the Bank’s employment and price stability goals moving out of reach, we expect the Bank to launch large-scale asset purchases soon, perhaps in August.

  • Previous government bond purchases were focused on restoring liquidity
  • Unemployment is rising and inflation set to slump
  • Bank may launch fresh round of purchases focused on lowering long-term rates

We suspect that the Reserve Bank of Australia will keep policy settings unchanged at the meeting on 2nd June. But with the Bank’s employment and price stability goals moving out of reach, we expect the Bank to launch large-scale asset purchases soon, perhaps in August.

RBA has stopped government bond purchases

The amount of liquidity the RBA has provided through its repo operations has been creeping higher again in recent weeks, reaching a fresh record high of $96bn at the end of last week. The generous provision of liquidity has kept 3-month interbank rates remain very low at around 0.1%.

By contrast, the Bank hasn’t bought any government bonds since 6th May. (See Chart 1.) That makes sense because 3-year yields remain close to the Bank’s 0.25% target.

Chart 1: RBA Government Bond Purchases ($bn)

Sources: RBA, Capital Economics

However, it is obvious that the economy needs additional support. The Bank’s latest “Statement on Monetary Policy” revealed that policymakers expect GDP to shrink by 5% this year and to only rebound by 4% across 2021. That would leave output around 6% below its pre-virus path by end-2021. What’s more, the Bank expects the unemployment rate to peak at 10% and to only fall to 6.5% by mid-2022, far above its estimate of the natural rate of 4.5%. That explains why the Bank expects underlying inflation to weaken from 1.8% to 1.25% by year-end and to remain below the lower end of its 2-3% target band for the foreseeable future.

Admittedly, the unemployment rate only rose to 6.2% in April which still left it below the peak reached after the end of the mining boom. But the unemployment rate is kept artificially low by two factors. First, nearly 6% of all employees were working zero hours because they were stood down or there was no work available. Second, the labour force participation rate plunged by 2.5%-pts in April as many of those who lost their jobs weren’t actively looking for work. One reason is that the government has temporarily waived the requirement to look for a job in order to receive unemployment benefits. Another reason is that looking for work wasn’t possible in many sectors during the lockdown. The upshot is that the true unemployment rate may be as high as 15%. (See Chart 2.)

Chart 2: Unemployment Rate (%)

Sources: Refinitiv, ABS, Capital Economics

Many of those who were working zero hours should start do work again as the economy reopens, but there’s still a risk that some workers will get laid off once the JobKeeper wage subsidy expires at the end of September. What’s more, many of those who lost their jobs will start looking for a new one as the economy reopens, but not all will be successful. While our forecasts for unemployment are similar to the RBA’s, we are more pessimistic about the outlook for inflation. Indeed, we expect underlying inflation to fall to 0.5% by early next year. That means that both the RBA’s price stability as well as its full employment mandate won’t be met for years.

Full-fledged QE may be launched soon

A quick look across the Tasman should convince the Bank that more can be done. 10-year yields in New Zealand have been higher than those in Australia in recent years, but they are now visibly lower. (See Chart 3.)

Chart 3: 10-year Government Bond Yields (%)

Sources: Refinitiv, Capital Economics

That reflects the fact that the RBNZ announced a large round of quantitative easing in March and announced an expansion this month. What’s more, the RBNZ has indicated that it is willing to launch negative interest rates at some point. (See here.)

The RBA has repeatedly ruled out negative interest rates, with Governor Lowe noting this week that they are “extraordinarily unlikely”. Indeed, the financial markets don’t expect short-term interest rates to fall any further and neither do we.

That still leaves the door open for quantitative easing, which the Bank had previously singled out as its preferred unconventional monetary policy tool once interest rates hit the zero lower bounds. One could argue that the Bank has already been doing this since March, when it launched a target for 3-year government bond yields. But the main aim of the Bank’s government bond purchases were to restore liquidity in financial markets. Indeed, Governor Lowe noted in March that the Bank’s focus was not on the quantity and timing of purchases, but that the Bank’s purchases will depend on market conditions and prices.

We suspect that the Bank will soon make an attempt to lower longer-term yields via large-scale purchases of government bonds. This could happen via a yield target for 5 or 10-year yields. But Governor Lowe warned in November about blurring the lines between fiscal and monetary policy as this could be seen as money-financed government spending. A target for longer-term bond yields may therefore be a step too far. We consider it more likely that the Bank will announce a certain quantity of purchases, perhaps pledging to buy 10% of the outstanding stock per annum.

Lower long-term yields should reduce the funding costs of Australian banks a little, which would allow them to lower lending rates. Long-term debt accounts for around 15% of their funding, though for most of the large banks, the bulk of that debt is issued in foreign currencies rather than Australian dollars. What’s more, lower risk-free yields should also help to reduce corporate bond yields even as corporate bond spreads remain elevated. If the sample used by the RBA to calculate corporate bond yields and spreads is any guide, the majority of corporate bonds in Australia have maturities above four years. (See Chart 4.)

Chart 4: Maturity Distribution of Bonds Included in the RBA’s Sample of Corporate Bonds (% of Total)

Sources: RBA, Capital Economics

The Bank could announce quantitative easing as soon as the upcoming meeting. But this would come out of the blue and we consider it more likely that the Bank will signal its intentions beforehand. A move in July is possible but we suspect policymakers will wait for the release of Q2 consumer prices, due at the end of July. We expect the QE bazooka to be launched at the August meeting.

Table 1: RBA Monetary Policy Background Information
Interest Rate MeetingsThe 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 MinutesTwo weeks after each meeting.
Other PublicationsThe 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 VotingNo, the votes and views of individual members are not identified in either the policy statements or the minutes of the meetings.
Inflation TargetThe 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 FrameworkThe 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 BoardThe 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.
GovernorPhilip Lowe
Deputy GovernorGuy Debelle
Other members of the Reserve Bank BoardMark BarnabaCarol Schwartz
Allan MossCatherine Tanna
Ian HarperSteven Kennedy, (Secretary to the Treasury)
Wendy Craik
*Denotes release of The Statement on Monetary Policy later that week4th Feb 2020*0.75%2nd Feb 2021*0.25%
3rd Mar 2020Cut to 0.50%2nd Mar 20210.25%
19th Mar 2020Cut to 0.25%6th Apr 20210.25%
7th Apr 20200.25%4th May 2021*0.25%
5th May 2020*0.25%1st June 20210.25%
2nd June 20200.25%6th July 20210.25%
7th July 20200.25%3rd Aug 2021*0.25%
4th Aug 2020*0.25%7th Sep 20210.25%
1st Sep 20200.25%5th Oct 20210.25%
6th Oct 20200.25%2nd Nov 2021*0.25%
3rd Nov 2020*0.25%7th Dec 20210.25%
1st Dec 20200.25%
Sources: RBA, Capital Economics

Marcel Thieliant, Senior Australia & New Zealand Economist, marcel.thieliant@capitaleconomics.com