The elements of today's package are as follows:
- a reduction in the cash rate target to 0.1 per cent
- a reduction in the target for the yield on the 3-year Australian Government bond to around 0.1 per cent
- a reduction in the interest rate on new drawings under the Term Funding Facility to 0.1 per cent
- a reduction in the interest rate on Exchange Settlement balances to zero
- the purchase of $100 billion of government bonds of maturities of around 5 to 10 years over the next six months.
Under the program to purchase longer-dated bonds, the Bank will buy bonds issued by the Australian Government and by the states and territories, with an expected 80/20 split. These bonds will be bought in the secondary market through regular auctions, with the first auction to be held this Thursday for Australian Government securities. Further details of the auctions are provided in the accompanying market notice.
The Bank remains prepared to purchase bonds in whatever quantity is required to achieve the 3-year yield target. Any bonds purchased to support this target would be in addition to the $100 billion bond purchase program.
At today's meeting, the Board also considered an updated set of economic forecasts. The global economy has been recovering from the initial virus outbreaks, with the recovery most advanced in China. Even so, output in most countries remains well short of pre-pandemic levels and recent virus outbreaks pose a downside risk to the outlook, particularly in Europe.
In Australia, the economic recovery is under way and positive GDP growth is now expected in the September quarter, despite the restrictions in Victoria. It will, however, take some time to reach the pre-pandemic level of output. In the central scenario, GDP growth is expected to be around 6 per cent over the year to June 2021 and 4 per cent in 2022. The unemployment rate is expected to remain high, but to peak at a little below 8 per cent, rather than the 10 per cent expected previously. At the end of 2022, the unemployment rate is forecast to be around 6 per cent.
This extended period of high unemployment and excess capacity is expected to result in subdued increases in wages and prices over coming years. In underlying terms, inflation is forecast to be 1 per cent in 2021 and 1½ per cent in 2022. In the most recent quarter, year-ended CPI inflation was 0.7 per cent and, in underlying terms, inflation was 1¼ per cent.
The Board views addressing the high rate of unemployment as an important national priority. Today's policy package, together with the earlier measures by the RBA, will help in this effort. The RBA's response is complementary to the significant steps taken by the Australian Government, including in the recent budget, to support jobs and economic growth.
The combination of the RBA's bond purchases and lower interest rates across the yield curve will assist the recovery by: lowering financing costs for borrowers; contributing to a lower exchange rate than otherwise; and supporting asset prices and balance sheets. At the same time, the RBA's Term Funding Facility is contributing to low funding costs and supporting the supply of credit to the economy. To date, authorised deposit-taking institutions have drawn $83 billion under this facility and have access to a further $104 billion.
Given the outlook for both employment and inflation, monetary and fiscal support will be required for some time. For its part, the Board will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range. For this to occur, wages growth will have to be materially higher than it is currently. This will require significant gains in employment and a return to a tight labour market. Given the outlook, the Board is not expecting to increase the cash rate for at least three years. The Board will keep the size of the bond purchase program under review, particularly in light of the evolving outlook for jobs and inflation. The Board is prepared to do more if necessary.
There will be a press conference at 4:00pm AEDT today."
Statement:
"Reserve Bank Purchases of Government Securities
Starting Thursday, 5 November 2020, the Reserve Bank will begin purchasing Australian Government securities (AGS) and securities issued by the state and territory central borrowing authorities (semis) in the secondary market under the $100 billion bond purchase program set out in the Governor's Statement of 3 November 2020.
The purchases of $100 billion will take place over a period of approximately six months, with weekly purchases of around $5 billion. The allocation of bond purchases is planned to be around 80 per cent AGS and around 20 per cent semis. Purchases will be conducted on Monday, Wednesday and Thursday of each week, excluding public holidays and excluding 24 December 2020 to 7 January 2021. The focus of purchases will be bonds with residual maturity of around 5 to 10 years, but may also include bonds outside of this range, depending on market conditions. Purchases of AGS with residual maturity of around 5 to 7 years are planned for Mondays, and purchases of AGS with residual maturity of around 7 to 10 years are planned for Thursdays. Semis purchases are planned for Wednesdays, alternating weekly between shorter-dated and longer-dated securities depending on market conditions. The size of the initial auctions for AGS will be around $2 billion and the size of the initial auctions for semis will be around $1 billion. The purchases will be conducted via multi-price auctions. The Bank will closely monitor the impact of purchases on market functioning and will adjust the auctions if necessary, including their size, composition and timing.
