RBA's last-ditch effort
Yesterday's drastic action by the Reserve Bank of Australia suggests it is embarking on a last-ditch effort to demonstrate its inflation targeting commitment, even at the risk of unleashing a major bubble in both house and equity prices.
Given the economic outlook has improved, rather than worsened, since the RBA last cut interest rates, it suggests the policy move is not based on new information but rather a major change in policy approach. Fear of the impact of persistent low interest rates on the financial system has been jettisoned, as has the fear of creating run-away asset prices.
Instead, the RBA has decided to now follow the aggressive global race to the bottom in terms of interest rates, and race to the top in terms of money printing – lest it be seen as somewhat more miserly than its global peers.
Above all, the RBA does not want to be accused of not supporting “Team Australia”, and the recent harsh criticism of former Prime Minister Paul Keating appears to have hit its mark.
Yet apart from good public relations, the economic impact of these measures is likely to be limited. By the RBA’s own reasoning, the Australian dollar is already close to fair value – supported by high iron-ore prices – so is unlikely weaken all that much in the face of an incremental further drop in interest rates.
Spending $100 billion to buy long-term government bonds also won’t do much to lower key local lending rates which are more sensitive to already rock-bottom short-term rates. That said, with interest rates now effectively zero, bond buying is the RBA’s new flexible policy tool. It can and likely will announce even greater bond buying in the months ahead – if only to continue to be seen to be doing something if the economic recovery falters.
Also following global peers, the RBA has now not only cut interest rates to practically zero but is promising to leave them there for a very long time. If, as I suspect, inflation continues to remain stubbornly low even as the economy improves – reflecting ongoing structural factors such as technology and globalisation – it remains to be seen whether an emerging asset bubble ultimately causes the RBA to lift rates well before its inflation target has been achieved.
Indeed, perhaps the greatest economic impact of the RBA’s bold new approach will be on asset prices – as the virtual guarantee of persistent low interest rates will push up valuations as investors chase yield and greater leverage.
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Author, columnist, investment strategist and macro-economist. Previous roles at Federal Treasury, OECD, Macquarie Bank and AFR. I develop economic insights and portfolio construction strategies for BetaShares' retail and adviser clients.