RBA Has Already Taken First Step on Path to Easing, Deutsche Says

(Bloomberg) --

Australia could already be on a path toward unconventional policy, Deutsche Bank AG said, noting the Reserve Bank’s expectation that interest rates will be low for some time is similar to language used by the Federal Reserve and European Central Bank before ultimately turning to QE.

In a research report surveying the RBA’s options given it only has 1 percentage point of ammunition remaining, Deutsche economist Phil Odonaghoe cited Governor Philip Lowe’s comments about an “extended period” of easy policy.

“That kind of explicit forward guidance will be familiar to anyone who has studied the Fed or the ECB over the past decade,” he said in a research report Wednesday. “So while it might remain ‘unlikely’ in Australia, the evidence suggests the RBA has embarked on a path that for others at least, has ended with entrenched unconventional policy settings.”

In a July 25 speech and in the Aug. 6 meeting statement, Lowe made the reference and added that policy makers were prepared to ease further in the event back-to-back cuts failed to revive economic growth and spur increased hiring. Deutsche forecasts the RBA will cut to 0.25% by year’s end as the U.S.-China economic confrontation intensifies and the threat of a worldwide recession rises, prompting a ‘race to zero’ on global bond yields.

It takes three lessons from the U.S. and European experiences:

  • QE can be effective. But Australia faces two problems: a comparatively limited supply of government bonds, and mortgage rates linked to short-end, not long-end rates
  • Four European central banks have adopted negative policy rates since 2014 and the lesson is that negative rates can be problematic, especially for a concentrated banking sector like Australia’s
  • The U.S. and Europe experiences suggest explicit forward guidance, like the RBA’s “extended period” language, ultimately becomes a gateway to other unconventional policy measures

As to what unconventional policy Down Under would look like, Odonaghoe offers the following:

  • The RBA’s first unconventional step will be to adopt even more explicit calendar guidance, saying the cash rate is expected to remain unchanged “until at least some fixed and specified point in the future”
  • Beyond that, the best alternative is for the baton to be passed to a “materially easier fiscal stance,” before more aggressive unconventional options are considered
  • In the worst case scenario, international evidence coupled with Australian circumstances suggest one course of action may be QE coupled with fiscal stimulus

“The limited supply of government bonds might mean QE would require increased issuance, of either ACGBs (Australian Commonwealth Government Bonds) or even semis (state government) directly, with that additional issuance primarily absorbed by the RBA,” he said. “That issuance could then fund a variety of infrastructure or household cash flow stimulus measures. To be sure, we remain some way from this scenario.”

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