The Reserve Bank will also continue to purchase government securities, as needed, to ensure that the yield on the 3-year Australian Government bond remains consistent with the Board's target and to address any market dislocations in the shorter end of the yield curve. These purchases will be announced as relating to the yield target, and will not form part of the $100 billion bond purchase program described above.
The $100 billion bond purchase program will involve purchasing fixed-rate, nominal bonds issued by the Australian Government and states and territories. Inflation-indexed bonds will not be purchased under the program. The Reserve Bank will exclude from purchases any bond lines that the Bank is aware had recently been tapped by the issuing authority or are newly issued bonds.
Announcements
The Reserve Bank will announce its intentions for government securities purchases at 11.15 am (AEST/AEDT) on the day of purchase via Yieldbroker DEBTS. The announcement will indicate the total face value (AUD) and specific securities the Reserve Bank is willing to purchase, the time within which offers are to be submitted, the settlement date (T+2), and whether the purchases relate to the $100 billion bond purchase program or to the yield target.
A less detailed notification of the operation will also be provided via the market data services (Reuters – RBA27; Bloomberg – RBAO8) at the same time.
Eligible Counterparties
All RITS members deemed eligible to participate in the Reserve Bank's domestic market operations may participate in the AGS auctions (see Eligible Counterparties).
Approaches
Approaches are to be made over Yieldbroker DEBTS.
Offers are to be made in absolute yields in quarter basis point increments, with a minimum offer of $5 million face value and increments of $1 million.
Participants who encounter difficulties in submitting their offers over that system should directly contact Yieldbroker DEBTS and also inform the Reserve Bank's Domestic Markets Desk by email.
Offers cannot be submitted, changed or withdrawn after the cut-off time for submissions has passed.
Allocation
Allocation within an individual bond line will be made on the basis of yield. Allocation between bond lines will be made on a relative value basis, subject to the Reserve Bank's discretion, and for the states and territories will also be guided by the stock of debt outstanding.
Approaches may be partially filled. Multiple successful approaches for a given security at the same yield are filled on a pro-rata basis.
An approach exceeding the total transaction amount indicated by the Reserve Bank for the operation is regarded as equal to the total transaction amount for determining pro-rata allocations.
Approaches that are partially filled are rounded up to the nearest million dollars.
Notification
All participants will be notified promptly of the success or otherwise of their offers via Yieldbroker DEBTS.
Aggregated results will be published on market data services shortly after the auction, and on the RBA website. Historical results are published in Statistical Table A3 on the Reserve Bank website. These include the issuer and series, face value and weighted average and cut-off yields for each security purchased. No information regarding the identities of the Reserve Bank's counterparties will be made public.
Securities Lending
The Reserve Bank stands ready to lend securities against AGS and semis (i.e. general collateral) on a reverse enquiry basis.
Reserve Bank of Australia
3 November 2020"
Statement:
Term Funding Facility – Reduction in Interest Rate to Further Support the Australian Economy
The Term Funding Facility (TFF) was announced in March 2020 as part of a comprehensive policy package to support the Australian economy in the face of economic and financial disruptions resulting from the COVID-19 pandemic. The TFF provides a source of low-cost funding for the banking system with funding available for three year terms. This helps to support the supply of credit and lower interest rates for borrowers. The TFF also provides an incentive for authorised deposit-taking institutions (ADIs) to increase their lending to businesses, especially small and medium-sized enterprises (SMEs), with an additional funding allowance linked to growth in business lending. In September 2020, the TFF was expanded with the introduction of a new supplementary allowance available from October 2020. By 3 November, ADIs had drawn $83 billion under the TFF.
The Reserve Bank is now providing further support to lending and low interest rates by reducing the interest rate on new drawdowns under the TFF. The interest rate on new drawdowns under the TFF is reduced to 0.1 per cent per annum, effective from 4 November, down from 0.25 per cent previously. All other parameters of the TFF remain unchanged.
