Tuesday 01 October 2019 by Andrew Mayes Opinion

Australian QE – Pushing Against The Same Monetary Policy String

As the Reserve Bank of Australia gradually pushes its policy rate towards 0%, the debate is growing if it will move to unconventional monetary policies rather than following the lead of the European Central Bank with negative interest rates.

The below is the executive summary from our recent article on the potential implementation of unconventional monetary policies in Australia as the Reserve Bank of Australia’s key rate keeps trending towards 0%. To read the full article, please click here.

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With interest rates priced to fall lower in the near term, an increasing dialogue is taking place about the effectiveness of a further lowering in interest rates and whether other, so-called unconventional monetary policy measures, should be considered.

Some market participants contend the efficacy of easing monetary policy is being stymied by the unwillingness of commercial banks to pass on in full recent changes to the official cash rate. This is only likely to intensify as the official cash rate moves lower. We would suggest the supply of money is not the problem, but rather the demand is, with both households and businesses reluctant to respond more positively to falling rates.

We believe monetary policy alone is unlikely to be sufficient to achieve the Reserve Bank of Australia (RBA’s) mandate. Even the central bank Governor is not convinced, recently stating “monetary policy cannot deliver medium-term growth…we risk just pushing up asset prices.”

With the government appearing reluctant to embrace further fiscal measures in the near term--instead seemingly hoping tax cuts and higher asset prices will stimulate demand--we believe the probability of the RBA employing unconventional monetary policy measures, such as quantitative easing in some form, is increasingly likely in the short-term (within the next one-two years).

The pursuit of quantitative easing effectively pushes against the same monetary policy string the RBA has been supporting for a number of years. In our view, it will ultimately be wealth and asset prices that emerge as the main beneficiary of quantitative easing, with higher risk asset prices feeding into increased spending. However, this effect is also premised on those with risk assets--generally the well-off--spending their new-found wealth.

Although the RBA believes it is unlikely it will need to employ unconventional monetary policy measures, it has indicated a preference for reducing the cash rate to a very low level and possibly further outside of the curve. For bondholders, rates should drift lower across the curve, although depending on the degree of ‘signalling’ from the central bank, much of the movement may already be priced in.

The effectiveness of quantitative easing in lifting growth and inflation expectations will take some time to materialise. We currently prefer fixed-rate bonds (more so at the shorter-end of the curve), although we continue to encourage a diversified portfolio given the unprecedented (and unpredictable) nature of monetary policy in Australia (and the rest of the world).

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