Call for active quantitative tightening by RBA to ‘spread the pain’

As the RBA considers another rate hike it should also be thinking about active quantitative tightening, a leading strategist says.

As the RBA meets to consider a further rate hike it should think about active quantitative tightening (QT).

While the board mulls a further increase in interest rates, it should consider selling government bonds to “spread the pain” of its monetary policy tightening to the 30 per cent of households that own their home outright, a leading financial market strategist says.

Since May 202, the RBA has been shrinking its balance sheet by “passive” quantitative tightening. By allowing its bond holdings to gradually diminish over time as they mature, the initial stimulatory effects of those holdings – namely, downward pressure on government bond yields and the Australian dollar – would gradually unwind, RBA assistant governor Chris Kent said at the time.

A decision to switch to “active” quantitative tightening would mean a more forceful reverse of the “quantitative easing” that supported asset values during the pandemic by lowering the risk-free rate.

“By selling these bonds, long-end yields could rise, and weigh on equities and house prices,” says Deutsche Bank macro strategist, Tim Baker. “Indeed, the correlation between the price-earnings ratio and 10-year yield has been quite strong in the past decade.”

In February he noted that active quantitative tightening would be a “worthwhile option” for the RBA as the Aussie bond market seemed to have more ready buyers than its offshore peers.

An additional reason that he mentioned at the time was that active QT could spread the effects of its policy tightening more broadly across the different kinds of households.

With house prices rebounding for the past four months and interest payments and rents surging as a result of RBA policy rate changes, Deutsche Bank’s Baker says this issue has even more relevance now.

Indeed a rise in housing costs has been the most visible manifestation of RBA policy tightening.

Interest payments have doubled and rents have soared 5 per cent in the past year.

It’s a heavy impost for these households, yet almost a third of households have been unaffected.

Many of those will in fact be enjoying more spending power as a result of rising bank deposit rates.

The latest data showed 37 per cent of households had a mortgage, with housing costs averaging 16 per cent of their income.

Renters comprised 34 per cent of households, with rents soaking up a fifth of their income.

But the 30 per cent of households that owned their home outright were “insulated from these big moves in housing costs”, according to Deutsche Bank’s Baker.

Moreover, asset values have held up relatively well. After falling 9.7 per cent from March 2022 to January 2023, the median capital city house price has risen 4.1 per cent, according to CoreLogic.

“Not only that, but outright homeowners have higher wealth levels overall,” Baker says.

“By definition they own their home, plus their financial assets are far higher – double that of mortgage payers, and more than six times what the median renter holds.”

“Compounding this, asset prices are only down a little from the record highs, and have done very well on a three-year view.”

Baker says active QT could thus produce a “tightening of financial conditions”, making the RBA less heavily reliant on the cash rate as its primary policy tool.

“It could also spread the impact of monetary policy tightening to the 30 per cent of households with tiny housing costs and an elevated asset position,” he says.

Moreover, the RBA has about $121bn of government bonds with five years or more to maturity – “a reasonably large” bond portfolio in the context of the AOFM’s (Australian Office of Financial Management) planned issuance of $75bn this year.

There is currently little expectation that the RBA will switch to active QT.

There has been media speculation that if it decided to do so, the RBA could decide to sell the bonds to the AOFM, thereby reducing the impact on financial markets.

The central bank’s balance sheet was already set to decline rapidly given the maturity of funding under the Term Funding Facility, and that bond sales might complicate governments’ bond issuance and reduce the effectiveness of any future quantitative easing program, May RBA minutes state. At its May meeting, the board reviewed the bank’s approach to reducing its holdings of government bonds, which had been purchased during the pandemic to support markets and provide stimulus.

It said the current strategy of holding these bonds until maturity, rather than selling them prior to that, recognised that the bank’s balance sheet was already set to decline rapidly given the maturity of funding under the Term Funding Facility, and that bond sales might complicate ­governments’ bond issuance and reduce the effectiveness of any ­future quantitative easing program.

“Members agreed that this approach remained appropriate for the time being,” the RBA said in May.

“However, they noted that the initial tranche of Term Funding Facility maturities would occur in coming months and would provide information on how financial markets respond as the bank’s balance sheet declines.”

“More generally, the bank’s large holdings of government bonds exposed its balance sheet to a significant level of interest rate risk.

“Accordingly, members ag­reed it was appropriate to review the current approach periodically,” the Reserve Bank of Australia said.