Australian central bank holds fire, braces for economic hit

Bloomberg

Australia’s central bank kept the interest rate and yield objective unchanged Tuesday, while broadening securities eligible for its daily liquidity operations to assist the functioning of capital markets and keep rates down across the economy.
Reserve Bank of Australia Governor Philip Lowe maintained both the cash rate and three-year bond yield target at 0.25%, as expected by economists and money markets. Since launching unconventional policy in March, the bank has purchased A$50.7 billion ($32.7 billion) of securities that has brought the short-end of the government yield curve down to target.
“The bank has scaled back the size and frequency of bond purchases,” Lowe said in today’s statement, after the RBA skipped a day of buying last week in its already reduced 3-day schedule. “The bank is prepared to scale-up these purchases again and will do whatever is necessary to ensure bond markets remain functional and to achieve the yield target.”
The Australian dollar edged slightly lower immediately following the central bank’s statement, before recovering ground to trade at 64.53 US cents at 4:52 pm in Sydney.
The RBA announced that it will broaden the range of eligible collateral in its daily open market operations to include Australian dollar securities issued by non-bank corporations with an investment-grade credit rating. This will help the smooth functioning of capital markets by making corporate credit more attractive.
Bank bonds have narrowed from peaks in early April, while corporate bond spreads remain elevated, data from ICE BofA indexes show. The new collateral measures should assist corporate spreads to converge as well.
The five biggest non-bank Australian-based members of the Ausbond Australia credit index are Ausnet Services Pty Ltd, Telstra Corp., Qantas Airways, plus property companies GTP Group and Dexus.
With Australia’s economy expected to contract about 10% this quarter, the RBA and government have assembled a massive fiscal-monetary support package to nurse households and firms through the crisis.
Australia, which has avoided a recession for almost 30 years and didn’t need to turn to QE during the 2008-09 crisis, now finds itself joining the US, New Zealand, UK and others in bond-buying operations.
The RBA has bought both federal and state government securities across a range of maturities and, as the targeted yield fallen, the bank has wound back purchases to three days a week.
The RBA reiterated the outlook scenarios that Lowe had previously discussed. The bank’s baseline is that output will slump 10% in the first half of 2020 and around 6% over the entire year.
A “bounce-back” of 6% next year is penciled in.

“A stronger economic recovery is possible if there is further substantial progress in containing the coronavirus in the near term and there is a faster return to normal economic activity,” Lowe said. “On the other hand, if the lifting of restrictions is delayed or the restrictions need to be reimposed or household and business confidence remains low, the outcomes would be even more challenging.”
On the labour market, the baseline has unemployment peaking around 10% “over coming months” and “still above 7% at the end of next year.”
Inflation is expected to turn “negative temporarily” in the current quarter due to falls in oil prices, the introduction of free child care and deferrals of a number of price increases, the RBA said. Further out, the baseline scenario is inflation of 1%-1.5% in 2021 and gradually picking up further from there.
The RBA releases its quarterly economic update with Friday’s statement on monetary policy that will flesh out the scenarios.
“The RBA’s baseline scenario for the economy mirrors our own forecasts. But for inflation targeting central banks, the risks in the recovery period are immense with the global economy likely to emerge on the other side of this pandemic with a significant overhang of excess capacity, battered balance sheets, and a dearth of demand. Most will be reliant on fiscal policy to bolster demand to the point that deflationary pressures — outside of food price spikes — can be gradually overcome,” said James McIntyre, a Bloomberg economist.
Australia’s authorities are moving to relax some restrictions as infection rates slow, assisting a rebound in the currency and share market. The national cabinet is meeting this week, with an announcement on a new baseline for restrictions due Friday.