RBA Dep Gov Debelle Says Forward Guidance Is State-Based, Not Calendar

Key Points from RBA Deputy Governor Guy Debelle’s Speech Thursday:
--State of Economy Key Determinant of policy settings, not calendar
--RBA has provided timeframe for rate hike that fits description of state of economy
--Effect of rise in swap rate on borrowing rate unlikely to be that large
--3-year yield target still playing significant role in anchoring that part of curve
--Bond purchase program reduced longer-term govt bond yields by around 30bps
--Not targeting any particular level of bond yields nor exchange rate
--Rise in yield due to improving econ conditions is desirable outcome
--Bond-buying not intended to hold whole yield curve down to any particular level
--Australia bond market not pricing any material risk of inflation breakout
--RBA QE Started Later But Is Now On Faster Upward Trajectory Vs Other Central Banks
--Alert to QE’s Impact On Mkt Functioning, Don’t Want To See Yld Up Due To Illiquidity
--RBA’s State-Based Forward Guidance Emphasizes On Outcomes Rather Than Forecasts
--Significant Monetary Support Will Be Required For Quite Some Time To Come
--Wages Growth Noticeably Weaker Despite Better Employment Outcomes

(Sydney, May 6, 2021) – The state of the Australian economy, not the calendar, is the key determinant of policy settings, Reserve Bank Deputy Governor Guy Debelle said in a speech Thursday.

Debelle went a step further to characterize the guidance as outcome-based but didn’t use the specific term. Instead, he said that in October the RBA changed its forward guidance to focus on actual outcomes for inflation, rather than expected outcomes.

The speech is titled, “Monetary Policy During Covid,” and provides a detailed account of monetary policy actions taken since the Covid-19 pandemic began, and a guide on the steps ahead.

Debelle said the RBA’s forward guidance takes the form of describing the economic conditions that it would be looking to see before it would consider raising the cash rate.

“That is, the guidance is based on the state of the economy, in technical terms, the guidance is state-based.” Debelle said.

The forward guidance is complemented by the 3-year government bond yield target, but it is the state of the economy that is the key determinant of policy settings, not the calendar, Debelle said.

This is the first time the RBA has provided clarity on its forward guidance. CB-Intel wrote earlier this week that it was time to do so given many focus on the calendar part of the guidance on account of the three-year yield target.

In the speech, Debelle talked in detail about the RBA’s Term Funding Facility, cash rate cut and reduction in rate on exchange settlement balances, three-year yield target, and Bond Purchase Program, apart from forward guidance.

Debelle also gave an idea on the sequence of how these policies will be unwound in the years to come. The TFF will end at the end of June and in July the RBA will make announcements on the three-year yield target and third round of bond purchases.

“These decisions will take account of state of the economy and the state of financial conditions, including whether financial conditions are appropriate for the state of the economy. The assessment will also take into account the state of the world economy and the policy settings of other central banks, as is always the case,” Debelle said.

 Beyond that, at some point in the future, the RBA will consider an increase in the cash rate target and the interest rate on exchange settlement balances.

Debelle reminded that the board does not expect the conditions that will lead to a hike in the cash rate to be met until 2024 at the earliest.

Talking about the economy, Debelle said the outcomes in the Australian economy have significantly exceeded even the optimistic expectations in terms of economic activity.

But this is not the case on the nominal side of the economy in terms of wages and inflation.

“While the Australian economy has experienced better employment outcomes than most other countries, wages growth in Australia has been noticeably weaker than in many comparable economies, most notably the United States,” Debelle said.

On the three-year yield target, Debelle talked about the rise in the swap rate in the past couple of months and said it will put some upward pressure on longer-term household and business borrowing rates. But he also added that the effect is unlikely to be that large.

On the Bond Purchase Program, Debelle said the aim is to put is to put downward pressure on bond yields and the exchange rate to provide stimulus to the Australian economy.

The program has continued to keep longer-term yields in Australia about 30 basis points lower than they otherwise would have been, and the exchange rate lower than otherwise.

The RBA does not target any particular level of bond yields, other than the 3-year target, nor the exchange rate.

Debelle noted that yields rose overseas and in Australia earlier this year to reflect the better outcomes in the global economy and locally, and a rise in market’s expectations for future inflation.

A rise in yields due to improving economic conditions is a desirable outcome and one that RBA and other central banks would not seek to resist.

In Australia estimates of inflation in the bond market have inflation just reaching 2 per cent in a few years’ time.

“That is only just reaching the bottom of the RBA’s inflation target range. The bond market is not pricing any material risk of an inflation breakout,” Debelle said.

--Contact: Sophia@centralbankintel.com