The RBA has left the cash rate on hold at 0.1% – but will begin winding back its pandemic stimulus

The RBA has left the cash rate on hold at 0.1% – but will begin winding back its pandemic stimulus
The RBA is considering three approaches to quantitative easing ahead of its first meeting back next year. Photo: Getty Images
  • The central bank has stood firm on a cash rate of 0.1% for a twelfth-straight month.
  • RBA Governor Philip Lowe said the Bank will continue to buy $4 billion in government bonds a week until mid-February, but do away with its April 2024 government bond yield target of 0.1%.
  • In a statement, the RBA Board made no mention on refraining from rising interest rates until 2024, as it has for months, but made a softer forecast subject to an inflation threshold of around 2.5%.
  • Visit Business Insider Australia’s homepage for more stories.

The Reserve Bank of Australia has pointed to sturdy vaccination rates and a broader post-pandemic economic recovery as justification for standing firm on the cash rate for a twelfth-straight month, and bringing an end to its three-year government bond yield target.

After its monthly meeting on Tuesday, RBA Governor Philip Lowe announced the central bank will continue to buy $4 billion in government bonds a week until mid-February, but dispense with its April 2024 government bond yield target of 0.1%.

“The decision to discontinue the yield target reflects the improvement in the economy and the earlier-than-expected progress towards the inflation target,” Lowe said.  

“Given that other market interest rates have moved in response to the increased likelihood of higher inflation and lower unemployment, the effectiveness of the yield target in holding down the general structure of interest rates in Australia has diminished,” he said. 

Lowe said the Board is committed to continuing on with supportive monetary conditions to drive national employment and inflation in Australia consistent with the Bank’s target.

“While inflation has picked up, it remains low in underlying terms. Inflation pressures are also less than they are in many other countries, not least because of the only modest wages growth in Australia,” he said. 

By dumping the “yield curve control”, one of the bank’s key COVID-19 stimulus measures introduced back in March last year, parts of the market suggest the RBA is signalling that borrowing costs may rise sooner than the Bank’s 2024 forecast. 

The Bank of Canada dumped a similar bond-buying stimulus policy on Wednesday last week, and America’s Federal Reserve is expected to announce a wind down of its debt buying scheme over the next few days. 

There was no mention of suspending interest rate hikes until 2024 in the Board’s statement, but economists predict that based on the RBA’s forecasts — which indicate that it won’t hike rates until inflation is above 2.5% — rates could rise as soon as next year. 

“The board will not increase the cash rate until actual inflation is sustainably within the 2 to 3% target range. This will require the labour market to be tight enough to generate wages growth that is materially higher than it is currently. This is likely to take some time,” Lowe said.

“The board is prepared to be patient, with the central forecast being for underlying inflation to be no higher than 2.5% at the end of 2023 and for only a gradual increase in wages growth.”

AMP Capital chief economist Shane Oliver said he remains of the view that the conditions for rate hikes could be in play as soon as late next year, with the first hike likely to come next November. 

Judo Bank economic adviser Warren Hogan made a similar prediction, saying that a rate hike over the next 12 months wouldn’t be out of the question. 

After inflation figures released last week delivered stronger-than-expected results at 2.1%, some banks started to price in interest rate rises from as early as next April, while each of the big four banks expect it will come in mid-2023. 

Meanwhile, survey of leading global economists found most the median expectation was a 15-point rise through the first six months of 2023.

NAB Economics, led by chief economist Alan Oster, wrote on Monday that inflation is rising at a speed most hadn’t anticipated, and that core inflation could even jump a touch higher, “to say, 2.3%”, by mid-2022.

But Governor Lowe said it might yet be too early to tell. 

“Inflation has picked up, but in underlying terms is still low, at 2.1 per cent. The headline CPI inflation rate is 3% and is being affected by higher petrol prices, higher prices for newly constructed homes and the disruptions in global supply chains,” he said.

“A further, but only gradual, pick-up in underlying inflation is expected.

“The central forecast is for underlying inflation of around 2.25% over 2021 and 2022 and 2.5 per cent over 2023. Wages growth is expected to pick up gradually as the labour market tightens, with the wage price index forecast to increase by 2.5% over 2022 and 3% over 2023.

“The main uncertainties relate to the persistence of the current disruptions to global supply chains and the behaviour of wages at the lowest unemployment rate in decades.”

Governor Lowe has drawn criticism from all corners of the market in the wake of the Bank’s monthly meeting, which saw the Bank axe its three-year yield curve control policy, after allowing a market selloff last week to continue without defending it.

Yields started to surge after the release of last Wednesday’s inflation data, which saw traders drive up the rate on the Bank’s April 2024 bond last Friday to more than eight times that level, per Bloomberg data

Yarra Capital economist Tim Toohey criticised the Bank’s failure to act on opportunities to hold the yield down, and then dump the policy altogether after refusing to defend it. 

“The RBA abandoning the 3-year yield curve control policy has been poorly handled. The policy was introduced to provide certainty for risk takers, but instead we’ve seen enormous volatility introduced into the broader bond market by virtue of the RBA’s refusal to defend its own policy,” Toohey said. 

“Not only has this caused one of the largest liquidity squeezes in decades, it has left risk takers wondering whether they can trust the remainder of RBA’s forward guidance going forward. The increased volatility and the higher level of yields will invariably see mortgage rates rise in coming months.”

Stephen Miller, an investment specialist at Grant Samuel Funds Management, accused the RBA of failing to acknowledge upside inflation risks, made worse by adopting a communications strategy void of nuance. 

“It is a little of a surprise that the RBA has minimally tweaked monetary settings when ‘emergency’ settings in monetary policy have persisted well beyond their useful application date,” Miller said. 

“At the very least the RBA should have acknowledged some upside risk to inflation rather than a grudging ‘uncertainties relate to the persistence of the current disruptions to global supply chains and the behaviour of wages at the lowest unemployment rate in decade’,” he said.

“More persistent inflation has been visible for some time globally and is an issue with which every developed-country central bank is currently grappling. Australia is never going to be immune to those same pressures.”