RBA To Consider Shorter-End Bond Buys If Need For Unconventional MonPol Arises
- Published on
- 21 Sep 2022, 08:23 AM
By Sophia Rodrigues
(Sydney, September 21, 2022)— If the Reserve Bank of Australia were to use unconventional monetary policy again in future, it would consider purchases at the shorter end of the yield curve rather than reintroducing a yield target and the format of bond purchases done under the bond purchase program.
A review of the RBA’s BPP, published Wednesday, said that compared with the BPP adopted in November 2020, short-end purchases would contribute more directly to lower household and business borrowing costs because these tend to “price” off the shorter end of the yield curve.
Such a BPP may also have a greater effect on the exchange rate and entail less financial risk compared with purchases of longer-term bond, the review said.
However, the review noted that because there is typically less new issuance by the government at shorter maturities, the amount of these bonds that could be purchased before market functioning issues arose might be more constrained. Also, the extent of stimulus able to be provided through the portfolio balance channel of such purchases may be limited.
The review presented four scenarios of the direct effect on the RBA’s earnings with different paths of policy rates. The Exchange Settlement balances rate was projected to evolve in line with future path of the cash rate out to mid-2023 and converge to 1.5%, 2.5%, 3.5% or 4.5% by 2033.
Based on this, the cumulative financial cost of the program to the RBA over the period to 2033 is estimated to be $35 billion, $42 billion, $50 billion and $58 billion under the scenarios from lowest to highest ES rate path. Under most scenarios, the RBA will not be in a position to pay dividends to the government for a number of years.
According to the review, the design and implementation of the BPP worked broadly as intended, without materially affecting market functioning. At the same time, it noted that the decision to end BPP in February 2002 took into account the fact that there had already been a deterioration in measures of market functioning in late 2021 and continued bond purchases would eventually create additional “strains” in the bond market.
The BPP led to a 30bps decline in long-term bond yield and around 1.5% depreciation in the exchange rate, which resulted in stronger economic activity and inflation than otherwise.
The review said that after the first three years, model estimates suggest there would be an extra A$25 billion of nominal GDP in cumulative terms.
“Because the effect of the BPP will persist for some time -- in line with the gradual reduction in bonds outstanding as they gradually mature -- the positive economic effect will also persist.” Even this understates the effect of the BPP given the limitations of the model.
DECIDED AGAINST INDEMNITY ARRANGEMENT
The RBA had considered whether to seek a government indemnity for the BPP but decided it was not necessary.
The RBA board was of the view that an indemnity arrangement would simply result in a transfer of BPP impact from its balance sheet to the government’s balance sheet. The board also considered the risk that an indemnity could reduce its policy effectiveness if it weakened perceptions of the RBA’s independence.
The decision also reflected the fact that a large loss that resulted in a negative equity position would not affect the ability of the RBA to do its job. It noted that a number of central banks in other countries have operated for extended periods with negative equity and several other central banks are, or are likely to be, in a similar position over coming years.
Overall, the RBA’s view is that the BPP was successful in lowering government bond yields, which flowed through to lower funding costs across the economy and a lower exchange rate than otherwise. This contributed to the strong recovery in the Australian economy following the pandemic.