QE question time
In the final weeks of 2019, two letters were on the lips of all participants in the Australian dollar high-grade bond market: QE. With successive rate cuts bringing the Reserve Bank of Australia (RBA) close to hitting its lower bound, it is understandable that attention has turned to what might be beyond the end of the road for monetary policy.
Laurence Davison Head of Content and Editor KANGANEWS
The idea of QE in Australia would have seemed preposterous as recently as early 2019. The RBA had cut the cash rate significantly from its elevated level of 7.25 per cent going into the financial crisis, but a 1.5 per cent rate had been a fixture of local monetary policy since August 2016. This still left plenty of scope for the reserve bank to ease further without contemplating additional monetary measures.
Last year changed that landscape. The RBA cut a further three times – in June, July and October. And entering 2020, there is a consensus among rates strategists that the year ahead will bring two further cuts, taking the cash rate to 0.25 per cent, which most view as the effective lower bound.
Even at that level, strategists say, policy may not be sufficiently stimulatory to prompt a pickup in growth or haul inflation up to the lower edge of the RBA’s 2-3 per cent target range. The hot topic is what might come next.
Speaking in November last year, RBA governor Philip Lowe acknowledged that speculation about what might follow the last rate cut was inevitable. “People are rightly asking, ‘If interest rates are going to stay low and be constrained by a lower bound, what other monetary policy options are there?’ ”
The first question on QE, then, is whether any such measures are a natural next step after the RBA has emptied the cash-rate magazine. Some central banks have been prepared to draw the conclusion that they are.
“We’re getting to the effective lower bound, and the question then becomes what we do next,” comments Damien McColough, head of Australian dollar rates strategy at Westpac Institutional Bank (Westpac) in Sydney. “The Bank of England’s introduction of the funding-for-lending facility was meant to be – and to be seen to be – a business-as-usual measure. Expectation of QE is just a function of where we are, specifically a central bank with a mandate that it has not been able to achieve.”
Global monetary policy in the last decade suggests the use of the phrase “unconventional monetary policy” to describe QE may be redundant. In this period, central banks in the eurozone, Japan, the UK and the US have introduced and ramped up a range of measures that previously would have been unconventional – and in many cases, the banks haven’t been able to wean themselves off.
On the other hand, there is no shortage of evidence that the RBA itself does not view QE as a natural extension of monetary policy, even if the cash rate reaches the effective lower bound. In November,
Lowe drew a clear distinction between “liquidity support measures” deployed specifically to calm stressed markets – for instance, extending repo facilities and providing funding to banks at a lower rate than stressed markets would offer – and other unconventional policy moves.
Lowe noted that central banks had been successful in stabilising the financial system and preventing gridlock when markets had broken down. Perhaps most importantly, he added that it had proved possible to unwind emergency measures when the task at hand was complete.
On the other hand, Lowe said he finds the evidence on some other unconventional measures “less compelling”. These include negative interest rates and ongoing asset purchases – or QE.
He explained: “These extraordinary measures certainly pushed down long-term yields and provided monetary stimulus in the depths of the crisis, when it was needed. But they have continued way past the crisis period. In some countries, asset purchases have yet to be unwound and it remains unclear when, and even if, this will happen.”
There is clearly no sign – across borrower sectors – of the type of funding squeeze that would prompt the policy responses Lowe describes as more obviously successful.
The most likely asset class for an Australian QE package is assumed to be government-sector bonds. Yet Australia’s sovereign is reducing its net new issuance, while the semi-government sector reports no difficulty fulfilling funding tasks that have grown in line with the size of state infrastructure programmes.
The situation is similar in the private sector. Australia’s major banks kicked off 2020 with a bonanza of tightly priced wholesale funding in the domestic, US and UK markets. Corporate borrowers continue to be offered a plethora of loan and bond options that comfortably exceed their emaciated capex requirements. And the household sector has maintained and even expanded its record indebtedness.
“We speak to borrowers, including corporates, and none of them has suggested cost of funding is the reason they are holding back from investment,” confirms Martin Whetton, head of bond and interest rate strategy at Commonwealth Bank of Australia in Sydney.
“We don’t have a steep curve or high outright yield even at 10 years,” he continues. “We are also a floating-rate, rather than a fixed-rate, market and our currency is already low. The question, given all these factors, has to be what we would be getting out of QE.”
This leads ANZ’s Sydney-based head of Australian economics, David Plank, to conclude: “We believe the hurdle for QE is very, very high for the RBA. The governor has already made clear QE is something the RBA would deploy only in a crisis – that it is not a natural progression of monetary policy.”
Even if the RBA did reach the point where it felt QE was necessary, Plank adds, additional measures probably should not be expected to emerge as an immediate progression from the cash rate reaching the effective lower bound.
He estimates that it would take about a year after the final rate cut before the RBA would elect to pull the trigger on QE, should it ever reach that point.
Another factor probably reducing the RBA’s inclination to trigger QE is the absence of stimulatory fiscal policy in Australia. The federal government has remained committed to delivering a surplus in its 2020 budget. While states are increasing their borrowing to fund infrastructure programmes, the impact on GDP is relatively limited.
