The Reserve Bank has announced a rate cut; Quantitative Easing and Term Lending while Treasury has announced the purchase of asset backed securities. All these measures are to be applauded and will support the Australian Financial System at this difficult time for the Australian Economy.

The Governor of the Reserve Bank has announced a number of important initiatives to support the Australian economy and the financial system. Most of these initiatives come as no surprise. Westpac released a note on March 16 which set out its expectation for these initiatives.

  1. The cash rate target has been reduced from 0.5% to 0.25%. Furthermore, it will not be increased until the Board believes that progress has been made towards full employment and inflation is sustainably within the 2–3% target band. Since exchange settlement balances are remunerated at the cash rate minus 0.25%, the Reserve Bank has committed to increase the remuneration to 0.10% in recognition that exchange settlement balances are likely to increase significantly as a result of this policy package.
  2. The RBA has now adopted Quantitative Easing. However, instead of nominating a volume of bond purchases, it has nominated a target yield for the three year Australian government bond rate of “around 0.25%”. This is a bold move given that, in admittedly light trading, the yield on these bonds had been around 0.6% up until the announcement. Since the announcement, the rate has fallen to around 0.4%, and further adjustments to market rates may occur. Of considerable interest has been the reaction of the bond market in longer term securities, where the rate has increased to a volatile 1.6%, indicating a very steep yield curve. This yield objective is expected to be achieved through purchases of government bonds and semi government bonds, with the purchases to occur across the yield curve. These will commence tomorrow.
  3. Westpac is particularly pleased to see that the RBA is offering a term funding facility for the banking system. This facility will be provided for three years to authorised deposit taking institutions (ADI’s) at a fixed rate of 0.25%. ADIs will be able to obtain funding for up to 3% of existing outstanding credit. The objective is to support small and medium sized business. ADIs will still be required to take on the credit risk associated with these facilities, but may consider switching more expensive facilities for existing borrowers into these facilities, providing a cash flow boost to small and medium sized businesses.
  4. These initiatives will not affect the Bank’s ongoing provision of liquidity to Australian financial markets through repo operations which have recently been extended to six month maturities or longer.

In addition to these initiatives announced by the RBA, the Treasurer’s Office has announced that the Australian Office of Financial Management (AOFM) will be provided with an investment capacity of $15 billion to invest in wholesale funding markets used by small ADIs and non-ADI lenders. As signalled in Westpac’s note of March 16, this initiative parallels a similar initiative by the AOFM during the Global Financial Crisis. It will be of particular support to issuers of Mortgage Backed Securities.

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Comment

The Bank is adopting a bold policy response to target the three year bond rate at well below current market pricing. This means that they are using their balance sheet to make a significant difference to the risk-free yield curve and therefore providing support to the financial system.

The market will no doubt take full advantage of this policy decision, and it will be interesting to see the volume of required purchases to achieve the interest rate target.

Westpac has been promoting the use of term funding facilities since around July last year, and we are particularly supportive of this initiative.

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