ADIs can access three year funding at the fixed rate of 0.1 per cent under the additional and supplementary allowances until 30 June 2021. The interest rate on existing drawdowns under the initial allowance, which closed to new drawdowns on 30 September 2020, will remain at 0.25 per cent. Further details are available in the Operational Notes.
The remainder of this notice recaps the main features of the TFF with updates to incorporate the reduction in the TFF interest rate.
Objectives
The Reserve Bank established the TFF to offer low-cost three-year funding to ADIs. The facility has two objectives:
- to reinforce the benefits to the economy of a lower cash rate, by reducing the funding costs of ADIs and in turn helping to reduce interest rates for borrowers. It complements the reduction in funding costs from the Reserve Bank's target for the three-year Australian Government bond yield
- to encourage ADIs to support businesses during a difficult period, ADIs have access to additional low-cost funding if they expand their lending to businesses. The scheme encourages lending to all businesses, although the incentives are even stronger for small and medium-sized enterprises (SMEs).
ADIs are encouraged to consider using this scheme to support their customers and help the economy through a difficult period.
Eligibility
All ADIs that extend credit are eligible to participate in the TFF.
To access the scheme ADIs must have the capacity to deliver eligible collateral to the Reserve Bank. To do this, they need to be members of the Reserve Bank Information and Transfer System (RITS) and Austraclear (the central securities depository used by the Reserve Bank in its domestic market operations). Over 130 ADIs satisfy these requirements and therefore should be able to participate in the TFF. Other ADIs can apply to become RITS members to enable them to participate (for more information, see RITS Membership).
The Australian Government has also developed a complementary program of support for the non-bank financial sector, small lenders and the securitisation market, implemented by the AOFM.
Eligibility and continued access to the TFF is dependent upon ADIs acting, in the opinion of the Reserve Bank, in good faith and in a manner consistent with the objectives of the TFF.
Term
The term of the funding provided under the TFF is for three years for each drawing by an ADI.
Participants may terminate any usage of the TFF, in part or in full, before its maturity date, in accordance with the procedures published by the Reserve Bank.
Interest rate
Prior to the Board's decision on Tuesday 3 November 2020, the TFF provided funding to ADIs at an interest rate of 25 basis points per annum, fixed for the term of the funding.
Following the Board's decision, from Wednesday 4 November 2020, the TFF provides new funding to ADIs at an interest rate of 10 basis points per annum, fixed for the term of the funding.
Interest accrues on the funding provided under the TFF and will be due at maturity or when a repo provided through the TFF is terminated.
Funding Allowance
Participants in the TFF may access funding up to their Funding Allowance. Their Funding Allowance is the sum of up to three components:
In the first phase of the TFF, between 6 April and 30 September 2020, the Funding Allowance for each participant was equal to an Initial Allowance plus an Additional Allowance.
In the second phase of the TFF, between 1 October 2020 and 30 June 2021, the Funding Allowance for each participant is equal to the sum of: any existing drawdowns against the Initial Allowance; a Supplementary Allowance; and an Additional Allowance.
The Initial Allowance is set at 3 per cent of a participant's Total Credit Outstanding to Australian resident households and (non-related) businesses, measured as the average of the participant's total credit in the three months ending 31 January 2020 for ADIs that report on the 720 suite of APRA reporting forms, or the quarter ending 31 December 2019 for ADIs that only report on the 323 APRA reporting form.
The Additional Allowance is equal to the sum of the following:
- one times the dollar increase in Large Business Credit Outstanding from the three months ending 31 January 2020 through to the three months ending 30 April 2021 (if there is a decline in Large Business Credit Outstanding, then this is zero)
- the larger of:
- five times the dollar increase in SME Credit Outstanding from the three months ending 31 January 2020 through to the three months ending 30 April 2021 (if there is a decline in SME Credit Outstanding, then this is zero)
- five times the dollar increase in SME Credit Outstanding from 29 February 2020 to the three months ending 30 April 2021 (if there is a decline in SME Credit Outstanding, then this is zero).
The Additional Allowance available to be accessed will be updated each month during this period, following the receipt of the most recent data on Large Business and SME Credit Outstanding, using the average of the most recent three months of data in the calculations above. The final update will follow the receipt of the data for 30 April 2021.