Australia’s bushfire crisis of 2019/20 could move the needle on the federal budget and the government has hinted that funding recovery efforts could change the equation on surplus. But, again, there is little or no expectation that this or the developing coronavirus crisis will prompt a move to full-scale fiscal stimulus.
The RBA is clearly reluctant to take unconventional monetary measures while fiscal policy is pulling in the opposite direction. Lowe has noted several side effects of unconventional monetary policy, one of which clearly relates to the relationship between reserve bank and government.
“The willingness of a central bank to use its full range of policy instruments might create an inaction bias in other policymakers – either the prudential regulators or the fiscal authorities,” Lowe argued in his November speech. “If this were the case, it could lead to an over-reliance on monetary policy.”
The RBA is clearly unwilling to undertake heavy lifting it believes is more appropriately the role of government. Lowe additionally commented that “political tensions” could arise if central-bank asset purchases “are seen to disproportionately benefit banks and wealthy people, at the expense of the person in the street” – even if evidence suggests they also support jobs and income growth.
While most market participants still say QE is unlikely in Australia, no-one is prepared to rule it out – even if there is no liquidity or funding crisis. However, there is a virtually universal view that QE will emerge in Australia only if an unforeseen economic or market crisis occurs or global economies – particularly the US or China – substantially weaken in 2020.
In 2011, when the Australian mining boom was at its peak while global economies were mired in the post-crisis doldrums, the Australian dollar reached US$1.10. It was higher than US$0.80 as recently as February 2018. As the US Federal Reserve (Fed) began lifting rates and the RBA started cutting, the Australian dollar moved to compensate. It has not touched US$0.70 since mid-2019 and dropped to a post-crisis low of US$0.67 late in January this year.
A weak currency adds stimulus to the Australian economy. US weakness, in contrast, might be enough to force the RBA’s hand at a time when it has already used all its conventional monetary policy bullets.
Speaking at the Australian Securitisation Forum (ASF) conference in Sydney in November 2019, Pendal Group portfolio manager Tim Hext said the chances of QE in Australia could be as high as 80 per cent. This view is based on the investment management firm’s global economic outlook.
“Most think the [US] economy is entering a mid-cycle trough, but we think it will turn down in 2020 and the Fed will be cutting aggressively – down at least to 1 per cent and probably lower,” Hext explained. “In this situation, the Australian dollar is likely to appreciate, even though the world economy is not in a great place. We’ll then be back in competitive currency wars.”
QE is also in the Westpac economics team’s base case – for the same reason. It anticipates a weak US economy in 2020 and, McColough says: “We aren’t forecasting QE because of a funding issue – we agree there isn’t unfulfilled demand for funding in the economy that would be solved by forcing rates still lower. It is primarily about driving the currency down.”
One wild card here is the coronavirus. In mid February, it was too soon to tell if it might provoke the sort of global market crisis that would bring about QE, but strategists say they are watching closely.
The other major question about Australian QE is what form an initial package of measures might take. Lowe gave an early indication in his November speech. He discussed four types of unconventional policy measures: negative interest rates, extended liquidity operations, forward guidance and asset purchases – QE.
Extended liquidity operations are the means by which the RBA would most likely respond to a crisis in the near term. The reserve bank does not appear to consider them to be an appealing long-term measure.
Some say more explicit forward guidance might be a step between the effective lower bound and QE. Plank, for instance, suggests the RBA could add to its monetary policy statements a forecast of how long a 0.25 per cent cash rate might remain in place, which would represent an evolution from the existing commitment to transparency to explicit, quantifiable guidance.
Even should the RBA work its way through all alternative methods short of QE to bolster loose monetary policy, any subsequent asset-purchase programme would probably be narrow.
Again, the assumption is this would mean a programme of buying of Australian government and semi-government bonds only. Plank says: “We can’t see how the RBA goes down any road but government and semi-government bonds. We think the hurdle to clear to get to QE is enormous in and of itself. The hurdle to doing anything beyond government bonds is even bigger.”
Lowe virtually confirmed this view in November, when he said: “If – and it is important to emphasise the word if – the reserve bank were to undertake a programme of QE, we would purchase government bonds, and we would do so in the secondary market.”
This makes sense in the context of an asset-purchase programme designed primarily to lower the value of the Australian dollar, rather than to stimulate private-sector credit. But timely execution could be challenging.
Alex Stanley, senior interest rate strategist at National Australia Bank in Sydney, says his bank’s research suggests that if the RBA does use QE, the scale of the programme could be roughly A$115 billion – though he acknowledges significant uncertainty on this figure.
The challenge in getting this volume of funds into the system, he adds, would be liquidity in the targeted instruments. This could make QE deployment slow.
“One question QE would pose is how much free-float there is in the Commonwealth government bond sector,” McColough posits. “It might only be A$40-50 billion.”
Speaking at the ASF conference, QIC’s Brisbane-based general manager, research and product innovation, Katrina King, commented that limited availability of Australian government bonds might force the reserve bank into assets beyond semi-governments, potentially including residential mortgage-backed securities.
“To have the equivalent impact of a cash-rate cut of 25 basis points, the RBA would need to buy 1.5 per cent of GDP in government bonds,” King suggested. “If you add this up in Australia, you find that you quickly and easily get the entire free float of government bonds.”
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