Ambitious Quantitative Easing and Persistent Low Interest Rates Characterise the RBAs COVID Recovery
In March 2020, Philip Lowe announced that the RBA would begin quantitative easing for the very first time in Australia. Quantitative easing is a form of monetary policy where the RBA purchases government bonds and other securities, in an attempt to inject money into the economy to boost the economy.
The expansion of the banks’ assets has almost doubled in the 12 months ending this February and, as of Philip Lowe’s last public statement, will continue with another $100 billion of spending at a rate of $5bn a week from mid-April.
Why does QE matter for investors?
Quantitative easing promotes investment and economic activity by pressuring down interest rates, having two pronounced effects on the market:
- It has an expansionary effect, pushing up stock prices.
- A pronounced depreciation of the Australian dollar, as investments are redirected overseas to higher-yield investments.
What is the outlook for QE in Australia right now?
On Tuesday 2nd of February, RBA Governor Philip Lowe surprisingly announced that the cash rate of 0.1% would likely remain until at least of 2024. This comes at a point where equity prices are at an 11-month high, and so seems to be unnecessarily dovish. Despite a strong impact on equity prices, it has been announced that liberal monetary policy continue until the RBAs other indicators of recovery (wages, payroll jobs and inflation) recovers to healthy levels. This monetary policy will have an impact on the following:
The unemployment rate has fallen by 1.1% since its peak in July (7.5%). However, QE is unlikely to be relaxed until the unemployment rate reaches pre-pandemic levels. Further, if the RBA believes that the nominal unemployment rate conceals job losses for many who have dropped out of the workforce altogether, a target of 5.5% may be more difficult to reach then anticipated.
Stagnating wage growth had been observed well before the pandemic, with sub-3% wage growth from 2012. This has been attributed to structural economic change in the forms of globalisation, technology, and the reduced productivity of labour with the rise of automation and replacement. Low interest rates are also aimed at encouraging private sector investment in capital to drive improvements in labour productivity and subsequent wage growth.
The RBA has an inflation target that is set at the 2-3% range. The inflation rate had been at healthy levels of 2.2% in January 2020 before hitting an all time low of -0.3% in July 2020. Currently sitting below 1%, the RBA is expected to maintain dovish monetary policy so long as the inflation rate does not improve. Although short term spikes into the target range is expected, the RBA has said that it wants to see inflation sustainably above 2% before increasing interest rate.
House prices have already surpassed pre-COVID-19 levels by 1%, and on Thursday the S&P/ASX200 closed at an 11-month high of 6,885.9 points. There is a significant body of analysts and fund managers that claim that we are heading fast into an asset and equities price bubble. Lowe has however claimed that he is unafraid that the rise in valuations is evidence of an impending bubble – which means dovish measures are likely to stay in place until September, if not for the entirety of 2021.
Exchange Rate Appreciation
An important consideration is the mechanism of international funds pouring into high-interest and high bond-yield countries and pushing the currency up. As some of the world’s most important economic regions (US, EU, etc) have announced extensive quantitative easing measures, the RBA is faced with the decision of holding ground or following suit.
If quantitative easing measures are undertaken overseas, the demand for overseas bonds increases and their yield decreases. The flow on effect is falling interest rates, which leads to an outpouring of funds as investors switch to higher yield investments. Therefore, domestic quantitative easing in Australia is also a measure to maintain a low value of the AUD, especially as the AUD will also likely increase as commodity demand increases as the global economy recovers.
This decision is central to Australia’s attempt to stimulate the economy, as a high AUD would cause export industries to suffer, further impeding the recovery of the economy. Therefore, Australia may not necessarily have truly “independent” monetary policy freedom, given it will be directly reactive to foreign countries’ policies in order to preserve export sector jobs.
Naturally, monetary and fiscal policy can act as complements and to a degree as substitutes. As it stands, the government is set to cut the coronavirus supplement to income support schemes on March 31st. If this is to go ahead, there may be a significant adverse impact in the economy provided that housing and rental prices have increased to pre-COVID levels, and the unemployment rate remains high at 6.4% (almost 1 million Australians).
The $100bn in spending announced may in fact be to directly counter the cuts to the COVID supplement payments. If predictions of a federal election in the second half of this year are to prove correct, then the Morrison government may find itself in a position where extending these payments will work in its favour. Further, this may nullify the need for the excessively dovish monetary policy announced on Tuesday.
Conclusion and Quantitative Easing Outlook
While the RBA notes that the Australian economic recovery is ahead of where it was expected to be, the RBA has remained dovish in its policy due to expectations. This is due to expectations that the Australian unemployment and inflation rates won’t recover until at least 2023, in their current best-case forecast. This will likely see its interest rates stay at their current lows of 10 basis points for many years.
Despite being expected to remain dovish when it comes to interest rates, the RBA is expected to, at the very least, reduce its current rate of QE, or potentially even end it once the current $100bn QE measures end in September. Ultimately though this decision will ultimately also depend on Australia’s economic results remaining in line with expectations and foreign QE decisions being accommodative, which could force the RBA to extend its current measures.