The Supplementary Allowance is set at 2 per cent of a participant's Total Credit Outstanding to Australian resident households and (non-related) businesses, measured as the average of the participant's total credit in the three months ending 31 July 2020 for ADIs that report on the 720 suite of APRA reporting forms, or the quarter ending 30 June 2020 for ADIs that only report on the 323 APRA reporting form.
ADIs were able to start using the TFF from 6 April 2020. Under the terms above, ADIs that expanded their business credit even ahead of this date benefited from a larger Additional Allowance.
Participants were able to draw down their Initial Allowance until end September 2020. The Supplementary Allowance has been available from 1 October 2020. Participants can draw down their Additional and Supplementary Allowances until end June 2021. Funding can be accessed on business days in Sydney or Melbourne (RITS settlement days) during the drawdown period, except on the three business days between the Boxing Day and New Year's Day public holidays (Tuesday 29 to Thursday 31 December 2020 inclusive). TFF Repo requests will not be processed during this period, though settlement of contracted TFF Repos will still occur (i.e. for requests submitted and accepted prior to Tuesday 29 December 2020). ADIs can make multiple drawings under the TFF up to the limit of their Funding Allowance.
If the Funding Allowance for an ADI declines below the amount that the ADI has drawn under the TFF, the Reserve Bank will require the ADI to reduce the amount of funding they have drawn back to (or below) the Funding Allowance.
The Reserve Bank publishes data on aggregate usage of the TFF on a weekly basis, and aggregate allowances on a monthly basis.
Credit measures used to calculate the Funding Allowance
The quantity of funding available under the Initial Allowance and Supplementary Allowance is calculated by the Reserve Bank based on the ADI's Total Credit Outstanding (loans, finance leases and bill acceptances) to Australian resident households and (non-related) businesses; credit extended to non-residents is excluded. ADIs with Credit Outstanding of over $200 million report these data on the 720 suite of APRA reporting forms (ARF 720). Smaller ADIs report these data on the 323 APRA reporting form (ARF 323).
The quantity of funding available under the Additional Allowance is calculated by the Reserve Bank based on the ADI's Business Credit Outstanding to Australian resident (non-related) businesses, comprising (a) Large Businesses (businesses with turnover of $50 million or more) and (b) SMEs (businesses with turnover below $50 million). Business Credit Outstanding includes both lending to corporate and unincorporated businesses. ADIs with Business Credit Outstanding of over $2 billion report these data to APRA on ARF 742.
ADIs that do not report on ARF 742 can provide data to the Reserve Bank in order to be eligible for the Additional Allowance. These data must include Business Credit Outstanding disaggregated into SME Business Credit Outstanding and Large Business Credit Outstanding for the three months to 31 January 2020 and going forward at a monthly frequency, or for the December quarter 2019 and going forward at a quarterly frequency, to enable the Reserve Bank to calculate the Additional Allowance.
The Credit Outstanding data provided by an ADI to APRA or the Reserve Bank must be the product of systems, processes and controls that have been reviewed and tested by an external auditor of the ADI. The Reserve Bank reserves the right to require independent audits of the Credit Outstanding data provided to APRA or the Reserve Bank at any time.
Eligible collateral
Funding under the TFF is extended by the Reserve Bank to ADIs under repurchase transactions (repo).
Eligible collateral consists of all collateral currently eligible for the Reserve Bank's domestic market operations. For more details, see Eligible Securities. This includes self-securitised asset-backed securities.
The Reserve Bank applies haircuts (including through Margin Ratios) to the collateral, as set out on the Reserve Bank's website from time to time. For more details on the haircuts that apply to the Reserve Bank's existing facilities, see Margin Ratios. The Reserve Bank may apply different haircuts to collateral under the TFF. The Reserve Bank has discretion to vary its haircuts at any time.
Legal and Operational details
The terms of the TFF can be revised by the Reserve Bank at any time, and this announcement is indicative only. For more details see the Operational Notes. Usage of the TFF is at the sole discretion of the Reserve Bank.
Reserve Bank of Australia
3 November 2020"
Webcast speech by RBA Governor Philip Lowe:
Good afternoon.
