Reserve Bank slimming down after QE feast during Covid pandemic

The Reserve Bank of Australia building in Sydney's Martin Place is still undergoing major renovations. Picture: NewsWire / Damian Shaw

The Reserve Bank has undergone the equivalent of a crash diet, with the central bank now 40 per cent trimmer than its pandemic-era peak.

It’s still working though the after effects of a time of gorging out on hundreds of billions of high-calorie government bonds.

But it is getting closer to putting the bold monetary experiment of Quantitative Easing behind it.

The RBA is slowly healing to the point of getting its balance sheet back in shape. This is important given a global financial shock could strike at any time. The recent extraordinary rally in gold suggests this could be closer than many expect.

Through the pandemic the RBA purchased an eye-watering $281bn in Australian government bonds aimed at injecting liquidity into the market while trying to hold longer-term interest rates artificially low.

In effect, through QE, the central bank was creating money to keep the economy moving. On top of that it acquired another $188bn of bank bonds, to give lenders access to ultra-cheap term financing.

This saw the amount of assets sitting on the RBA balance sheet surge to more than $600bn – nearly a quarter of Australia’s GDP. The bank bonds were redeemed over a set period, but the government bonds are being held to maturity and it’s these instruments that have been playing havoc with the central bank’s balance sheet.

The RBA balance sheet “assets” are now down to a more manageable $403bn but what the bank “owes” through banknotes and deposits is $408bn (when a bond is “bought” by the RBA it is credited in a deposit).

Still, the mismatch between the two has put it in a net negative position of $5.3bn. This negative position was as much as $20bn shortly after the pandemic.

With the RBA backed by the Commonwealth, it can trade through this position over coming years. The latest accounts show the RBA delivered an $11bn profit from a loss last year of $4.1bn. The central bank has racked up more than $34bn in accumulated losses over the past four years.

Leading up to the Covid pandemic the RBA’s balance sheet was largely around $150bn to $200bn. It is expected the central bank will return closer to this figure over the time.

Following an internal review of the monster QE program following the pandemic, the RBA said the unorthodox tools will would only be considered again “in extreme circumstances” when the cash rate target had been “lowered as far as possible” – or next to zero. Essentially this means the RBA has set a high bar for a future bond buying program, which adds to inflation when cash rates are low.

US Treasury Secretary Scott Bessent recently took aim at the US central bank’s extensive use of quantitative easing during the pandemic which he believes has “uncertain theoretical underpinnings and problematic economic consequences”.

The RBA has since declared it will let the rest of the QE bonds roll off naturally – this will be up to five years for the bulk of them. In effect it’s a quantitative tightening as it is money being taken out of the system, so at the margins working against lower interest rates.

Other central banks like the Bank of England or the RBNZ are looking at speeding up the process of quantitative tightening by selling bonds early. The US Federal Reserve is effectively slowing the process by reinvesting some of the maturing bonds.

[e-mail]