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Reserve Bank dismisses need for special measures
RBA Governor Speech

RBA Governor speech: “Unconventional Monetary Policy: Some Lessons from Overseas.”

Key point: “There may come a point where QE (quantitative easing) could help promote our collective welfare, but we are not at that point and I don’t expect us to get there.”
Speeches from the RBA Governor can influence financial market pricing.

What did he say and what does it all mean?

• The Reserve Bank Governor is not a fan of so-called “unconventional monetary policies”. While some measures have worked for a period, he says that there is also the risks of side effects.

• The four “unconventional monetary policy” tools are: negative policy rates; extended use of central bank liquidity operations; outright purchase of assets from the private sector (quantitative easing or QE); and forward guidance.

• The Reserve Bank Governor said that “if the Reserve Bank were to undertake a program of quantitative easing, we would purchase government bonds, and we would do so in the secondary market.” The Governor stated that the preference would be for purchases of Commonwealth Government bonds rather than private sector assets like mortgage backed securities or semi-Government securities.

• While the Reserve Bank would consider a package of measures to support the economy, the Governor said that “if markets were to become dysfunctional, you can be reassured by the fact that we have both the capacity and willingness to respond. But this is not the situation we are currently in. Things are operating normally.”

• So the Governor has effectively thrown cold water on the need for special monetary policy measures. Financial market economists have written numerous column inches on a topic that can sit on the shelf – at least for now.

• It is right and proper that the Reserve Bank Governor outlines possible approaches to be considered should interest rates get to 0.25 per cent. But the Governor stresses that we aren’t at that point – and importantly – doesn’t expect us to get to that point.

• The “effective lower bound” for the cash rate – before special measures are deemed necessary – is 25 basis points or a quarter of a per cent (0.25 per cent). The cash rate is currently 0.75 per cent. Key points

• “There may come a point where QE (quantitative easing) could help promote our collective welfare, but we are not at that point and I don’t expect us to get there.”

• “The Board is also committed to maintaining interest rates at low levels until it is confident that inflation is sustainably within the 2 to 3 per cent target range.”

• “The central scenario for the Australian economy remains for economic growth to pick up from here, to reach around 3 per cent in 2021.”

• “QE (quantitative easing) is not on our agenda at this point in time.”

• “It is difficult to be precise, but QE would be considered if there were an accumulation of evidence that, over the medium term, we were unlikely to achieve our objectives. In particular, if we were moving away from, rather than towards, our goals for both full employment and inflation, the purchase of government securities would be on the agenda of the Board. In this world, I would hope other public policy options were also on the country’s agenda.”

•“Our current thinking is that QE becomes an option to be considered at a cash rate of 0.25 per cent, but not before that…the threshold for undertaking QE in Australia has not been reached, and I don’t expect it to be reached in the near future.”

• “if – and it is important to emphasise the word if – the Reserve Bank were to undertake a program of quantitative easing, we would purchase government bonds, and we would do so in the secondary market.”

• “QE would be considered if there were an accumulation of evidence that, over the medium term, we were unlikely to achieve our objectives. In particular, if we were moving away from, rather than towards, our goals for both full employment and inflation, the purchase of government securities would be on the agenda of the Board. In this world, I would hope other public policy options were also on the country’s agenda.”

• “negative interest rates in Australia are extraordinarily unlikely….We are not in the same situation that has been faced in Europe and Japan. Our growth prospects are stronger, our banking system is in much better shape, our demographic profile is better and we have not had a period of deflation. So we are in a much stronger position.”

What are the implications for interest rates and investors?

• The Reserve Bank Governor hasn’t given any hints on interest rates. More than likely the Bank is on hold now until early 2020.

• The Reserve Bank Governor is not particularly worried about a new boom in home prices. Governor Lowe indicated he would be worried if the lift in home prices was accompanied by a large increase in household debt.

• The Reserve Bank Governor said that the likelihood of recession is low – the expectation is that growth picks up to around 3 per cent over the coming year…“we have a lot of positives going for us”.

• The Reserve Bank Governor reinforced his hope that wage growth returns to 3.5 per cent.

• The Governor said that the solution to the current period of low rates and low inflation is to get businesses to invest – to use the excess supply of savings across the globe.

Published by Craig James, Chief Economist, CommSec