The June Board Minutes provide useful colour for the upcoming July Board decisions on Yield Curve Target and Quantitative Easing. Westpac confirms its views that there will be no extension to the November 2024 bond while the Board is likely to announce a flexible policy on QE.
Interest in the Minutes for the Reserve Bank Board’s June meeting was always going to be dominated by any “clues” on the decisions on Yield Curve Targeting and Quantitative Easing that will be made at the July Board meeting.
On the Yield Curve Targeting policy the Minutes state that “A key consideration for the decision regarding the yield target would be an assessment of the prospect of this condition (“actual inflation is sustainably within the 2 to 3 yield curve target range”) being met sometime in 2024”.
Until recently Westpac had argued that a move to targeting the November bond would be consistent with the Board not expecting to achieve the conditions by the first half of 2024.
That seemed to be consistent with the Board noting since the February meeting that the conditions would not (from May Minutes “unlikely”) “be met until 2024 at the earliest”.
However, it became clear that the Board’s view was that a condition for moving to the November bond would only be justified on the basis that it did not expect to achieve the inflation condition until 2025.
On that basis we changed our view to expect that the Board would not extend the Target to the November bond.
2025 is too far out to make a decision on that basis and “sometime” in 2024 “gives the Board plenty of latitude, particularly given the improvement in the economy since the February Board meeting , when the “2024 at the earliest” was first adopted.
Also bear in mind that Central Bank Boards do take notice of market pricing. The Minutes refer to “market pricing still implying an expectation that the cash rate will begin to be increased from its current level late in 2022 or early in 2023.”
On that basis it seems a reasonable position for the Board to take to feel that “sometime in 2024” is a conservative approach and therefore choose not to extend the Yield Curve Targeting to the November bond.
The Minutes also provide more guidance on the outlook for Quantitative Easing.
A range of options for policy after the current $100 billion program is completed by late August/ early September was discussed at the June meeting.
These included “ceasing purchasing bonds in September”; “repeating $100 billion of purchases for another six months”; “scaling back the amount purchased” or “moving to an approach where the pace of bond purchases is reviewed more frequently, based on the flow of data and the economic outlook.”
Readers will be aware that Westpac favours the latter approach (see Bulletin June 4) with the initial pace being set at the current weekly pace of $5 billion per week.
The Minutes point out that by the end of the current program the RBA will hold around 30% of outstanding AGS but only 15% of bonds issued by Australian States and Territories. On that basis there is an argument for the future program to favour a higher ratio of purchases of States’ paper than the current 80/20.
The only definitive “clue” about the future total program was that “members thought it would be premature to consider ceasing the program.”
A crucial observation is that “Key considerations for the decision in July would be progress made towards the Board’s goals for employment and inflation and the likely effect of different options on overall financial conditions.”
One key component of “financial conditions” is the exchange rate.
In the “international financial markets” section of the Minutes the Board refers to “a few central banks had slowed their government bond purchases in prior months”. The obvious example has been Canada where a tapering has seen the Canadian dollar appreciate 3–4% against both the USD and the AUD.
The message from that development to the Board would be to expect a higher AUD and associated tightening of financial conditions if it were to clearly taper its QE program.
Note that the spirit of “key considerations” will be tracking progress against the Board’s goals of inflation and full employment.
A flexible approach where the pace of purchases is reviewed on the basis of such progress seems to be the most consistent with the “key considerations “approach of assessing the policy stance against progress in achieving goals.
But adopting the flexible approach is also likely to come with some strong commitment on the course on purchases.
Deputy Governor Debelle (May 6, Shann Memorial Lecture) noted that “the announcement effect of the program on bond yields and the exchange rate will include some impact from the market’s assessment of the whole size of the bond purchase program.”
He also points out that “it is the size of the bond purchase program that is relevant for assessing the degree of stimulus.” He identifies two metrics – size of the program relative to GDP; and the size relative to bonds on issue.
On both metrics Australia is well behind other developed economies.
For those reasons we expect that the announcement of the flexible program will be accompanied by a clear message that the reason for the new approach is to enhance flexibility and it will discourage any prospects of a taper before the new year.
Westpac’s forecast is that while the pace of purchases will ease through 2022 the total size of the new program will eventually reach around $150 billion.
That would put total bonds held by the RBA at around 18% of GDP and 36% of AGS on issue( lower if the 80/20 ratio is changed) – still well below other developed countries with the exception of US given its burgeoning fiscal deficits.
The Minutes also provide some guidance on the Bank’s current assessment of market expectations. “ranging from a further $50 to $100 billion of purchases over the course of the six months or so after September.”
By nominating a review date of around the December Board meeting (by which time around $65 billion of bonds would have been purchased) the Board would clearly be signalling to the market that it expects to significantly exceed the $50 billion targets of some market expectations.
Other Observations from the Minutes
The other key policy trigger relates to the outlook for the housing market.
Westpac has argued that the Bank is unlikely to see the need to advise the Regulator to impose any macro prudential style policies until next year.
While these Minutes noted “growth in borrowing by investors had also started to increase in recent months” the conclusion that “members continued to emphasise the importance of maintaining lending standards and carefully monitoring trends in borrowing.” was unchanged from the Minutes in May.
There is significant new information on the likely decisions to be made at the July meeting.
Westpac remains comfortable that the Board will not extend the Yield Curve Target to the November 2024 bond while Quantitative Easing will be extended on the basis of a flexible target beginning with $5 billion per week and accompanied by clear guidance that the “new” approach is likely to significantly exceed the $50 billion which is expected by some market participants.
Westpac expects that by the time the QE program has been fully wound back the RBA will have purchased around $150 billion more bonds.