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RBA Policy Announcement: Monetary Policy Normalisation Begins……….. Slowly

Bottom Line

Despite the strong recovery from last year’s economic downturn and surging labour demand this year, the RBA has not changed their view that wages and inflation will remain undesirably low for a number of years to come.

Yesterday’s announcements will do little to change what are highly stimulatory financial conditions in Australia. The 3-year fixed rate may drift a little higher in line with what has happened to 4 and 5-year rates but this will have very little impact on the economy over the next six months.

Details

At the monthly board meeting yesterday, the RBA made some small adjustments to unconventional policy programs that signal the process of monetary policy normalisation has begun. At the very least they are getting ready so that they are positioned to start normalising policy.

These are minor, largely operational changes, and amount to very little tightening of financial conditions.

The changes announced yesterday give the RBA more flexibility to wind back unconventional policies further should economic and financial conditions warrant. The RBA did not change the cash rate and maintains forward guidance that the cash rate will remain at the current historical low level of 0.10% until 2024.

The 3-year yield target of 0.10%, also known as Yield Curve Control (YCC), will be allowed to ‘mature’, that is, the operational focus of the yield target will remain fixed to the April 2024 Australian Government Bond. That bond is already a 2 year and 9-month maturity. In 9 months, it will be a 2-year bond and hence the RBA will be targeting the 2-year rate. The 0.10% yield level will not change but the time horizon will roll down the yield curve.

The bond purchase (QE) program will be reviewed more regularly and adjusted as circumstances warrant. The size of the QE program will be cut by 20% in September with the quantity of bond purchases falling from the current $5bn a week to $4bn a week. Although much will be made of the RBA ‘tapering’ purchases, the reality is that this lower rate of bond purchases largely reflects less government bond issuance due to lower state and federal government budget deficits.

When the current $100bn 6 month program finishes in September the RBA will move to a weekly purchase target and will review the terms again in November (after 10 weeks). What the RBA has done with these changes to the QE program is to create more flexibility for themselves so that they can make changes to the program should conditions warrant.

The RBA Governor also mentioned that the Australian Prudential Regulatory Authority (APRA) is considering the various ‘macroprudential tools’ that it might employ to combat a housing bubble (my words not his!). Although nothing is likely in the short-term, APRA stands ready to put in place temporary regulations on lending standards if evidence emerges of excesses in the mortgage market.

Implications

The adjustments to unconventional policy programs announced yesterday are as much operational guidance for financial markets as they are a material change to financial conditions in the economy. There has been no real tightening of monetary policy with yesterday’s announcement and importantly there has been no ‘real’ signal sent that the RBA intends to move the cash rate anytime soon.

This is a starting point for the winding back of the YCC and QE policies over the next few years, keeping in mind that the RBA has already wrapped up the Term Funding Facility (TFF) for banks.

Monetary policy is still highly stimulatory, and the RBA intends to keep it that way for many years to come. In this respect, nothing has changed. The cash rate will remain at the current historically low level of 0.10% until inflation is ‘sustainably’ within the RBA’s 2-3% target band. The RBA continue to believe that this will not happen until 2024 despite the mounting evidence of a major supply and demand imbalance in labour markets which could put upward pressure on wages and inflation.

Views

Fixed rates have drifted a little higher since the announcement but are unlikely to continue to drift up much further in the short term. While the RBA has ‘released’ the 3-year rate to market forces, the reality is that QE programs both here and overseas will ensure long-term rates do not rise all that much in the months ahead.

These policy changes are not a signal to go out and fix interest rates. If you did not think fixing your loan exposure was a good idea on Monday, I doubt there is anything in what the RBA has said that would change your mind today. Fixing rates is primarily about two things; having certainty about future interest repayments or taking a view that variable interest rates are going to rise over the years ahead. The RBA continues to signal the variable rate will remain at the current level for 3 years despite developments in the labour market.

The only reason I would be fixing a part of my loan is because I can get a fixed rate that is comparable to the variable rate. I am of the view (like many in the market) that interest rates are going to go up earlier than what the RBA is signalling. But I doubt they will go up by all that much. We will be lucky to see the cash rate rise much above 2% in the next 5 years.

I do not expect to see APRA put in place macroprudential policies this year. The regulator will be targeting excessive (speculative) borrowing activity rather than people borrowing for their own homes. While investors are starting to make a strong comeback into the Australian property market, I do not think APRA will try and get ‘ahead of the market’. They will react to persistently strong credit growth driven by the investor segment. While new mortgage demand is growing at an extraordinarily strong clip in 2021, the overall stock of outstanding mortgage credit is only rising by just over 5%. I doubt that the regulators will act until credit growth is closer to a 10% annual rate.

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