Westpac: How Will The RBA Revise The Discount On Its Deposit Rate?

Westpac note that “while the debate about the shape of the forward cash curve and the starting point for the RBA’s tightening cycle remains unresolved and data dependent, the market is beginning to discuss what the RBA’s policy corridor will look like once the first hike is delivered. Specifically, how will the RBA adjust its deposit rate (the interest rate paid on surplus ES)? Traditionally the “corridor” around the RBA’s target rate was 25bp either side. However, as the cash target was slashed, the RBA reduced the discount for the deposit rate relative to the target from -25bp to -15bp in March 2020 and then to -10bps in November 2020. The adjustments were necessary to avoid transactions at a negative cash rate. The adjustments were made with unprecedented liquidity in mind, as reflected in the surge in surplus ES balances.”

• “That excess liquidity has meant that the effective cash rate has remained well below target. So how will the RBA shift the corridor in the future? Options include reversing the earlier process, so a 15bp hike back to 0.25% has a 0.10% floor and the following hike, to 0.5% would restore the historical 25bp discount. The question is, however, whether by doing so, with so much liquidity in the system, that the RBA will have difficulty with shifting the effective cash rate higher. So there are some discussions around whether a different, or slower removal of the 10bp discount would be more attractive. There is even some discussion around putting the deposit rate at the cash rate level. We think the latter is unlikely as at the end of the day the RBA knows that gaining traction in the cash market, such that the deposit rate rises to the target, will be tied up with the reduction in their balance sheet, which will only start accelerating around Q223 and beyond. So, a crucial consideration for the RBA will be how “elastic” the demand for ES funds is as surplus dimmish.”