Friday, 12 February, 2021
Fwd:FW: AFR: The RBA could increase its QE program at any time…
AFR: The RBA could increase its QE program at any time…
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AFR: The RBA could increase its QE program at any time…
While the analyst community believes the RBA’s QE program is fire-and-forget, every board meeting is, in fact, live and there is nothing stopping the RBA tweaking the size of the program at any time, just as they did with the Term Funding Facility in September 2020.
By Christopher Joye, Portfolio Manager, Coolabah Capital Investments
First, let it be said that Dr Andrew Leigh is the only person in parliament capable of going head-to-head with the imposing Martin Place mandarins when it comes to the intricacies of monetary policy. In this instance, the central bank was represented by three of its best and brightest: the governor, Dr Phil Lowe, the deputy governor, Dr Guy Debelle, and assistant governor, Dr Luci Ellis.
The sizing, timing, and direction of the RBA’s QE initiative is crucial right now because it is the only powerful policy left in its arsenal that has not been exhausted at a time when it is still years away from hitting its full employment and core inflation targets, and fostering the 4 per cent annual wages growth that is a condition precedent to such.
Lowe and Debelle have done a brilliant job in deftly delivering Australia’s first QE program, the initial iteration of which shocked many when it was launched in November 2020 (consensus was remarkably slow on the uptake when the RBA was telegraphing its intent in September and October).
This intervention is responsible for lowering Australia’s 10 year risk-free interest rate by about 0.3 per cent and materially slowing the inexorable ascent of the Aussie dollar according to the RBA’s analysis. In doing so, Martin Place is furnishing the domestic economy with much-needed stimulus as a time when it is operating with substantial excess capacity and faces the spectre of the unwinding of the federal government’s temporary fiscal stimulus, which will drag on growth.
Lowe’s announcement in February of an extension of QE 1.0, which expires in April, to QE 2.0 with another $100 billion of bond purchases through to September, was perfectly timed to eliminate the burgeoning “tapering” debate. Once again, economists and the market were behind the curve, with the consensus predicting prior to the RBA’s February board meeting that it would start tapering its purchases down to $63 billion via QE 2.0.
There is, nonetheless, a legitimate policy question posed by Leigh, which boils down to this: if QE 1.0 has been effective, and you have such a daunting challenge in normalising wages growth, employment, and inflation, why not do some more? Why not expand the size of these purchases to some larger number and study the ensuing effects? Put differently, what have you got to lose?
“I’m still concerned that it might be the case for the entirety of your term as governor that inflation sits below the target band, with the consequence that there are fewer jobs in Australia than there would otherwise be,” Leigh worried. “If you had announced $200 billion of QE on Tuesday rather than $100 billion, would your forecasts for wages in 2022 be higher or lower?”
This question casts into sharp relief the RBA’s dilemma. And both sides knew the answer. The governor had no qualms responding with the concession that Leigh was seeking, albeit in a round-about way. “I think any shift in those forecasts would have been marginal because the channels that $200 billion, as opposed to $100 billion [of QE], would have worked through would be perhaps a slightly lower value of the Australian dollar and perhaps a lower value of bond yields,” Lowe said. “That would have had some marginal [positive] effects—that’s true, yes.”
“Some marginal effects in producing higher wages, right?” Leigh retorted, looking to expand the scope of the RBA’s admission. “Analytically, that’s certainly possible”, Lowe concurred, emphasising that, “we haven’t ruled out further bond purchases after the current program.”
“I think the best approach is to repeat what we’ve done so far, with effectively $100 billion of government bonds,” Lowe explained. “That’s what we’ve bought over the past five months or are buying now, and we’ll buy another 10 per cent of the stock, so that’s 20 per cent of the stock over this bond purchase program. If we need to keep doing that, we will.”
In a revealing interview with Bloomberg on Thursday, board member Dr Ian Harper hammered Lowe’s point home further, stressing that “the bank can continue to buy bonds for as long as it likes—there’s no obstacle to that”. And there is nothing stopping them upsizing the program!
Yet like a pit-bull locking its jaw on a target, Leigh would not give up: “But surely your own MARTIN model [used to produce forecasts of the economy] would suggest that, if you had doubled the size of QE, inflation would be higher, wages would be higher and we’d be closer to full employment?”
“It could,” Lowe agreed. “By that logic, though, you would just keep going and going and going. If $200 billion would do that, you could make the same argument for $300 billion, $400 billion or $500 billion.”
“Until eventually you’re in your target band and achieving your mandate,” Leigh interjected. “It’s not obvious that this is a bad thing.”
Here the forthright Debelle entered the fray. “So, yes, you’re right,” he remarked in what was becoming a tautological debate. “The issue is: at what point do you start not getting the transmission through to those prices that you might expect? We don’t know what that point is.”
Debelle reiterated Lowe’s message that QE’s transmission mechanism through to the economy remains uncertain. The RBA started this experiment in November, and believes that QE 1.0 has been valuable insofar as it has helped keep long-term interest rates and the trade-weighted exchange rate lower than they would otherwise be. Every day Martin Place accumulates new information on the efficacy of QE, which should allow it to be recalibrated over time.
While it is perfectly reasonable for the RBA to keep the base-line at $100 billion every six months for the first year, there will also presumably be a point where there is a case for varying this base-line to some larger number, say $125 billion or $150 billion, to study the relationship between policy changes and economic variables. Or, as Leigh might put it, to simply help stimulate extra employment and wage growth through a lower real exchange rate.
Debelle did also warn of the potential for dysfunctions in the bond market if the RBA ends up being too large a part of it. Yet the RBA owns a much smaller percentage of the Aussie government bond market than peers overseas. It holds about 15 per cent of all Commonwealth government bonds and just 7 per cent of state government bonds. Central banks in New Zealand, Japan, and the UK own over 40 per cent of their government bond markets. The ECB is on track to control a similar share of all German bonds. And the US Federal Reserve holds 23 per cent of the massive treasury market.
The RBA is the first to acknowledge that its slower balance-sheet expansion vis-à-vis foreign central banks is one reason why our long-term interest rates and exchange rate are higher than they need to be. This is borne out by global data suggestive of a negative relationship between central bank asset purchases as a share of GDP and the change in a country’s real exchange rate.
When all is said and done, the RBA will only know the limit of its QE program once it actually reaches it. With little in the way of downside risks or opportunity costs (buying long-dated bonds has no direct impact on mortgage rates), there is value in exploring where that ceiling lies. I would not, therefore, be surprised if the RBA once again shocks market participants by recalibrating its QE commitments upwards somewhat.
While the analyst community believes the RBA’s QE program is fire-and-forget, every board meeting is, in fact, live and there is nothing stopping the RBA tweaking the size of the program at any time, just as they did with the Term Funding Facility in September 2020.
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