Australia’s Rate Cuts Drive Lowe to Eye Unconventional Tools

(Bloomberg) --

The Reserve Bank of Australia is poised to deploy its remaining interest-rate ammunition Thursday and delve into its policy toolkit for unconventional measures to support the battered economy.

Governor Philip Lowe will reduce the cash rate to 0.25%, its effective lower bound, and likely pledge to keep it there for an extended period, money market pricing suggests. Traders are also wagering the RBA will set an objective for government bond yields in order to lower risk-free rates across the economy.

The bank is likely to control yield levels for bonds due in three-to-five years, said Andrew Ticehurst, a rates strategist at Nomura Holdings Inc. “We believe the RBA could nominate a target of around 0.25 to 0.40% for this part of the curve, and set an initial target for this position at around 0.40%.”

The central bank is pushing stimulus to the maximum as it joins the government in a fiscal-monetary injection to cushion an economy spiraling toward its first recession in almost 30 years. Prime Minister Scott Morrison is developing a follow-up spending package to expand on the A$17.6 billion ($10.6 billion) program announced just a week ago. It could come as soon as today.

Stressed Markets

Australia’s credit markets are stressed and the RBA has been pumping liquidity into the financial system in recent days to help calm them.

Su-Lin Ong, head of economic and fixed-income strategy at Royal Bank of Canada, says the RBA could follow Canadian policy makers in purchasing bank bills to help ensure sufficient liquidity in the short-end funding space. It could also boost its foreign-exchange swap activity by lending more Aussie dollars into the market, she said.

Following a 2:30 p.m. announcement in Sydney, Lowe will deliver a speech and then conduct a question-and-answer session via teleconference at 4:00 p.m. In the lead up the event, economists have revised their forecasts for the economic outlook. Australia & New Zealand Banking Group Ltd. think quarantine and social distancing efforts to contain the coronavirus could result in unemployment climbing to 7.8% by year-end, a level last seen in 1998.

In terms of unconventional measures, the RBA is likely to talk about the future path of interest rates, known as forward guidance, Deputy Governor Guy Debelle said March 11. It would also likely set a numerical target for government bond yields.

Following BOJ

The approach would differ from that used by the Federal Reserve and others, 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 this would more closely resemble Japan’s yield-curve control.

Stephen Kirchner, an economist at the U.S. Studies Centre in Sydney, worries such an approach could mean the RBA no longer gets price signals from the market as to whether its program is working.

“In the U.S., yields rose during QE episodes and fell during intervening periods,” he said. “This gave the Fed a clear reading that QE was raising expectations for inflation and economic growth. The RBA’s approach will reduce the information content of bond market prices.”

Either way, the RBA is likely to have exhausted its rate ammunition and be venturing into uncharted territory by the end of the day.

©2020 Bloomberg L.P.