As expected, the Reserve Bank this week cut its key policy rates – the cash rate; three-year target bond rate; and Term Funding Facility (which can be accessed by commercial banks) – from 0.25 per cent to 0.1 per cent.
The RBA board also expanded its quantitative easing program, committing to purchasing $100 billion of government bonds of maturities of around five to 10 years over the next six months. Given this will compliment the RBA’s purchase of bonds in whatever quantity is required to achieve the three-year yield target, yesterday’s announcement represents a more aggressive approach than expected.
The key motivation for the new $100bn program is to lower the Australian dollar by dissuading foreign investors to purchase these securities.
But the Governor also made the important point that lowering interest rates would support asset prices, including housing, and he is less concerned about inspiring a “bubble” than in the past. This aligns with our more upbeat views on the housing market aired in September, expecting a less severe 5 per cent fall between April this year and June 2021, before rising 15 per cent until mid-2023, or 7.5 per cent per year.
In terms of the $100bn bond buying program, this will see the RBA’s balance sheet increase to around $550bn from $300bn currently, when also factoring in, say, $140bn for the TFF (entities have access to a further $104bn) and an additional, say, $10bn to defend the three-year bond rate target of 0.1 per cent.
To put that in perspective, that growth will see the RBA increasing its balance sheet from $180bn before COVID, or a stunning 300 per cent.
At $550bn, the balance sheet would equate to 27.5 per cent of GDP. In contrast, the US Federal Reserve has increased its balance sheet since COVID from $3.8 trillion to $7.05 trillion – an increase of 85 per cent. The FED’s balance sheet is now around 33 per cent of GDP.
The RBA will be very rapidly closing in on the FED from a “standing start”!
Finally, a more surprising component of yesterday’s announcement was that the rate paid on commercial banks’ Exchange Settlement balances held at the RBA would be cut from 0.1 per cent to zero. Consensus expected it would fall to five basis points and our view was it would be set at one basis point. At zero, banks will face a difficult decision whether to offer positive deposit rates to wholesale customers, which will likely be weighed against long term relationships.
It also opens up the possibility of negative short term private rates from time to time.
However, the Governor confirmed the board’s view that a negative policy rate is “extraordinarily unlikely” – the main issue being the impact of negative rates on the supply of credit.
Still, this wasn’t ruled out, the most likely reason why this might change being if “the biggest central banks in the world” went negative. Given that the ECB and BOJ are already negative, that keeps all eyes on the Fed.
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