MNI: RBA QT Seen Unlikely, Would Have Little Impact

The Reserve Bank of Australia would need to sell a large portion of its portfolio of long-term Australian Commonwealth Government Bonds to slow the economy significantly, while injecting unpredictable volatility into fixed-income markets, making any form of quantitative tightening highly unlikely in the near future, ex-staffers and commentators told MNI.

A sale of the RBA’s total portfolio of bonds would likely equate to a 30bp raise to the cash rate, according to Sean Langcake, head of macroeconomic forecasting at BIS Oxford Economics and a former RBA economist. “The RBA's research suggests that the purchases had about the same effect of loosening policy 30bp. So we're talking about the same impact as one more rate hike."

While the RBA will not likely execute QT anytime soon, it could review its policy upon the maturity of other pandemic stimulus measures, such as the Term-funding Facility, Langcake said, noting that the size of the central bank’s balance sheet was material, at about 35% of total outstanding ACGBs.

The RBA Board reviewed the Reserve’s plans to reduce its government bond holdings at the May 2 meeting, according to the minutes. David Jacobs, its head of domestic markets, told an audience in Japan Wednesday the Board had agreed to hold its AUD300 billion portfolio until maturity (see chart below), but noted it would review the strategy in future.

Langcake explained QT would have unknown impacts on capital markets. "I don't see a burning need for them to shrink the balance sheet very quickly," he said. "Yes, it carries a little interest rate risk, but the central bank can do that.”

COMMUNICATION KEY

James Morley, professor of macroeconomics at the University of Sydney, noted that the RBA’s manipulation of the overnight cash rate was a far more effective communication tool than changes to its balance sheet.

A rebalance of the RBA’s balance sheet was unlikely, Morley added. “It would lock in losses made when it conducted the easing,” he added. “It would not provide much in terms of policy beyond moving the cash rate.”

He argued QT would also dilute the usefulness of quantitative easing, "muddying the waters” on the use of the less traditional monetary policy. “[QE] signaled a commitment to ‘do whatever it takes’ to maintain inflation expectations," he added. "But I don't think QT would have the same effect compared to changing the cash rate with another rise.”

FUTURE HIKES?

Both Morley and Langcake agree the RBA will likely rely on a cash rate hike over QT to control inflation.

Langcake noted the Reserve could hike a further 25bp in June, though the recent rise in unemployment could lead to another pause. “A challenge [the RBA] faces is the flow of information on the economy as the year progresses will get worse as the economy slows,” he argued. “There's a strong argument to take the medicine now because the alternative is rates higher for longer.” One possibility for the Bank would be to hold rates steady until after the next quarterly CPI print on July 26.

Morley said the chance of a rate rise on June 6 was about 50%. “The RBA will look closely at the monthly inflation number and the slight uptick in unemployment might ease pressure for raising rates,” he noted. “[The RBA] is also worried about just how big of an effect rental rises and the inevitable increases in energy, will have on headline inflation for the next year.” The Australian Bureau of Statistics will publish the next monthly CPI print on June 28.

The overnight index swap market has priced in a pause to the cash rate over the next two meetings with a 25bp hike to 4% on Aug 1.

Morley said the RBA will likely put more weight on the monthly inflation figure than it should. “If that comes in showing potentially substantial y/y decline at the end of Q2, then I suspect it will pause and wait to see more indications on the labour market and inflation. That number will come in, suggesting inflation is definitely coming down, despite the rental and energy price pressures.”