Australia joins QE club as first recession in 29 years looms
Australia's central bank joined the international fold with the announcement it will enter the government bond market to lower yields, having exhausted its remaining conventional policy ammunition.
Reserve Bank Governor Philip Lowe's unconventional approach set out Thursday after an emergency meeting differs from his European and U.S. counterparts, who pledged to buy a certain amount of government securities to keep yields down. Instead, he'll aim to keep three-year government bond yield at 0.25%.
Lowe also cut the cash rate to 0.25%, a level he has nominated as the effective lower bound, noting it wasn't a coincidence that policy makers in the U.S., New Zealand and the U.K. all eased to the same level. Similarly, in line with other central banks, the RBA governor set out forward guidance by saying he expects to remain on hold for "some years."
Australia's economy is spiraling toward its first recession since 1991 and its credit markets are under stress from investors worldwide trying to head for the exits. In a speech after the policy announcement, Lowe didn't try to sugar coat the months ahead, saying "we are expecting a major hit to economic activity and incomes in Australia that will last for a number of months. We are also expecting significant job losses."
Qantas Airways on Thursday furloughed most of its 30,000-strong workforce and scrapped all international flights.
The RBA also announced a term funding facility of at least A$90 billion ($50 billion) for the banking system, with particular support for credit to small and medium-sized businesses.
In a complementary program, Australia's government will invest up to A$15 billion to allow smaller lenders to support consumers and smaller businesses during the coronavirus outbreak, according to a statement from the treasurer. Prime Minister Scott Morrison is also developing a follow-up spending package to expand on the A$17.6 billion program announced last week.
The combined fiscal-monetary salvo aims to keep firms open and workers in jobs.
Australia now finds itself in uncharted territory: The country was a poster-child for its response to the 2008-09 financial crisis and worldwide downturn. It deployed a combination of fiscal and monetary policy that allowed the economy to escape the recession that enveloped most of the developed world, without ever adopting unorthodox monetary policies.
Prime Minister Kevin Rudd's administration had been in office less than a year when credit markets seized up. The government put together two packages worth more than 4% of GDP and the central bank cut interest rates by 425 basis points. Andrew Charlton was Rudd's chief economic adviser at the time and ran point on the fiscal stimulus.
"The key feature of the Australian response to the global financial crisis was speed and size," said Charlton, now director of consultancy AlphaBeta in Sydney. "We wanted to use our fiscal firepower to keep the economy going, not to restart it after it had stalled."
It's a similar approach today.
In a speech explaining Thursday's moves, Lowe said the board expects "the cash rate will remain at its current level for some years, but not forever." Lowe said he expects that the yield target will be removed before the cash rate is increased, once the economy improves.
In a move to relieve the margin squeeze facing banks, the RBA said it'll pay lenders 10 basis points on funds deposited with it overnight, rather than the usual 25 basis point discount to the cash rate. It's trying to avoid the type of stress banks in Japan and Europe have faced in a low-rates world.
By targeting a flat yield curve over three years, the RBA is hoping to put more cash into the pockets of households that tend to have variable mortgage rates. It's also seeking to lower borrowing costs so businesses will be tempted to expand again once the worst of the virus shutdown passes.
By saying it'll also buy semi-government securities, the RBA aims to avoid a blow out in yields on state government debt relative to commonwealth bonds. It will make purchases "across the yield curve" to achieve its target and avoid dislocations.
The yield on Australian government three-year bonds tumbled after the policy statement and traded about 16 basis points lower at 0.34% as of 6:38 p.m. in Sydney. The Aussie dollar is trading higher from intra-day lows of 55.10 U.S. cents at 56.68 U.S. cents.
Lowe noted the Australian dollar had come down "a reasonable amount." "Liquidity is thin, but it hasn't been to a point where we needed to intervene, but we are prepared to if liquidity conditions deteriorate," he said in response to a question.
Australia's credit markets have been stressed and the RBA has been pumping liquidity into the financial system in recent days to help calm them.
Lowe said the timing and strength of the economy's recovery after the virus depends "in part upon how successful we are, as a nation, in building that bridge to the other side." Ever the optimist, he pointed out that Australia has "fantastic" fundamentals.
