The minutes of the November monetary policy meeting of the Reserve Bank Board give us no significant reason to change our view that the next rate cut will occur in February.

While some forecasters have been promoting the idea of a move in December, the minutes provided the flavour of a Board that is in no hurry to make the next cut. The minutes conclude that “the Board would continue to monitor developments”. It also referred to “having already delivered a substantial monetary stimulus in recent months, there was a case to wait and assess the effects of this stimulus, especially given the long and variable lags”.

Nevertheless, the minutes do not want to leave the reader in any doubt that the Board continues to have a clear easing bias. The minutes concluded that the Board “was prepared to ease monetary policy further if needed” and also noted that “members reviewed the case for a further reduction at the present meeting”.

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Some commentaries interpreted the latter remark as indicating that the Board was close to cutting rates at the meeting. However, my view is that it was used to emphasise a strong easing bias, particularly aimed at containing any upward drift in the AUD rather than any serious risk of an unexpected move in November.

The second important issue around the policy outlook is the “effective lower bound” (ELB) of the cash rate. Westpac has argued since July that the ELB will prove to be 0.50% and will be reached in February 2020. One factor that has been important to our thinking has been the response of the Westpac-MI Consumer Sentiment index to the rate cuts that began in June 2019. The index has been on a clear downward trend ( see Figure 1) since that first cut and the Board has recognised that by noting that “a further reduction in interest rates could have a different effect on confidence than in the past”. Put another way, the Board “recognised the negative effects of lower interest rates on savers and confidence”.

There are two elements to this downward pressure on confidence through these recent cuts; firstly the impact on consumers of the explanation behind very low rates and, secondly, the media coverage around the banks’ responses to ultra-low rates.

In that regard, the Board was informed that it appears that banks still have adequate scope to pass on future rate cuts. The minutes noted that “while close to a quarter of deposits were estimated to be earning interest at rates between 0-50bps, most deposits earned interest at rates over 1%”. The RBA reports that banks’ response to the cumulative 75bp reduction in the cash rate was to lower interest on at-call retail deposits by an average of 60-70bps.

As noted above, this reduction in deposit rates is affecting the confidence of savers, whereas the data also showed that borrowers had been repaying existing loans at a faster pace. This observation puts one of the most important channels of monetary policy, a boost to spending from the increased cash flows of borrowers, at some risk.

In last week’s preview to these minutes, we were hopeful that they might cast some light on the sentence in the November Statement on Monetary Policy (SMP), “the Board was mindful that rates were already very low, and that each further cut brings closer the point at which other policy options might come into play”. The issue here is whether these “other policy options” refer to unconventional monetary policy, fiscal policy, or both. It is most likely “both”.

So more details on the unconventional side would have been helpful. The Governor is speaking on “Unconventional Monetary Policy: Some Lessons from Overseas” next week on November 26. Hopefully, he will cast some light on his thinking in that speech. It is also the last day before the blackout for the December RBA Board meeting. If he wanted to signal to the market that the very disappointing labour force and wages reports from last week, which printed after the November Board meeting, had swayed his thinking towards a December move, that speech would be the time. However, we would be very surprised, given the earlier discussion about these minutes, to see such a move from the Governor.

On the reasonable expectation that the Governor will cast more light on the “unconventional ” issue next week it is worth providing a “summary” of our views on this issue which have been communicated on these pages and other Westpac reports in recent times.

Back on July 24 when we extended our rate cut cycle to a final cut to 0.5% in February next year we noted that with rates likely to reach the “effective lower bound” at 0.5% the preferred policy approach would be to link that cut with a “package” of unconventional policies.

The Governor has noted five policies that have been used offshore: negative rates; forward guidance; term lending to banks; large scale asset purchases; and FX intervention.

Various comments from RBA officials, including the Governor, have effectively eliminated negative rates and FX intervention.

Forward guidance has already been embraced, “we are expecting interest rates to stay low for a very long period of time” (Governor Lowe). However, the more hard edged form of “forward guidance” – for example “we are not expecting to raise rates any time before the underlying inflation rate is firmly entrenched near the mid-point of the 2-3% target band” – has not, to this point been used, and it seems unlikely that the RBA would be prepared to make such a rigid commitment.

“Term lending to banks” may well be considered in one form or another. On July 24 we noted the policies of the Bank of England following the surprise Brexit vote in June 2016. The Bank of England cut the bank rate from 0.5% to 0.25% and offered, conditional, fixed rate loans to the banks up to 4 years in duration at 0.25%. At the time the banks’ alternative sources of funding – retail and wholesale were both considerably more expensive.

