Reserve Bank flags resorting to quantitative easing

The RBA ‘stands ready’ to buy Australian government bonds, as it also considers further policy measures.

The Reserve Bank has laid the groundwork to start quantitative easing in Australia on Thursday, as it considers another cut in the official cash rate.

In an emergency statement, RBA governor Philip Lowe said in response to a deterioration of trading liquidity in some markets as Australia’s financial system adjusts to the coronavirus, the central bank “stands ready to purchase government bonds in the secondary market to support the smooth functioning of that market, which is a key pricing benchmark for the Australian financial system.”

While RBA buying of government bonds in the secondary market wouldn’t necessarily involve a commitment to quantitative easing via large scale asset purchases or bond buying to target a specific yield - yield curve control - the RBA’s statement that it is prepared to intervene in the bond market was nonetheless extraordinary and the market expects quantitative to start soon.

As disclosed earlier Monday in a statement by the Council of Financial Regulators, Dr Lowe said the RBA will also be conducting one-month and three-month repo operations in its daily market operations until further notice to provide liquidity to Australian financial markets, as well as longer term repo operations of six months maturity or longer at least weekly, as long as market conditions warrant.

“The Reserve Bank and the AOFM (Australian Office of Financial Management) are in close liaison in monitoring market conditions and supporting continued functioning of the market,” Dr Lowe said. “The bank will announce further policy measures to support the Australian economy on Thursday.”

Following a co-ordinated round of official interest rate cuts on Monday by central banks including the US Federal Reserve, the Bank of New Zealand and the Hong Kong Monetary Authority, the RBA is now widely expected to cut the official cash rate by 25 basis points to its nominated lower bound of 0.25 per cent and begin quantitative easing with yield curve control – buying bonds to target a certain yield.

Market pricing on Monday showed an implied cash rate of 0.105 per cent by the time of the RBA’s April 7 meeting. The cash rate is currently 0.5 per cent.

“Global markets have dislocated further with increasing signs of stress in some markets, sharply reduced liquidity, and price action hinting at forced selling,” said RBCCM chief economist Su Lin Ong.

“Beyond just a tightening of financial conditions, the risk is these moves worsen a real economy already struggling with COVID-19.

“Against this backdrop, we think the risk is increasing of an unscheduled final 25 basis point cut from the RBA ahead of its 7 Aprril meeting.

“It could also start to signal more detail on unconventional policy and even announce some of these measures ahead of the April meeting.”

Australian Commonwealth government 10-year bond yields dropped from 0.93 to 0.81 basis points after the RBA’s announcement.

Australian three-year bond yields dropped from 0.45 to 0.376 basis points.

The Australian dollar slipped from US61.54c to a fresh 11-year low of US60.96c.

Last week RBA deputy governor Guy Debelle said the central bank would “absolutely” be considering adopting a target level to keep government bond yields low, which would lower the yield structure of the rest of the local financial market.

Mr Debelle said the RBA would “act in the government bond market as necessary” to keep yields on treasuries low in a bid to force money managers to funnel capital into more productive investments.

The RBA has flagged it could intervene in the bond market if the official cash rate is dropped from its recent record low of 0.5 per cent to a new low of 0.25 per cent — as is widely expected — and the economy still needs stimulus.

“We need interest rates to be low for a sufficiently long period of time,” Dr Debelle said.

“That would be the sort of option we would be considering,” Dr Debelle said.

“There are scenarios in which we are certainly going to have to consider that — absolutely.”