RBA EXTENDS QE

Chief Economist's View 

Download the PDF version including our economic update by region here: RBA Extends QE

It was pretty much a foregone conclusion that the RBA would have to extend QE, if not at last Tuesday’s meeting then at some point in the future. In his Wednesday speech to the National Press Club, Governor Lowe identified the outlook for inflation and jobs, along with pressure on the currency as factors that influenced their decision to extend QE.

But given how much the economic outlook has improved relative to the RBA’s expectations, one suspects it was fears around the direction of the currency that forced the RBA to act sooner rather than later. Of course, the AUD has also benefited from the rapid increase in the terms of trade, and with iron ore prices peaking, a retracement of the terms of trade over coming months is expected.

If the decline in commodity prices and the terms of trade continue, it will provide an offset to the upward pressure on the currency from looser monetary policy overseas. The question is, will it provide enough of an offset to lower the exchange rate?

The answer is probably no, given the size of QE programs in major central banks around the world. So, unless the RBA increased its QE program, we would probably see continued upward pressure on the AUD. We think that the AUD trading within a band of US70c and US75c is a comfortable range for the RBA, and to achieve this our view is that the RBA will have to extend, yet again, its QE program. We expect a further $100 billion of QE commencing in October, which will extend into the first half of 2022.

There’s also been chatter about the RBA absorbing most of the issuance of the Federal Government bonds, similar to what has happened in Europe and Japan that left those central banks perilously close to running out of government bonds to buy, potentially disrupting bond markets and distorting the pricing of risk. It is indeed the case that the RBA will be buying around $4 billion of Australian government bonds a week, while the government will be issuing only $2billion to $3 billion a week.

But the pool of existing bonds (as opposed to new issuance) is still large enough for the RBA to implement its extended program and also an extension of the program further into 2022 without running out of bonds to buy. A more pertinent risk is around the housing market, where the level of mortgage rates and pickup in household confidence levels threatens to result in a surge in house prices.

Despite the building heat, the RBA appears relaxed as their focus is on household debt levels (which have been falling) and bank lending standards (which are tight) as indicators of sustainability in the housing market rather than price growth. The RBA is also happy to let the housing market run a little further as the pickup in dwelling construction generated by the demand uptick is a strong positive for the economy; given the labour intensity of the industry and the boost to domestic supply chains that the construction industry generates.

Stability in the Australian economy and financial markets is also a key driver of broader investor sentiment, including domestic and overseas investors. As a small economy with strong linkages to the rest of the world via trade and migration, stability is often difficult to achieve in times of a volatile global economy.

Of course, strong international trade and migration linkages have helped drive Australia’s outstanding economic performance over the last three decades and we are proving resilient in the face of COVID-19. This is partly due to decisive fiscal and monetary policy, which act as strong stabilisers of economic growth during times of downturns. During COVID, this has been reinforced by the way Australia approached the health risks of COVID, with strong bipartisan political support for COVID suppression measures.

The combination of policies (fiscal, monetary and health) have also delivered stability in investor confidence in Australian assets as evidenced by our AAA sovereign risk rating and the high risk ratings of our major banks. Currently, the RBA is rightly focused on job creation, but it can never risk a collapse in the financial stability of the economy.

Table 1: Financial market movements: 28 January - 4 February 2021

Source: Bloomberg