Safe bet QE top of mind for RBA this summer

A promise to buy mortgages will prove politically more popular than buying government debt. Picture: AP

The big question for the Reserve Bank of Australia board over the summer won’t be what to do with the official cash rate.

It was no surprise it left interest rates on hold on Tuesday, and few expect the Reserve to cut the official cash rate to a new record of 0.5 per cent when it meets for a final time this year in December before its summer recess.

How to implement quantitative easing – buying assets with newly created money – if inflation and economic growth continue to disappoint will, rather, top of mind of the board and senior officials.

Any excitement the modest uptick in inflation generated in Martin Place earlier in the week was quickly doused by the September retail sales figures, which extended a sluggish patch that has drowned out the stimulatory fanfare surrounding the government’s signature July tax rebates.

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At that rate, it’s only a matter of time before the RBA follows other central banks in advanced countries down the QE path.

Unlike the US Federal Reserve, ECB and Bank of England though, which have had the luxury of massive inventories of government bonds to choose from, the RBA might have to opt for other assets if it want to pull the trigger on quantitative easing. There’s no textbook right answer.

There are around $600bn of federal government debt outstanding, and most of this is held abroad. Up to a fifth is held by our banks to satisfy regulation, which leaves maybe $150bn sloshing around domestically. Moreover, the federal government appears determined to produce surpluses and thereby reduce the stock of debt further.

What to buy? QE with Australian characteristics could include the purchase of corporate bonds, or mortgage backed securities.

“If the RBA wanted to match the proportionate size of the Fed’s final QE program, amounting to 9 per cent of GDP, this would equate to around $175bn of government bonds and mortgage backed securities,” said John Llewellyn, former Lehman Brothers chief economist, in a note to clients this week. “The risk would be of heavy RBA purchases rapidly depressing liquidity and distorting price signals,” he added.

A promise to buy mortgages will prove politically more popular than buying government debt.

The former can be cast as helping home buyers rather than financing wasteful government borrowing. But the unintended consequences or buying up mortgage securities would be worse, given the property market is already awash with stimulus, and underwriting standards will inevitably fall if brokers know they can give the loans to the RBA.