The motivation behind that policy was both to ensure adequate liquidity and to enhance the effectiveness of monetary policy. The liquidity concerns stemmed from the fears around the markets’ response to the Brexit vote. Separately, the Bank of England noted the difficulty banks would have in passing on the rate cut to private borrowing rates and noted that pressure on banks’ margins might compromise the supply of credit.

Other forms of “term lending to banks” might take the form of term repurchase facilities at attractive rates (used by central banks during the GFC, including RBA) although the motivation has generally been around boosting liquidity rather than enhancing the impact of monetary policy.

On a number of occasions the Governor has seemed to favour “large scale asset purchases” – the specific definition of Quantitative Easing (QE).

The US Federal Reserve adopted QE in three major tranches. QE 1 and QE 2 defined specific volumes of asset purchases (including US Treasuries and ABS). Those tranches were generally targeted at boosting liquidity, whereas QE 3 was targeted at boosting the effectiveness of the monetary transmission mechanism. QE 3 also differed from QE 1 and QE 2 in that monthly purchase quotas of Treasuries and ABS were nominated without tying the program to a specific total volume.

I expect that structure of QE 3 should be adopted by RBA if it decides to purchase CGS (Commonwealth Government Securities).

Westpac has previously estimated that the supply of CGS that might be available for purchase by the RBA is probably around AUD 140 billion ( due to the majority of the AUD 600 billion on issue being “locked” in the portfolios of overseas investors, particularly central banks). Of course, the Federal government’s commitment to Budget surpluses from 2019/20 further tightens the available supply (current Budget forecasts are for surpluses of AUD 7 billion in 2019/220; AUD 11 billion in 2020/21; and AUD 17.8 billion in 2021/22).

Readers may be aware that Westpac has set out a “plan” to bring forward the personal tax cuts which are legislated for July 2022 to July 2020 in two tranches, providing the economy with a timely boost while allowing slim surpluses in 2020/21 and 2021/2022 of around AUD 4 billion in each year.

In any case, that limited supply of tradeable CGS should not deter a QE strategy. However it must take the form of an open ended monthly purchase commitment of, say, AUD 2-3 billion rather than a specific total target.

One of the RBA’s most important objectives behind unconventional policies should be to convince the market that it has an ongoing easing commitment. That could be achieved with an open ended monthly program rather than a finite program, which, once completed, would risk upward pressure on the AUD as the market perceived the RBA as “done”.

Purchases of other securities, including RMBS, (around AUD 80 billion currently available) should also be considered with RMBS issued by the banks dominating supply (non- bank issuance around AUD 20 billion). Banks are capable of boosting RMBS supply over and above that supply required for the CLF liquidity facility through their self-securitisation processes.

Hopefully by November 26 we will see the RBA’s clearer preferences for unconventional policy so we can move on from this “constructive speculation” and assess the specific policy preferences.

To again return to the November Board meeting, the minutes also discusses the Staff’s revised growth outlook. As we noted in the discussion of the SMP, there were very few changes in the RBA’s forecasts. The RBA continues to forecast trend growth (2.8%) in 2020, and above-trend growth (3.1%) in 2021. Westpac is forecasting 2.4% growth in 2020, with the major differences being around the outlook for business investment and dwelling construction. In fact, the minutes highlight that the RBA remains uncertain about the pace of recovery in the dwelling cycle with one of the key factors being the impact of rising prices in the established market on new construction of detached dwellings.

Westpac, which sees the bringing forward of the legislated personal tax cuts as central to boosting demand through 2020, would be much more comfortable if the RBA had a more “downbeat” view on growth next year. The case for tax cuts is not assisted by RBA growth forecasts pointing to a return to trend growth.

Commentary around the international outlook continues to point to risks being tilted to the downside. However, a key reason justifying the decision not to move in November was around the “decline in pessimism” which had been signalled by global financial markets. A further reason to delay any more cuts is to await outcomes for the global economy, with the developments around the US-China trade conflict being front of mind.

Recent developments would not be encouraging but, we expect, insufficiently disturbing to trigger an unexpected move in December.

Conclusion

The minutes provide little support for a December rate cut but certainly keep our preferred timing – next February – in the picture.

We will be eager to see more light cast on the RBA’s intentions around unconventional policies next Tuesday.

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