The Reserve Bank Board met this morning. It decided on a package of further measures to support the Australian economy as it recovers from COVID-19. Given the significance of this package, I wanted to explain in person what we are doing and why we are doing it and to answer your questions.
At its core, today's decision reflects the Reserve Bank's commitment to do what we reasonably can, with the tools that we have, to support the recovery of the Australian economy. The Board views addressing the high rate of unemployment as a national priority and it wants to do what it can to support job creation. Importantly, today's decision complements government efforts to support the Australian economy and to lower unemployment.
When the virus first arrived on our shores, economic policy quickly turned to building a bridge to the recovery. This was the right strategy and this bridge has made a major difference to people's lives, helping many people and businesses get through a very difficult period. This bridge was constructed through close co-operation by governments across Australia, the Reserve Bank, the financial regulators and Australia's financial institutions. For the Reserve Bank's part, we have kept borrowing costs low and the financial system very liquid and supported the supply of credit to the economy.
This broad economic policy response and Australia's progress on the health front have meant that the Australian economy is in a better shape than many others. While Australians have experienced a severe recession, it has not been as bad as was earlier expected or experienced in many other countries.
In light of this experience, we have recently updated our economic outlook, with the full details to be published on Friday. These updated forecasts will contain an upgrade to the near-term economic outlook, although there are a number of factors weighing on the medium-term outlook, including lower population growth.
On balance, both the recent household spending and employment data have been a little stronger than we were expecting. It now appears probable that GDP increased solidly in the September quarter despite the lockdown in Victoria. And growth over the year to June 2021 is expected to be close to 6 per cent compared with an expectation of 4 per cent growth when we reviewed our forecasts three months ago. The fiscal support, including through the Budget, has played an important role here. The unemployment rate is also now expected to peak at a lower rate than previously – at a little below 8 per cent, rather than the 10 per cent expected three months ago.
This upgrade to the near-term outlook is clearly welcome news. At the same time though, we need to recognise that the pandemic has inflicted significant damage on our economy. It will take time to repair that damage and it is highly likely that the recovery will be uneven and drawn out. In particular, we face the prospect of a long period of higher unemployment and underemployment than we have become used to. In the RBA's central scenario, job creation is slow over coming months and the unemployment rate is still around 6 per cent at the end of 2022. One consequence of this is that wages growth and inflation are both likely to stay very low. In each of the next two years, we are expecting annual wages growth of less than 2 per cent. And inflation, in underlying terms, is expected to be just 1 per cent next year and 1½ per cent in 2022.
Given this outlook, the Board judged that it is appropriate to take further steps today to support the economy. Unemployment is a major economic and social problem that damages the fabric of our society. So, it is important that it is addressed. The Board recognises that, in the context of the pandemic, the responsibility for job creation falls mainly on the shoulders of business and government. But the Reserve Bank can, and will, make a contribution too. Today's policy package does that and it builds on the contributions from our policy measures earlier in the year.
Today's package has three elements. These are:
- first, a reduction in the cash rate target, the three-year yield target and the interest rate on new drawings under the Term Funding Facility to 10 basis points, from the current 25 basis points.
- second, a reduction in the interest rate on Exchange Settlement balances to zero from the current 10 basis points.
- and third, the introduction of a program of government bond purchases. In particular, we are intending to buy $100 billion of government bonds over the next six months, purchasing bonds issued by the Australian Government as well as by the states and territories.
Together, these three elements represent a significant package. The lower interest rates and our plan to buy $100 billion of government bonds over the next six months will help people get jobs and support the recovery of the Australian economy.
The package combines the price-based target at the shorter part of the yield curve that has been in place since March with a quantity target at the longer part of the yield curve. In doing so, it will lower the whole structure of interest rates in Australia. This lower structure of interest rates will work to support the economy through the normal transmission mechanisms, including lower borrowing costs, a lower exchange rate than otherwise and higher asset prices.
To be clear, the inflation target remains the cornerstone of Australia's monetary framework. Even so, the priority over the next couple of years is jobs, with inflation risks remaining low. The RBA has a broad legislative mandate for price stability, full employment and the economic welfare of the Australian people. Today's decision reflects that broad mandate.
