QE coming next year, predicts JPMorgan economist Auld

Unconventional monetary policy will be a reality in Australia by the end of next year, according to JPMorgan’s Sally Auld.

JPMorgan chief economist Sally Auld. Picture: Hollie Adams

Unconventional monetary policy — including quantitative easing — will be a reality in Australia by the end of next year to help fire up the economy, according to JPMorgan Australia’s chief economist Sally Auld.

After reviewing the Reserve Bank’s revised economic forecasts and assumptions in its quarterly Statement on Monetary Policy released last week, Ms Auld has concluded that the current policy settings in Australia — including ultra-low interest rates — may not be enough to spur on growth.

She becomes the latest major economic forecaster predicting QE, with economists from Westpac, AMP and Capital Economics also tipping unconventional approaches.

The RBA’s latest forecasts — which largely assume that another 25 basis point interest rate cut is delivered in the first half of 2020, on top of the 75 basis points of cuts delivered since June — still show unemployment above the RBA’s estimate of the non-accelerating inflation rate or “Nairu”, and core inflation inconsistent with the inflation target at the end of the forecast horizon in 2021.

“In our view, this leaves the door wide open for the RBA to move towards the next phase of easing, via unconventional monetary policy,” Ms Auld said.

“For some time, we have forecast that the RBA will cut rates by a further 25 basis points in February 2020.

“We now add quantitative easing to this forecast, and anticipate that the RBA will deliver a package of unconventional monetary policy measures in the fourth quarter of 2020.”

She expects such policy measures will comprise another 25 basis point cut in the cash rate to 0.25 per cent, a plan to buy $35bn-$50bn of nominal commonwealth government bonds, and continued use of “forward guidance” regarding the outlook for interest rates.

It is a scenario that could have major implications for asset prices because it is not widely expected.

The market-implied chance of another 25 basis point rate cut by the RBA at any point in the next year was little more than 68 per cent as of Monday.

The yield on Australia’s benchmark 10-year government bond — which would be directly affected if QE were to include such assets — touched a four-month high of 1.34 per cent last week.

After hitting a record low of 0.85 per cent in August, the 10-year bond yield rose significantly in line with a similar rise in US bond yields as interest rate cuts by central banks fuelled hopes that the global economy will avoid a recession next year amid a softening of US trade policy.

The Australian dollar has slipped to US68.5c from a three-month high of US69.3c two weeks ago.

The S&P/ASX 200 share index rose 0.7 per cent to a three-month high of 6772.5 points.

Ms Auld is assuming the RBA favours a package of measures as “more impactful” — a key conclusion of the bank’s study of QE programs overseas, that credit markets are “functional” at the time of implementation, that the government delivers only “modest” fiscal easing in the May budget, bank funding costs remain “contained”, and the global backdrop improves in the first half of 2020, “allowing the RBA plenty of time to pause after the first-quarter rate cut before implementing QE”.

The Australian last month revealed that the Reserve Bank’s likely course of action, should it need to launch unconventional monetary policy, would be a program of buying residential mortgage-backed bonds. This would lower bank funding costs and allow borrowers to access cheaper credit. The comments were made in a Treasury briefing note released under Freedom of Information.

While the risks to the global outlook have shifted in a favourable direction of late and a firmly “on hold” outlook for US monetary policy also takes some pressure off the RBA, Ms Auld says it is worth remembering that the RBA’s current set of forecasts — which see the unemployment rate at 5 per cent by mid-2021 and core inflation at 1.9 per cent by end-2021 — assume “some chance” of a further rate cut to 0.5 per cent in the first half of 2020.

“Fundamentals would need to improve markedly for this to be no longer required, and data we have so far for the September quarter are a sobering reminder that the economy hasn’t reached escape velocity just yet,” she says.

“In addition, the prospect of currency strength will keep the RBA on notice, given the importance of currency stability or currency under-performance to the broader economic outlook.”

With its downward revisions to wages growth and a longer period of below target inflation, the November Statement on Monetary Policy was a “clear reminder that the RBA has more work to do”.

“It is increasingly clear that a further 25 point cut will be insufficient to achieve desired objectives,” she says.

The final quarter of 2020 is seen as the most likely start date for a QE program on the basis that, by then, the RBA will have seen three sets of national accounts after the expected February rate cut, showing whether the economy is sustaining a growth rate consistent with trend or “potential”.

“In order to render QE unnecessary, we think the RBA would need to be confident by the September quarter that the economy has reached a point where quarterly GDP growth of 0.7 per cent on quarter is sustainable,” Auld says. “Our own forecasts are a little below this for 2020.”

One caveat is that the RBA aims to lift core inflation to the middle of its 2-3 per cent target.

“This assumption can’t be taken for granted, given the governor’s view that the pursuit of higher inflation should be viewed within the broader objective of welfare maximisation.”

Her modelling suggest that, other things being equal, 50-75 basis points of additional cuts would be needed — beyond her forecast cash rate of 0.50 per cent — to get core CPI convincingly inside the target band, whereas a 0.25 per cent cash rate plus QE could “make up the difference”.

In her view, the RBA’s comment last week that “each further cut brings closer the point at which other policy options might come into play” suggests that the bank is perhaps prepared to move towards unconventional policies sooner than expected.

If the government were to deliver meaningful fiscal expansion in the May budget, then the RBA would be unlikely to deliver QE next year, according to Auld.

Morgan Stanley economists have predicted a stronger fiscal stimulus to be announced in the May budget, and Westpac and CBA have urged the government to bring forward for tax cuts.