Analysis: Back to Early-1980s; Landmark RBA MonPol Moment We Missed

By Sophia Rodrigues

A landmark moment in the Reserve Bank of Australia’s monetary policy went largely unnoticed last month – the use of two instruments to pursue monetary policy objective after using one for at least three decades.

One instrument is the historical one targeting the interbank overnight rate, and the second targets bond yields further across the curve.

On March 18, the RBA held an ad hoc monetary policy meeting where it lowered the cash rate target by 25 basis points to its Effective Lower Bound of 0.25%.

At the same time, the RBA announced it will target a rate of around 0.25% for the three-year Australian government bond.

Governor Philip Lowe said in a speech on that day, “Over recent decades, the Reserve Bank's practice has been to target the cash rate, which forms the anchor point for the risk-free term structure. We are now extending and complementing this by also targeting a risk-free interest rate further out along the yield curve.”

The two rates now appear on the RBA's home page as "cash rate target" and "3-year AGS target," replacing just "cash rate" previously.

FOCUSED ON QE

That the monetary policy instrument had changed to two from one was largely missed because the focus of the market and commentators was entirely on the 0.25% target for the bond yield that marked the introduction of Quantitative Easing in Australia.

While one could debate whether it is QE or not, Governor Lowe understands why it is being viewed as such because bond-buying is resulting in an expansion of the RBA’s balance sheet.

Lowe, though, doesn’t seem to think it is QE because according to him the RBA’s emphasis is not on the quantity of bonds it will buy like some other central banks have done but on the price of money and credit.

This means the RBA is now using, not one, but two instruments to affect the price of money and credit in the economy.

The second instrument is expected to be in existence for a while but how long is unknown.

What is known is that the RBA thinks it is likely the cash rate would remain at a very low level for an extended period, and before raising the cash rate it would remove the yield target.

BACK TO PRE-1980s

The use of multiple monetary policy instrument is not a new development, and neither is targeting the bond rate.

“Until the early 1980s, monetary policy was exercised through a variety of instruments – such as interest rate ceilings, the setting of bond rates, variations in the Statutory Reserve Deposit Ratio, lending controls, monetary targets, pegged exchange rates – and the Treasurer and Treasury were very much involved in their use,” RBA’s then-governor Bernie Fraser said in a speech in 1992.

“Deregulation and other changes have seen these controls abandoned to the point where short term interest rates are now virtually the only monetary policy instrument,” he added.

CASH RATE TARGET VS CASH RATE

In a very interesting change, the RBA for the first time ever used the term “cash rate target” instead of just cash rate when announcing the rate decision on March 18.

While the RBA’s cash rate is technically a “cash rate target”, it was never referred to as such in any monetary policy statement.

Note the difference:

On March 18, the RBA announced, “A reduction in the cash rate target to 0.25 per cent.”

On March 3, the RBA announced, “At its meeting today, the Board decided to lower the cash rate by 25 basis points to 0.50 per cent.”

The first monetary policy statement where the cash rate was targeted was on January 23, 1990 by Governor Fraser and he referred to “cash rates” when announcing a reduction in the overnight rate of 50-100bps to a range of 17.0% to 17.5%.

The cash rate target was a range until August of the same year when it became a single number of 14%, down from a range of 15.0% to 15.5%.

Since then it has remained a single number.

The use of technical term “cash rate target” now is not without a reason. The RBA might be calling it so because after years of achieving the interbank overnight cash rate at exactly same level as the cash rate, the RBA is no longer confident it will remain the case.

This is due to excess liquidity in the system caused by the combined effect of its repo operations, bond purchases and term funding. Indeed, the interbank overnight cash rate has been drifting lower and was at 0.20% on Tuesday.

Referring to the cash rate as a target means the RBA is accepting that the overnight rate would be a range, rather than identical to the cash rate.

Would that be back to the January 1990 to August 1990 period?

Does it mean the RBA would eventually announce the cash rate target as a range of 0.10% to 0.25%?