Reserve Bank cuts bond buying despite Covid resurgence

Reserve Bank of Australia in Sydney. Picture: NCA NewsWire/Joel Carrett

The Reserve Bank stuck to its plan to lessen economic support via its quantitative easing program next month despite recent Covid-19 lockdowns hitting the short-term growth outlook.

While acknowledging that the economy now faces a September quarter contraction, the bank will trim its weekly buying of government bonds to $4bn in early September from $5bn previously.

Interest rate targets and guidance that the cash rate won’t rise until inflation is “sustainably within the 2 to 3 per cent target range” were not changed.

But the decision to push ahead with QE tapering came as a surprise to financial markets.

The Aussie dollar jumped 0.6 per cent to a three-day high of US74.08c, the 10-year bond yield spiked about 3 basis points to 1.163 per cent and the ASX 200 share index dipped to 7455.5 points.

In a statement after the RBA’s July board meeting, governor Philip Lowe said Covid outbreaks were “interrupting the recovery”, but the economy had typically recovered quickly in the past.

The economy was “still expected to grow strongly again next year” as it was “still benefiting from significant additional policy support and the vaccination program will also assist with the recovery”.

“Domestic financial conditions remain very accommodative, sovereign bond yields have declined and the exchange rate has depreciated to around its lowest level this year, despite elevated levels of commodity prices,” Dr Lowe added.

“The recent fiscal responses by the Australian government and the state and territory governments are also providing welcome support to the economy at a time of significant short-term disruption.” CBA head of Australian economics Gareth Aird said it was “hard to reconcile” the fact that the change in the near-term outlook for the economy because of the Covid‑19 situation had had no impact on the RBA’s monetary policy decisions.

“That same decision is still deemed appropriate despite the lengthy lockdown in Sydney, which will see GDP contract and the unemployment rate rise over the near term,” he said.

In light of recent events, the governor’s statement was “very much glass half full”, particularly since the RBA maintained its forecasts for the unemployment rate in the medium term, despite the expected “economic hit” expected in the short term from Covid lockdowns.

Westpac chief economist Bill Evans – who had expected an increase in bond buying to $6bn a week – noted the rationale that the economy tended to rebound quickly, adding that “presumably a policy change may have undermined confidence in that outlook”.

“We found this decision surprising given that the consistent guidance which the board has provided is that ‘the program will continue to be reviewed in light of economic conditions and the health situation’,” he said.

“A key reason behind Westpac’s view that the board would respond to the current economic downturn was that it now appears that the economy will contract in the September quarter – a significant deterioration from the situation in July.”

The fact that the RBA did not respond suggested “the hurdle for adjusting policy is surprisingly high”.

“Arguably, what we have seen is the view that adjusting policy may have detracted from the perception of the RBA’s confidence in the recovery,” he added.

“The board will still retain flexibility to respond in September or October should conditions deteriorate substantially more than their central view.

“… it seems likely that there will be no policy adjustment in September and October.”