MNI 5 Things:RBA Debelle: Imp To Know Cenbk Reaction Function

By Sophia Rodrigues

     SYDNEY (MNI) - The following are the five key observations we made from the

Reserve Bank of Australia deputy  governor Guy Debelle's speech Friday. Kent

spoke at the Financial Risk Day conference in Sydney on the topic, "Risk and

Return in a Low Rate Environment."

     --Debelle didn't talk about the Australian economy or monetary policy. But

he made interesting comments about central bank forward guidance. He spoke about

it in the context of low financial market volatility. According to him, greater

use of forward guidance as a policy tool may be one reason for low volatility as

it provides more certainty about path of monetary policy. But he warned that

market doesn't have to believe the central bank guidance will come to pass.

"There are any number of instances in the past where central bank forward

guidance didn't come to pass," he said, adding, that is more important for the

market to have a clear understanding about the central bank's reaction function.

"If that is sufficiently clear, then forward guidance does not obviously have

any large additional benefit, and runs the risk of just adding noise or sowing

confusion."

     --Debelle said that at least the short-end of yield curves would rise if

the global recovery continues to play out as currently anticipated and the

monetary stimulus is unwound.

     --Debelle said he struggles to see how one can hold a view with any great

certainty that interest rates are going to continue to remain lower for longer.

"Yet there appears to me to be very little, if any, compensation for this

uncertainty in fixed income markets. Most estimates of the term premium in the

10-year US Treasuries are around zero, or are even negative. Investors are not

receiving any additional compensation for holding an asset with duration."

     --Debelle said that his view previously that volatility would move higher

structurally in the past turned out to be wrong. But he is more confident of

that view this time. "I think there is a higher probability of being proven

correct this time."

     --Debelle said if interest rates continue to rise without a similar rise in

expectations about future earnings growth, one would expect to see a repricing

of other assets, particularly equity markets. "Such a repricing does not

necessarily mean a major derailing of the global recovery, indeed it is a

consequence of the recovery, but it may have a dampening effect," he added.

--MNI Sydney Bureau; tel: +61 2-9716-5467; email: sophia.rodrigues@marketnews.com

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