The Reserve Bank of Australia’s (RBA) record low rate of 1% has been forecasted to fall further by the end of the year and Governor Phillip Lowe recently discussed what form QE would take if implemented in Australia, stressing it would only be considered under certain circumstances.
In this special note for Livewire, we discuss the probability of this happening, what it means for markets and how investors could prepare for it.
What are the chances of RBA using QE?
In Governor Lowe’s view, several stimulus measures working in conjuncture with one another would be more effective than one unconventional monetary response. He discussed the tools used by other global central banks over the years such as negative interest rates, which encourages people to borrow more and stop holding cash, Governor Lowe said that this policy is unlikely in Australia. Instead, the RBA has assured it will provide forward guidance of pledging extended periods of low interest rates.
Other methods include providing longer-term funding to banks to support credit, buying private sector assets, such as mortgage-backed securities or equities, and foreign exchange intervention to drive the currency lower.
If QE was introduced, the most likely form it would take would be the purchasing of government bonds, something that has already been done in Australia but on a smaller scale. If the RBA were to implement a QE program similar to the United States Federal Reserve’s from 2009 to 2014, it would need to purchase $550 billion worth of assets, representing 70% of Australia’s long-term government debt securities market (as of the end of 2018), which is not realistic.
Economy unlikely to be weak enough to justify QE
We consider it unlikely that a quantitative easing program would be implemented in Australia anytime soon, primarily because we expect to come out of this economic slowdown in the first quarter of 2020.
Australian economic growth is expected to exceed that of most developed economies due to its low unemployment, population growth and several promised tax cuts.
The factors that have affected the stagnant growth this year are likely to begin to fade by the start of 2020 and the boosts to consumer disposable income are likely to translate into greater stimulus, justifying little need for an unconventional monetary policy.
QE supports asset prices with little effect on an economy
Historically it was thought that a QE program would lead to economic growth while also increasing inflation across the economy. Recent examples have failed to stimulate economic growth and only caused asset price inflation.
Japan was the first country to implement QE in 2001, following the Asian financial crisis of 1997 and years of low growth, yet despite these efforts, it failed to create any tangible growth and Japanese GDP fell from USD 5.45 trillion to USD 4.52 trillion between 1995 and 2007.
Since the 2008 global financial crisis, several other countries began employing QE such as the United States, United Kingdom and several European countries. The United States Federal Reserve increased the money supply by USD 4 trillion, however banks held onto much of it as excess reserves instead. The direct relationship between the recovery of the US economy and the policy of QE is unclear and difficult to quantify - what is clear is that asset prices rose as a result.
QE in the Australian context
If QE was implemented in Australia, it is likely to artificially inflate asset prices, while failing to boost economic activity or productivity in real terms. QE pushes down the real cost of money, and coupled with low interest rates, could be bad for the bank sector in particular.
Australia’s bond market is not particularly deep compared to other countries, therefore QE does not have particularly far to go.
If a structural change in the money base was to be implemented, there would be less risk in holding investments in equities over the longer-term or investing in commodities such as energy and base metals. Long-term holdings provide resilience and allow any risk premiums to materialise over an extended period of time.
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Good stuff Matt!