RBA pares back stimulus on strong economic recovery
Reserve Bank Board meeting

What happened? The Reserve Bank (RBA) has left the target rates for both the cash rate and 3-year government bond yield (April 2024 maturity) at 0.1 per cent. The RBA will slow its bond-buying program from early September, reducing its weekly bond purchases from $5 billion to $4 billion until at least mid-November.

Implications: Virus lockdowns have weighed on risk sentiment with Aussie shares easing from recent record highs. But accommodative policy settings remain supportive of the uptrend in equities.

What has changed since the last Board meeting on June 1?

• The Australian economy (as measured by gross domestic product) grew by 1.8 per cent in the March quarter. From a year earlier, the economy was 1.1 per cent larger.

• Employment rose by 115,200 in May. The jobless rate fell from 5.5 per cent to a 17-month low of 5.1 per cent.

• Job vacancies rose by 23.4 per cent over the three months to May to a record 362,500 available positions.

• Retail spending rose by 0.4 per cent in May to stand 7.7 per cent higher than a year ago.

• Australia’s total household wealth climbed 4.3 per cent to a record $12.7 trillion in the March quarter.

• The NAB business confidence index eased from a record high of 23.5 points in April to 19.8 points in May. But the business conditions index rose from 31.9 points in April to an historic high of 37.2 points in May.

• The Westpac-Melbourne Institute Index of Consumer Sentiment fell by 5.2 per cent in June to a five-month low.

• The CoreLogic national home value index lifted 1.9 per cent in June to be up 13.5 per cent on the year.

• Council approvals to build new homes fell by 7.1 per cent in May but were still up 52.7 per cent on a year ago.

• Private sector credit (effectively outstanding loans) rose 0.4 per cent in May to be up 1.9 per cent on the year.

• The value of new loan commitments for housing rose by 4.9 per cent to a record high $32.6 billion in May.

• In June in the US, the Dow Jones index fell 0.1 per cent, but the S&P 500 index rose 2.2 per cent and the Nasdaq index lifted 5.5 per cent. The Australian S&P/ASX 200 rose by 2.1 per cent – the 9th straight monthly gain.

• The Aussie trade-weighted index lost 1.3 per cent in June with the Aussie dollar finishing June at US75.18 cents.

The assessment

• Australia’s rapid economic recovery and the strengthening job market have enabled the Reserve Bank (RBA) Board to begin the very gradual process of unwinding emergency monetary policy measures enacted during last year’s pandemic-induced health and economic crises.
• The first change in policy settings took place on June 30 when the RBA’s Term Funding Facility (TFF) – which provided a low-cost source of funding for banks – closed to new drawdowns or expired.

• In today’s highly anticipated meeting, the official cash rate was held steady at a record low 0.1 per cent. Importantly, previous forward guidance (or pre-conditions) on the potential timing of the first rate hike was adjusted, “The Bank’s central scenario for the economy is that this condition will not be met before 2024. Meeting it will require the labour market to be tight enough to generate wages growth that is materially higher than it is currently.”

• The first main ‘live’ policy decision handed down today related to whether the Board would retain its 3-year government bond yield target – which links the April 2024 borrowing rate to the 0.1 per cent cash rate – or to roll over the target to the November 2024 maturity. By retaining the status quo, the Board has potentially laid the foundations for eventually retiring its yield curve control program, also signalling that the first rate hike will occur before 2025.

• The other ‘live’ decision was whether the RBA would renew its $100 billion bond buying or quantitative easing (‘QE’) program for a third time. In the end, the Board opted for a flexible approach, incrementally scaling down its bond purchases, enabling it to be data-dependent and responsive to central bank policy changes globally. The RBA will slow its bond-buying program from early September, reducing its weekly bond purchases from $5 billion to $4 billion until at least mid-November.

Perspectives on interest rates

• The RBA left the cash rate at 0.1 per cent after cutting the rate from 0.25 per cent on November 3. The RBA previously cut the cash rate on March 3 and March 19, 2020, each by 25 basis points. The target rate for 3-year bond yields was left at 0.1 per cent. On November 3, the RBA cut the 3-year bond target from 0.25 per cent to 0.1 per cent. The RBA implemented the 0.25 per cent target rate for 3-year bond yields on March 19, 2020.

What are the implications of today’s decision?

• The Reserve Bank Governor Philip Lowe today provided an upbeat assessment of Australia’s economic outlook: “The economic recovery in Australia is stronger than earlier expected and is forecast to continue.” And, “The labour market has continued to recover faster than expected.” On the latest Covid-19 outbreaks he said, “One near-term uncertainty is the effect of the recent virus outbreaks and the lockdowns. But the experience to date has been that once outbreaks are contained and restrictions are eased, the economy bounces back quickly.”

• But those seemingly ‘bullish’ comments were laced with some caution, suggesting a still-‘dovish’ policy stance. In fact, Dr. Lowe said, “Despite the strong recovery in jobs and reports of labour shortages, inflation and wage outcomes remain subdued. While a pick-up in inflation and wages growth is expected, it is likely to be only gradual and modest.” And, “The Bank will continue to purchase bonds given that we remain some distance from the inflation and employment objectives.” So the RBA’s overriding objective remains a determination to drive the economy towards “full employment” to stoke wage growth to around 3-3.5 per cent and to propel the annual core inflation rate sustainably into its 2-3 per cent target range.

• From an investor perspective, monetary policy remains ultra-accommodative, despite today’s decision by the RBA to slow its bond-buying program. Bond purchases have capped market interest rates enabling households, businesses and governments to borrow at rock bottom levels.

• But ‘tapering’ is not ‘tightening’ and already we’ve seen the Bank of England and Canada slow their bond buying programs in response to the brighter economic outlook. But the RBA will be keen to be seen as not tightening too much relative to other central banks to avert an unhelpful appreciation of the Aussie dollar.

• Virus lockdowns have weighed on risk sentiment with Aussie shares easing from recent record highs. But accommodative policy settings remain supportive of the uptrend in equities.
• Commonwealth Bank (CBA) Group economists expect the RBA deliver the first hike in the cash rate in November 2022.

• The Reserve Bank Governor provides further remarks on today’s decision at 4pm AEST.

Published by Ryan Felsman, Senior Economist, CommSec