The Board expects that this new lower level of interest rates will be in place for an extended period. The Board will not increase the cash rate until actual inflation is sustainably within the target range. It is not enough for inflation to be forecast to be in the target range. For inflation to be sustainably within the target range, wage growth will have to be materially higher than it is currently. This will require a lower rate of unemployment and a return to a tight labour market. On the current outlook, it will take some years to get there. Given this, the Board is not expecting to increase the cash rate for at least three years. It remains the case that prior to any increase in the cash rate target, the Board intends to remove the three-year yield target.
I would now like to provide some further details of the bond purchase program.
At the start, it is important to point out that all purchases will be made in the secondary market through an open auction process. The RBA will not be buying bonds directly from governments.
We plan to hold auctions three times a week: on Mondays, Wednesdays and Thursdays, with the first auction being on this Thursday.
On Mondays and Thursdays we plan to purchase bonds issued by the Australian Government (AGS) and on Wednesdays we plan to purchase bonds issued by the states and territories (semis).
We will focus on buying bonds with maturities of around five to 10 years, but may also buy bonds outside this range, depending upon market conditions. To assist with the smooth running of the auctions, we plan to buy AGS with five to seven-year maturities on Mondays and AGS with seven to 10-year maturities on Thursdays. For semis, we plan to alternate weekly between the five to seven and seven to 10-year securities, subject to market conditions.
We will be purchasing fixed-rate nominal bonds only, as these are the benchmark fixed-income securities in Australia and they underpin the pricing of many other assets. Inflation-indexed bonds are not part of the program.
The initial auctions for AGS will be for around $2 billion and the initial auctions for semis will be around $1 billion. This means that we expect to purchase around $5 billion per week.
We will closely monitor the impact of our purchases on market functioning and are prepared to adjust the size and timing of the auctions if necessary. If the size of these initial auctions is maintained, 80 per cent of the bonds purchased would be AGS and 20 per cent would be semis. In allocating our bond purchases across the various states and territories we will be guided by the stock of debt outstanding and relative market pricing.
These bond purchases mean that the RBA is now conducting quantitative easing, or QE, similar to that of many other central banks. I want to point out, though, that there has already been a very substantial increase in the size of our balance sheet as a result of our earlier measures. Once these additional bond purchases are completed mid next year, our balance sheet would have nearly tripled since the beginning of 2020, provided that the funds currently available under the Term Funding Facility are drawn upon.
I also want to point out that this bond purchase program is separate from any bond purchases that we undertake to support the three-year yield target. We remain committed to buying bonds in whatever quantity is needed to support that target. Any bonds purchased in support of the three-year yield target will be separate from the $100 billion.
I would now like to address four specific questions that I know some people would have. I will then answer questions more broadly.
These four specific questions are:
- Why make this change now?
- Is the RBA now financing the government?
- Why have a price and a quantity target?
- With interest rates so low, is the RBA now out of fire power?
Why make these changes now?
This is an understandable question, especially given that we are easing monetary policy further today at the same time as we are upgrading the near-term outlook for the economy.
Apart from the general case for further monetary easing that I have already spoken about, there are a couple of other factors that have influenced the timing.
The first is that over recent months we have learnt more about the pandemic and its economic impact. As the months have passed, it has become increasingly apparent that there will be long-lasting effects, including high unemployment. While the outlook does remain uncertain, we do have a somewhat clearer picture of the future state of the labour market. A sharp bounce-back in jobs is unlikely and it will take time to return to where we were before the pandemic. We have responded to this clearer picture today.
The second factor is that monetary easing is likely to get more traction today than it would have when widespread restrictions were in place. In earlier months, the usual transmission mechanisms were not working as normal and the challenges facing the country were best addressed by other policy tools. However, as restrictions are eased and people have more opportunities to spend, our judgement is that further monetary easing now provides additional support to other policies, including the fiscal initiatives and the RBA's earlier monetary policy package.
In reaching today's decision, the Board also considered the effects on medium-term financial and macro stability as well as the impact on savers. The Board recognises that low rates can encourage some additional risk-taking, as investors search for yield. It also recognises that low deposit rates can create difficulties for some people. These issues will need to be closely watched over the months ahead. But the Board judged that the bigger risk at the moment was the threat to our economy and to balance sheets from an extended period of high unemployment. Today's decision will lessen that risk.
