Reserve Bank lays ground for November rate cut and massive quantitative easing program

RBA’s Philip Lowe says cutting rates to 0.1pc as the economy opens back up would ‘get more traction’ than earlier in the year.

Reserve Bank governor Philip Lowe’s speech at the Citi conference was titled ‘The recovery from a very uneven recession’. Picture: AAP

Reserve Bank governor Philip Lowe has laid the foundation for Melbourne Cup day rate cuts and possibly the start of full-blown quantitative easing, declaring monetary policy still has a role to play in helping drive the nation’s economic recovery from the COVID-19 recession.

In a speech at the Citi Investment conference in Sydney, Dr Lowe said further central bank support for the economy would “get more traction” now than during widespread restrictions earlier in the year.

“When the pandemic was at its worst and there were severe restrictions on activity we judged that there was little to be gained from further monetary easing,” he said.

“The solutions to the problems the country faced lay elsewhere.

As the economy opens up, though, it is reasonable to expect that further monetary easing would get more traction than was the case earlier.”

Bank economists and investors quickly moved to factor in a higher chance of a cut from 0.25 per cent to 0.1 per cent when the RBA board next meets on November 3. At the same time some leading economists pencilled in the prospect of up to a $100bn quantitative easing program – essentially buying of long-dated bonds in a bid to pump funds into the financial system.

The RBA in March launched a bond-buying program aimed at keeping three-year rates at 0.25 per cent, in line with the cash rate. Any rate cut at the next meeting would be reflected in this target.

The Australian dollar dropped 0.8 per cent to a six-day low of US70.97c as the 3-year bond yield hit a record low of 0.121 per cent and the 10-year hit a six-month low of 0.744 per cent.

Shares reacted positively, with the S&P/ASX 200 index rising as much as 1 per cent to a seven-month high of 6233.3 and beneficiaries of a lower exchange rate outperforming the broader market.

But a 0.5 per cent fall in S&P 500 futures saw the local index finish up 0.5 per cent at 6210.3.

CBA senior economist Kristina Clifton said she now expected a 0.15 percentage point cut next month, as well as an extension of the three-year bond rate target out to 5-10 year bonds.

“The governor has made it very clear that we can expect to see more monetary policy easing from the RBA,” Ms Clifton said. She added that it’s also likely the RBA will start buying 5-10 year bonds after highlighting that interest rates in these maturities are higher than in other countries.

“Lower bond yields will have the first round effect of reducing interest costs for the government as they continue to provide a massive amount of fiscal support to the economy,” Ms Clifton noted.

Other economists went further, predicting the RBA will soon start buying a set amount of bonds.

“Pure QE (quantitative easing) in November seems likely, but it may be delayed until next year,” said ANZ’s head of Australian economics, David Plank.

“On the question of whether or not a move to ‘pure’ QE is on the table, Dr Lowe’s comments suggested it’s actively being considered.

“Our balance sheet has increased considerably since March, but larger increases have occurred in other countries,” he said.

We are considering the implications of this as we work through our own options.”

After his speech, Dr Lowe noted that Australian 10-year bond yields are higher than other countries and the RBA was examining if that was due to the fact that it hasn’t bought 10-year bonds since March, and whether lowering the 10-year yield might help with employment and inflation goals.

“Earlier research by the RBA suggests it will,” said ANZ’s Mr Plank.

“On this basis we think the RBA will opt for QE in November, but we aren’t as confident on this as we are on the call that the cash rate will be reduced to 0.1 per cent.”

Some economists predicted the RBA would start buying as much as $100bn of bonds a year.

“Overall, we viewed the speech as dovish – including an important pivot in the RBA’s reaction function – and raise our subjective odds of an easing package at November’s Board meeting to 80 per cent,” said Goldman Sachs Australia chief economist, Andrew Boak.

“In particular, we expect the RBA to lower the cash rate, yield curve and term funding facility targets by 15 basis points to 0.1 per cent and announce a new $100bn QE program aimed at reducing longer-term yields…we note there is still relatively more uncertainty around the exact size, scope and timing of the QE component.”

Similarly, JP Morgan Australia senior economist, Tom Kennedy, said Dr Lowe’s speech marked “another dovish shift by the central bank” and “a growing preference to provide further support.”

“Following these remarks, we now expect the RBA to embark on a quantity-based QE program focused on both Commonwealth and State Government debt commencing in February.

Our expectation is for a program size of $75 billion-$100 billion over one year, implying weekly average purchases of between $1.4 billion-$2 billion.”

KPMG chief economist Brendan Rynne said Dr Lowe’s “whatever-it-takes monetary policy setting”, combined with the recent easing of responsible lending requirements, “means the Australian economy is likely to become awash with money sooner rather than later”.

In his speech, Dr Lowe described an “uneven” recession that hit the young, women and lower-income households hardest, and indicated the central bank was mulling whether pushing long-term bond rates down would help create more jobs.

“Is there a benefit of us buying more longer-term bonds and what benefit would that have?

If we buy bonds in the five to 10-year range, will that create more jobs?

That’s what we are discussing at our meetings,” the RBA governor said.

Weakening the currency stands as a major – and perhaps the sole – benefit of a bond-buying program aimed at pushing 10-year rates down, as most business and fixed-rate home lending in Australia is based on three-year terms or less.

Dr Lowe flagged the prospect of further easing in the near term to assist the recovery, and a major change in guidance that raised the bar for future monetary tightening even further into the future.

He said the central bank would only move rates higher when the bank’s inflation and unemployment goals were met, rather than within its forecast 2-3 year time horizon.

“The board will not be increasing the cash rate until actual inflation is sustainably within the target range,” he said. “It is not enough for inflation to be forecast to be in the target range.”

Dr Lowe said he had largely given up trying to set monetary policy according to where he believed inflation would be in the future, abandoning a multi-decade approach to managing the rate cycle that only made sense when “the inflation dynamics were relatively stable and well understood”.

Dr Lowe also said “we want to see more than just ‘progress towards full employment’.”

The announcement represents a significant change from altering policy based on the expected achievement of those goals within its 2-3 year horizon.

“In terms of inflation, our forward guidance has been forward looking – we have focused on the outlook for inflation, not just current inflation,” Dr Lowe said.

“This was a sensible approach when the inflation dynamics were relatively stable and well understood. In today’s world, things are much less certain. So we will now be putting a greater weight on actual, not forecast, inflation in our decision-making.”

The RBA, which is the most highly regarded economic institution in the country, has received loud and unusually high profile criticism in recent weeks from, variously, a former prime minister, a former senior staff economist, and an ex-governor.