Macro

I've written a lot about the coming of Aussie QE since we first forecast it in May this year (the notion was dismissed by many at the time), and there is mounting evidence that the RBA is slowly starting to burnish its narrative on this front, as we have suggested they should do. 

The RBA's August board minutes put the prospect of QE squarely on the table, reviewing best practically internationally and concluding that “a package of measures tended to be more effective than measures implemented in isolation”. 

Then on the weekend a long-time RBA voice-piece, the SMH's Ross Gittens, waded into the subject, interestingly asserting that "the measure Lowe seemed least uncomfortable with is the central bank buying long-term government securities to try to lower risk-free long-term interest rates". "This is similar to conventional policy, just at the long end rather than the short end," Gittens argued. 

As I explained in my latest AFR column on the rise of Zombie companies, it is not that straightforward. In a prescient speech on QE in December 2018, the RBA's deputy governor, Guy Debelle, made the following remarks:

"QE is a policy option in Australia, should it be required. There are less government bonds here, which may make QE more effective. But most of the traction in terms of borrowing rates in Australia is at the short end of the curve rather than the longer end of the curve, which might reduce the effectiveness of QE. The RBA's balance sheet can also expand to help reduce upward pressure on funding, if necessary, as occurred in 2008."

So buying government bonds will not be especially effective for reducing domestic lending rates. But if the RBA is more concerned about the impact of, say, Fed and ECB rate cuts on the Aussie dollar, then this particular form of QE could be quite powerful given that global currencies price off risk-free rate differentials. Inverting the Aussie yield curve would presumably have a material impact on the exchange rate. 

Having said that, there is nothing worse than a central bank appearing impotent. And here it is worth revisiting the RBA board's conclusion in August that deploying a package of QE policies is superior to relying on one specific measure. The RBA has many options in this respect, including lengthening the tenor of its direct lending to banks via repurchase (repo) agreements as it did during the GFC, and buying assets that are already eligible for its repo facilities, such as bank issued covered bonds, senior bonds, and AAA rated RMBS/ABS. 

If the RBA does not feel that it has a realistic hope of returning inflation to target and getting the jobless rate below 4.5%, which it has clearly stated are its key policy goals, partly because any future cash rate cuts will get scant pass-through from the banks, then it is going to have to consider a synergistic suite of solutions to ensure monetary policy continues to work. And this means measures beyond just buying government bonds.

Here it was also interesting to read Gittens say that the RBA might commence QE well before the official target cash rate hits 0%, as we have long argued makes sense. It would be pretty silly to cut the cash rate to its terminal level around 0.5%, get little-to-no pass-through from the banks, and only then declare conventional monetary policy bankrupt and switch to a Plan B involving QE. In Gittens' words:

"Lowe also said that, if it became necessary to start buying long-term securities, you wouldn’t need to have cut the official interest rate to zero before you started. He implied he might go no lower than 0.5 per cent. Why stop there? Why stop there? Because by then the banks’ deposit rates would be too low to be cut any further, meaning they couldn’t pass the cut on to their home-loan and business borrowers."

It is funny to see Gitten suggest that the RBA buying government bonds is not necessarily unconventional because it is just targeting longer-term rather than short-term risk-free rates. I have repeatedly made the same points in my AFR columns, and on Friday argued:

"There is absolutely no doubt that this would massively enhance the power of its transmission mechanism. Indeed, it is perhaps surprising the RBA has not already kicked off this process, which is increasingly a conventional part of the central banking toolkit.

While some think QE is a radical next step, it is simply about allowing the RBA to influence a wider range of interest rates that better reflect the cost of borrowing across the economy rather than just limiting itself to its (theoretical) target cash rate.

History suggests that if the RBA does start QE because of the cash rate’s effective lower bound, there is no point doing so in a half-hearted fashion. It is going to be much more effective erring on the side of a more assertive program, which can be subsequently moderated if core inflation returns to the RBA’s target band and the jobless rate drops down to its full employment level around 4.5 per cent.

There is also merit in the RBA warming the market up for QE to maximise the efficacy of any future cash rate cuts before it reaches the effective lower bound. The RBA can capture substantial “announcement effect” benefits simply by stating it is considering a range of QE alternatives. In a way, its August board minutes lay some of the foundations for this evolving narrative."



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Damian Steward

So if the cash rate is dropped to 0.5% and one or more rounds of QE are completed, will that really do much to help Aus companies and thus the local share market? Because low interest rates and QE don't appear to have done much for Europe. And it looks to me that we have more in common with parts of Europe than the US.