Is the RBA now financing the government?
The answer is a simple no. Today's decision does not change the long-standing separation of monetary policy and fiscal financing in Australia. The RBA is not financing government spending.
I want to highlight the important distinction between providing finance and affecting the cost of that finance. The RBA is not providing finance to the government, but our actions are lowering the cost of government finance. I should point that our actions are also lowering the cost of finance for all other borrowers in Australia, whether they are a household buying a home or a business wanting to expand. This lower cost of finance for everybody is supporting the recovery from the pandemic.
It is important to point out that the bonds purchased by the RBA will have to be repaid by the government at maturity. They will have to be repaid in exactly the same way as would occur if the bonds were held by others. The same is true for the ongoing coupon payments on the bonds. The fact that the RBA is holding some bonds makes no difference to the financial obligations of the government, other than through a lower cost of finance.
The Australian Government and the states and territories continue to fund themselves in the market, as they should. Raising funds in the market is an important discipline and movements in market prices can contain valuable information. Recent bond auctions have been heavily oversubscribed, even though the size of these auctions has been a record high. There is strong demand by domestic and global investors for bonds issued by the Australian Government and by the states and territories. I expect that this will remain the case.
Why have a price and a quantity target?
As part of the RBA's March package, we announced a price target for the yield on the three-year Australian Government bond, rather than a quantity of bonds to purchase. We viewed the yield target as the more direct way of achieving our objective of low funding costs. The target also reinforced our forward guidance regarding the cash rate. Given that we expected the cash rate to remain low for some years, we judged it appropriate to target a three-year yield and stand behind that target with our balance sheet.
These arguments for a yield target remain valid and so we are continuing with the three-year yield target. We considered targeting a longer yield – say five years – but decided against this. This was on the basis that the yield target is most effective when it is consistent with our forward guidance on the cash rate. As I said earlier, we expect the cash rate to be at its current level for at least three years. Beyond that, we have less confidence. I certainly hope that the economy will be sufficiently strong sometime over the next five years to warrant an increase in the cash rate. So three years, not five years, is the appropriate maturity for the yield target.
Today's decision supplements this price target with a quantity target further out along the yield curve. This quantity target is similar to the approach adopted by many other central banks, which have responded to the pandemic with government bond buying programs. The evidence is that these programs have lowered government bond yields in other countries. One result of this is that Australia has had higher long-term bond yields than elsewhere, even though the setting of the short-term policy rate is similar across countries. These higher bond yields have added to the attractiveness of Australian dollar assets and this has put some upward pressure on the exchange rate.
There has also been an accumulation of evidence that central bank balance sheet expansion has a stimulatory effect beyond that resulting from lower bond yields. When the central bank buys assets, investors in the private sector adjust their portfolios, buying different assets with the proceeds of their bond sales. This portfolio rebalancing can affect the price of other assets and international capital flows, as well as the exchange rate.
Given these considerations, the Board judged it was now appropriate to combine the three-year yield target with QE further out along the yield curve.
Is the RBA now out of firepower?
The short answer here again is no. The Reserve Bank is not out of firepower. We have additional monetary policy options and we are prepared to use them if the circumstances require.
In terms of interest rates, I think we have gone as far as it makes sense to do so in the current environment. There has been no change to the Board's view that there is little to be gained from lowering the policy rate into negative territory. While a negative rate might lead to a helpful depreciation of the Australian dollar, it could impair the supply of credit to the economy and lead some people to save more, rather than spend more. Given this assessment, the Board continues to view a negative policy rate in Australia as extraordinarily unlikely.
But monetary policy is now about more than just short-term interest rates – we have returned to a world in which quantities matter too. In this world, it is certainly possible for us to increase the size of our bond purchases. Given this, we will continue to closely monitor the economic situation and the impact of our purchases on market functioning. If we need to do more, we can and we will.
The RBA also has a range of tools to support the proper functioning of markets and address market dysfunction were that to occur. These tools include further liquidity provision, asset purchases and transactions in the foreign exchange market.
So it would be incorrect to conclude that we are out of firepower.
That brings me to the end of the four questions I posed. I am now happy to answer any other questions that you might have.
Thank you."
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