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Lowe gives first signal more QE is coming

John KehoeSenior writer

For the Reserve Bank of Australia, there is a fine line between being alert to and captive to ructions in the bond market.

Philip Lowe is keeping his options open on QE. Dominic Lorrimer

RBA governor Philip Lowe on Tuesday showed he would not be pushed into perpetually increasing the size of quantitative easing (QE), while, paradoxically, signalling the bank was preparing to extend the duration of QE beyond September this year.

The RBA board met on Tuesday in the wake of a vicious global bond market sell-off, which Australia was at the epicentre of when government borrowing costs last week spiked.

The central bank responded with a doubling of its daily bond purchases to $4 billion on Monday.

Yet the RBA is characterising the temporary extra QE as a “bring forward” of its initial $100 billion, six-month program.

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The move should not be extrapolated to bake in a permanently higher QE level.

Nevertheless, if illiquidity returns to the bond market, the RBA stands ready to step in more aggressively again.

“The bank is prepared to make further adjustments to its purchases in response to market conditions,” Lowe said in his statement.

If buyers vanish, as they did last week, the RBA will buy extra bonds to suppress yields and keep a lid on the Australian dollar, which temporarily broke above US80¢ last week.

To be sure, the bank is not targeting a specific government bond yield or differential with the US Treasury yield.

Rather, it will prioritise liquidity and bond market functioning during times of market turbulence.

For some time the RBA has said: “The bank will closely monitor the impact of purchases on market functioning and will adjust the auctions if necessary, including their size, composition and timing.”

For the first time, on Tuesday the RBA gave an explicit signal that it is willing to extend the QE program – already slated at $200 billion over 11 months – beyond September 2021.

QE 3 is all but locked in for later this year.

“A further $100 billion will be purchased following the completion of the initial program and the bank is prepared to do more if that is necessary.”

As long as other major central banks are printing money, so too will the RBA, to avoid an unhelpful jump in the Australian dollar.

Nevertheless, the RBA hasn’t convinced the market that it is genuinely committed to keeping rates near-zero until at least 2024.

Sustainable inflation levels

“The Board will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range,” is the RBA’s pledge.

The key word is “sustainably”.

“For this to occur, wages growth will have to be materially higher than it is currently,” the RBA says.

“This will require significant gains in employment and a return to a tight labour market.

“The Board does not expect these conditions to be met until 2024 at the earliest.”

A brief or temporary jump in inflation back above 2 per cent will not trigger a rate rise, according to the RBA’s guidance.

While market-based inflation expectations are not pricing in inflation of 2½ per cent, the market is pricing in rate rises in the 12-24 months before 2024.

The disconnect suggests the market does not fully believe the RBA’s “lower for longer” story.

Meanwhile, bond traders have pointed to the Australian 10-year bond yield jumping 40 basis points above its US equivalent last week, before a pull back in recent days.

But the rise is broadly in line with yield increases in Canada, the United Kingdom and New Zealand.

What is surprising is the relative lower US yields, given that US economic growth and inflation should get a larger boost from President Joe Biden’s proposed $US1.9 trillion ($2.4 trillion) stimulus that is being considered by the US Senate.

One explanation is that the US benefited from lower relative yields due to a “flight to safety” during last week’s “risk off rally”.

The US is a safe haven and has a much deeper and more liquid fixed income market.

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Summary | 9 Annotations
would not be pushed into perpetually increasing the size of quantitative easing (QE),
2021/03/02 20:49
bring forward” of its initial $100 billion, six-month program.
2021/03/02 20:50
extrapolated
2021/03/02 20:50
bank is prepared to make further adjustments to its purchases in response to market conditions
2021/03/02 20:51
keep a lid on the Australian dollar
2021/03/02 20:51
A brief or temporary jump in inflation back above 2 per cent will not trigger a rate rise, according to the RBA’s guidance.
2021/03/02 20:54
market is pricing in rate rises in the 12-24 months before 2024.
2021/03/02 20:54
disconnect suggests the market does not fully believe the RBA’s “lower for longer” story.
2021/03/02 20:55
The US is a safe haven and has a much deeper and more liquid fixed income market.
2021/03/02 20:56