Analysis: Rising AUD May Force RBA to Take True QE Path

• Published on
• 27 May 2020, 04:44 PM

By Sophia Rodrigues

One factor that could potentially have been an impediment to large scale asset purchases, or a true form of Quantitative Easing, in Australia has turned into an enabler, and it is likely the Reserve Bank would take advantage of it to flatten the yield curve and put downward pressure on the exchange rate.

This means there is a likelihood the RBA would go down the same path as the Bank of Japan, except that it would be the reverse. The Bank of Japan did QQE with yield curve control, and the RBA would be doing Yield Target with Quantitative Easing.

GOVT BOND STOCK NOW AN ENABLER

In his speech on Unconventional Monetary Policy delivered late last year, RBA governor Philip Lowe said the international experience showed “QE does put additional downward pressure on both interest rates and the exchange rate.”

Lowe also talked about one important consideration the RBA would need to keep in mind if they were to consider QE – the impact on market functioning.

This was due to the limited supply of government debt on issue, and expectation that the gross stock was projected to decline over the years ahead.

However, that situation has now changed. The government’s huge spending program in response to the COVID-19 pandemic has meant that they have had to increase their borrowing from the market, and as a result the stock of government debt is projected to increase sharply.

This year alone the government has issued A$105 billion of Treasury bonds and is expected to issue up to A$25 billion more by the end of June.

The increase in government stock means the RBA has one less thing to worry about when it considers the need for QE, and weigh its positive effects with possible side-effects.

RISING EXCHANGE RATE

The need for QE has grown because the Australian dollar has risen in recent weeks and could rise further if monetary policy remains unchanged. Also, given Governor Lowe reiterated last week that negative interest rates remain extraordinarily unlikely in Australia, QE remains among the last remaining tools for further easing especially given it is known have a dampening effect on the exchange rate.

The Australian dollar is currently trading around US$0.665, up 3.5% from RBA’s technical assumption of US$0.64 at the May Statement on Monetary Policy. It is currently just 5% lower from a year earlier.

In the latest SOMP, there was no discussion on the exchange rate with respect to growth outlook. It was confined to impact and outlook on inflation.

But in April Lowe said the exchange rate is the great shock absorber and has stabilized the economy more than anything else, even more than monetary policy.

He noted the exchange rate was in the high sixties earlier in the year, and after a more-than-expected fall during period of panic in March it had risen a bit. But was still down very significantly on the year, and that was helping stabilize the economy.

On that day, the Australian dollar was around US$0.63.

FLATTEN YIELD CURVE

A large-scale asset purchase program is also needed to flatten the yield curve which would lower borrowing costs for both governments and private borrowers.

According to the RBA’s explainer on yield curve, “Different terms of the yield curve are important for different sectors of the economy.”

Many Australian households have mortgages with variable interest rates, so the cash rate and up to 3-year yield is important for them. On the other hand, firms and governments often wish to borrow for a much longer term, say 5 or 10 years, so this part of the yield curve is important for them, the RBA said.

--Contact: sophia@centralbankintel.com