The Reserve Bank of Australia Board meets today where it will recalibrate the settings for its 3-year yield target policy and bond purchase program. At 2:30PM, the decision statement from Governor Phillip Lowe will confirm the changes, with a special press conference at 4:00PM to provide further insights (times are AEST). The target for the benchmark interest rate will remain at 0.1%, while the access window for drawdowns under the RBA's Term Funding Facility has now closed after it expired at the end of June.
Since the previous meeting, the main theme in the RBA's communications has been the transition underway as the economy progresses from recovery to expansion. Given the latest setbacks from the pandemic, prompting a return to lockdowns and tighter restrictions in several major cities, as well as slow progress in vaccinations, the renewed uncertainty places added emphasis on how today's changes are communicated, though it appears unlikely to be enough to delay a slight reduction in policy accommodation. The recovery to date has exceeded the RBA's expectations and the Board now sees an unemployment rate back to where it was prior to COVID at 5.1%, while employment and economic output have rebounded to pre-pandemic levels.
The RBA's forward guidance on rates has been that the conditions that would justify hikes are unlikely "until 2024 at the earliest". Reinforcing this has been the 3-year yield target, which is currently aimed at holding yields on April 2024 AGS at around 0.1%. Today's meeting will give a decision on whether the target remains at the April 2024 bond or is extended to the next maturity, being the November 2024 line. Market consensus is for no extension and it appears likely the RBA will meet this expectation. As has become clear in recent communications from the Bank (June minutes and Governor Lowe speech on June 17), key to the decision is an assessment of the prospects for the economic conditions to be sufficient to justify a rise in the cash rate at some stage over the next 3 years. With this clarification and given the strength of the recovery, it is likely that the Board will assess that they have sufficient confidence that inflation will be within the 2-3% target and the labour market at full employment with higher levels of wages growth (around 3%) by 2024. The 3-year AGS yield has recently been trading above the 0.1% target, with the catalyst being the hawkish interpretation markets took from the latest US Federal Reserve meeting, as front-end rates repriced higher in anticipation of an earlier start to its hiking cycle. It would not surprise if the RBA uses this juncture to at least signal to the markets that it is prepared to restart its 3-year purchases to keep yields closer to the 0.1% target. With the yield target still in place, this suggests no change to the RBA's forward guidance on rates.
With regards to the bond purchase program, the RBA is currently adding to its balance sheet $5bn of Commonwealth and state and territory government bonds (with maturities of between 5 and 10 years) per week in an "80/20" split. Purchases commenced after the November 2020 Board meeting when an initial $100bn tranche was announced over a 6-month period. A second $100bn tranche was then announced at the Board's meeting in February, and with these purchases starting in April they are on track to be completed by early September. Today's decision will inform us of the parameters purchases will take after this. Options the Board has under consideration include maintaining the status quo ($100bn over 6 months), a tapered approach where either the size of purchases is reduced or the timeline for those purchases is lengthened (resulting in a lower weekly pace of purchase), or shifting to a flexible structure where the pace of purchases is reviewed more frequently and can be adjusted to changes in the underlying economic conditions. My expectation is for a shift to the flexible option, with a plan for open-ended purchases to be announced, starting at the current pace of $5bn per week (in the "80/20" split). Reviews regarding the pace of purchases can be conducted to coincide with the release of the Bank's quarterly Statement on Monetary Policy, where the Board can use updated economic forecasts to help explain changes.
The tapered approach seems less likely in the circumstances. Signaling tapering stikes as too hawkish a response coming on the back of the expiry of the Term Funding Facility, as well as the expected non-extension to the 3-year yield target. With the Federal Reserve yet to outline its plans for tapering, such a move by the RBA risks tightening financial conditions through a higher exchange rate and higher bond yields. The recent setbacks with the virus domestically and also employment and inflation still short of the RBA's goals also argue against any tapering signal at this point.
