Why Central Banks Down Under Are Moving Closer to QE: QuickTake

(Bloomberg) -- Australia and New Zealand’s central banks are having to ponder the once unthinkable: undertaking the types of extreme monetary policies that were spawned elsewhere by the 2008 global financial crisis. Bond-purchase programs and negative interest rates were long seen Down Under as meant for countries that had gorged on risky derivatives and been reckless with debt. But with very little conventional ammunition remaining and a coronavirus pandemic weighing on the world economy, the prospect of having to use unconventional policies is suddenly a lot greater than it was.

1. What’s changed?

The Reserve Bank of Australia and the Reserve Bank of New Zealand began to talk more soberly and thoughtfully about unconventional policy last year, amid China’s slowing economy and its trade fight with the U.S. That suggested Australia and New Zealand might need to find extra monetary stimulus, having cut rates to levels the Federal Reserve and Bank of England were at when they turned to asset purchases -- known as quantitative easing, or QE -- to support their economies following the financial crisis. The RBA and RBNZ both acknowledged their limited rate firepower, particularly if they need to respond to an external shock. With that in mind, RBA Governor Philip Lowe and his New Zealand counterpart Adrian Orr said it was prudent to discuss unconventional options. At that stage, a shock in the form of a health crisis had hardly occurred to anyone.

2. Has the RBA given details?

The RBA would talk about the future path of interest rates, known as forward guidance, Deputy Governor Guy Debelle said after a March 11 speech. It would also likely set a numerical target for government bond yields. The approach would differ from that used by the Federal Reserve, which announced the dollar amount of fixed-income assets it would buy each month and then observed the impact on the market. The RBA is looking at price first, and its program would more closely resemble Japan’s yield-curve control. For example, the RBA might aim to ensure rates were around, say, 25 basis points for a specific maturity. The bank would then adjust its purchases of government bonds depending on how the market responded. The “announcement effect” might be enough to shift yields to the desired target, though chances are the RBA would need to back this up with some purchases. In other words, the RBA would use its market credibility to help achieve its objective. And it would be flexible. If, for example, the bank aimed to keep yields out to four or five years around 25 basis points, it wouldn’t be worried if they happened to be at 26 or 27; but if they were at 50, then that wouldn’t be consistent with the objective.

3. What about negative rates?

Lowe has made clear that negative rates are “extraordinarily unlikely” in Australia and there’s no appetite at the RBA for outright purchases of private-sector assets in a QE program. In a Nov. 26 speech, he said the bank’s goal was “lowering risk-free interest rates along the yield curve.” This, he said, would also have a “signaling effect” that the RBA intended to keep rates low for an extended period. The governor, in the address, set the bank’s lower bound for rates at 0.25% -- and made clear there’s “not a smooth continuum running” from rate cuts to QE, as the latter is a more significant step. But that was before the coronavirus outbreak. In response, on March 3 the RBA reduced its cash rate to 0.5%. It is now only one cut away from having to deploy unconventional policy if it wants to provide additional stimulus. The RBA has signaled it’s ready to cut further and money markets are pricing in a cut in April.

4. What about Orr?

Some bank economists predict Orr will cut his official cash rate (OCR) to 0.25% from 1% currently. Markets are pricing in at least two cuts from the RBNZ by May (it makes its next decision on March 25). ANZ Bank says that with a recession in New Zealand now highly probable, “risks are clearly increasing that a more sizable policy response will be needed, potentially taking monetary policy into unconventional territory.” In an interview with Bloomberg, Orr said the RBNZ’s benchmark rate is higher than many of its peers, so it still has conventional “powder in the gun.” Still, on March 10 he delivered long-awaited details on the bank’s approach to unconventional monetary policy, saying it is prudent to be prepared should such measures be needed.

5. When and what might Orr do?

Orr said the central bank would continue to use conventional policy until it was exhausted by taking the OCR to zero. Should further stimulus be required, it would cut the OCR into negative territory, eventually hitting an effective lower bound, though he told Bloomberg this bound could not be determined in advance because it was “context dependent.” The RBNZ would also use forward guidance to ensure markets understood its commitment to meeting its mandates. The next step would be to intervene in the interest-rate swaps market to lower market rates, though Orr said he was aware this hadn’t been done anywhere in the world before. After that, the RBNZ would turn to large-scale purchases of domestic government bonds to lower longer term rates, and would also look at buying foreign currencies or assets to exert downward pressure on the New Zealand dollar. A final measure would be long-term loans to banks which could be conditional on them increasing their credit supply.

6. And Australia?

While Lowe has said the bar for a move to QE would be different to a rate cut, that’s the only way he could go for additional stimulus if the RBA moves in April. In other words, the RBA might be in a position to deploy unconventional policy as soon as May. That said, Australia’s government announced a A$17.6 billion ($11.3 billion) fiscal stimulus package on March 12 to keep firms operating, workers in jobs and consumers spending. It also has the annual budget in May, when it could announce additional support. That may ease some immediate pressure on the RBA.

7. Has this stuff worked elsewhere?

The broad consensus is yes, particularly in the initial stages when economies and markets were facing severe shocks. Borrowing costs have been lowered and financial conditions eased in economies that went unconventional, though the impact diminishes the longer the measures remain. The Fed’s forward guidance is generally viewed as having been effective in supporting the U.S. economy, while QE’s impact on interest rates, bank lending and company behavior suggest it largely helped stimulate activity. And while there were fears that negative rates would prompt savers to pull their cash out of banks and stuff it under their mattresses, this hasn’t come to pass. The experience in Japan has been less convincing. While prices are rising again, inflation remains a long way short of the central bank’s 2% target and negative side effects, such as strains on regional lenders, are piling up. But as the RBA has noted, much is still in progress and it’s tricky to draw firm conclusions.

8. Is there a downside?

It wouldn’t be economics if there weren’t. One potential fallout is that, as central banks lap up bonds, any subsequent squeeze on yields might encourage a move toward riskier assets in search of higher returns. Very cheap money can also lead to inflated valuations -- real estate is a classic example -- and set the stage for a sharp correction. Critics have also warned that the more central banks become involved in multiple objectives and policy instruments, the more exposed they are to political interference. A broader question is whether future policy will ever return to the conventional status quo, with more than half of central bankers in a recent survey expecting QE to stay around.

9. And for the banks?

The other key issue is bank profitability. Margins are going to be compressed when the yield curve is lower and flattened. Any RBA target for the yield on government bonds would do that -- and its implications for bank margins would be clear. But, it’s worth noting, if unconventional policy leads to a stronger economy -- its basic aim -- then that’s good for bank profitability because it means there will be fewer loan defaults.

The Reference Shelf

• “Unconventional Monetary Policy Tools: a Cross-country Analysis,” published by a committee at the Bank for International Settlements.
• More QuickTakes on the Fed’s policy rethink, negative rates and what the European Central Bank is trying to ease the pain.
• Japan’s latest, desperate experiment in monetary policy.
• Central bankers are happy with their performance overall.
• The fall of Australia’s and New Zealand’s “rock star” economies.
• A transcript of RBA Governor Lowe’s August parliamentary testimony, where he discussed unconventional options.
• Bloomberg Opinion’s Daniel Moss looks at the impact of the Fed’s rate cut, and Ferdinando Giugliano considers “Green QE.”

To contact the reporters on this story: Michael Heath in Sydney at mheath1@bloomberg.net;Matthew Brockett in Wellington at mbrockett1@bloomberg.net

To contact the editors responsible for this story: Malcolm Scott at mscott23@bloomberg.net, Matthew Brockett, Paul Geitner

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