RBA rules out quantitative easing for now

Economists expecting the start of unorthodox monetary policy in Australia next year may need to rethink their views.

Reserve Bank governor Philip Lowe. Picture: AAP

Economists expecting the start of unorthodox monetary policy including quantitative easing in Australia next year may need to rethink their views after the Reserve Bank raised the bar for adopting such policies and maintained an optimistic outlook for the domestic economy.

In a widely watched speech to Australian Business Economists, RBA governor Philip Lowe said he would cut interest rates twice more before even considering quantitative easing.

Furthermore, he wouldn’t automatically resort to QE at that point and the RBA most likely would only be prepared to buy government bonds in the secondary market rather than private-sector assets.

“Our current thinking is that QE becomes an option to be considered at a cash rate of 0.25 per cent, but not before that,” Dr Lowe said.

Westpac’s high-profile chief economist Bill Evans recently predicted that QE would start at 0.5 per cent. The cash rate is currently at a record low of 0.75 per cent after three cuts since June.

But while not ruling out further rate cuts, Dr Lowe said the threshold for undertaking QE in Australia “has not been reached, and I don’t expect it to be reached in the near future”.

He said: “It is difficult to be precise, but QE would be considered if there were an accumulation of evidence that, over the medium term, we were unlikely to achieve our objectives.

“In particular, if we were moving away from, rather than towards, our goals for both full employment and inflation, the purchase of government securities would be on the agenda of the board. In this world, I would hope other public policy options were also on the country’s agenda.

“At the moment, though, we are expecting progress towards our goals over the next couple of years and the cash rate is still above the level at which we would consider buying government securities. So QE is not on our agenda at this point in time.”

He also indicated that any cut in the cash rate to 0.25 per cent would not necessarily trigger QE.

“In my view there is not a smooth continuum running from interest rate reductions to quantitative easing,” Dr Lowe said.

“It is a bigger step to engage in money-financed asset purchases by the central bank than it is to cut interest rates.”

The RBA governor also narrowed the scope of any QE program in Australia, saying the bank had “no appetite to undertake outright purchases of private sector assets as part of a QE program”.

The RBA would not buy private sector assets because there was “no sign of dysfunction in our capital markets that would warrant the Reserve Bank stepping in”, and that presented “a significant intervention by a public sector entity into private markets”.

“It comes with a whole range of complicated governance issues and would insert the Reserve Bank very directly into decisions about resource allocation in the economy,” he said.

Scenarios where such intervention might be considered were “not on our radar screen”.

“An important advantage in buying government bonds over other assets is that the risk-free interest rate affects all asset prices and interest rates in the economy,” Dr Lowe added.

“So it gets into all the corners of the financial system.”

While there was “strong evidence” that liquidity support measures and targeted interventions in stressed markets overseas were successful in calming things down and supporting growth, evidence of positive effects from other unconventional measures was “less compelling”.

“These various measures certainly pushed down long-term yields and provided monetary stimulus in the depths of the crisis when it was needed,” Dr Lowe noted.

“But these extraordinary measures have continued way past the crisis period.

“In some countries, asset purchases have yet to be unwound and it remains unclear when, and even if, this will happen. So a full evaluation is not yet possible.”

Still, he said there were circumstances where QE “could help”.

In stressed market conditions, central banks “can help stabilise the situation” by buying bonds.

QE put “additional downward pressure on both interest rates and the exchange rate”.

But any positive effects would need to be balanced against “possible side-effects” since government bonds were used as collateral in financial markets and there was a limited supply on issue.

“We are also conscious that the Australian government’s fiscal position means that the gross stock of government debt is projected to decline relative to the size of the economy over the years ahead,” Dr Lowe said.

“These considerations are not impediments to undertaking QE, but we would need to take them into account.” Despite a lack of strength in retail sales and business or consumer confidence in recent months, Dr Lowe maintained monetary and fiscal stimulus was helping.

“It is important to remember that the economy is benefiting from the already low level of interest rates, recent tax cuts, ongoing spending on infrastructure, the upswing in housing prices in some markets and a brighter outlook for the resources sector,” he said.

“Given the significant reductions in interest rates over the past six months and the long and variable lags, the board has seen it as appropriate to hold the cash rate steady as it assesses the growth momentum both here and elsewhere around the world.”

The RBA was “also committed to maintaining interest rates at low levels until it is confident that inflation is sustainably within the 2 to 3 per cent target range”.

It expected growth to increase to 3 per cent in 2021 versus 2.3 per cent forecast for 2019.

“This pick-up in growth should see a reduction in the unemployment rate and a lift in inflation,” Dr Lowe said. “So we are expecting things to be moving in the right direction, although only gradually.”

While the RBA “recognises the benefits that would come from faster progress … it also recognises the limitations of monetary policy”, he said.