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May 2020

Where to now for Australian

Monetary Policy?
It’s been just over a month since the Reserve Bank of Australia (RBA) enacted
drastic changes to its monetary policy framework and approach. In this note,
we review the changes that were made, and provide some insights into the
likely implications of the new policy framework.

What has happened to the cash rate? Chart 1: Short Term Benchmark Interest Rates in Australia
The RBA reduced its target for the cash rate by 25 basis
points on 19th March 2020. The new target cash rate is 0.25 2.50
per cent, and this is its terminal value. In making their final
conventional policy easing on 19 March, RBA Board members 2.00
were clear: "Members also agreed that the cash rate was
now at its effective lower bound. Members had no appetite
1.50
for negative interest rates in Australia."

If we are at the effective lower bound, why are bank 1.00

%

bills trading under the cash rate?

For over 20 years, the RBA's approach to monetary policy 0.50
implementation has been to use its domestic market
operations to ensure that the actual overnight interest rate 0.00
traded in the cash market was in line with the Board's Dec 18 Mar 19 Jun 19 Sep 19 Dec 19 Mar 20
guidance. However, one side-effect of its recent policy
Overnight Cash Rate 1 month bank bills
framework changes was a large increase in excess liquidity for
the banking system as a whole. This excess liquidity has 3 month bank bills 3 year government bond
placed downward pressure on short-term market-determined
interest rates, including the overnight cash rate, bank bill Source: UBS, Bloomberg Finance LP. Data as at 30 April 2020.
yields, and government bonds. The RBA no longer intervenes
to ensure that the actual overnight cash rate trades around its
target level. As we had expected, the actual overnight cash
rate and BBSW have both tended to gravitate towards 0.10
per cent, which is the deposit rate that the RBA now pays
banks on their excess cash.
What is yield curve control?
As part of the measures announced by the RBA Board on
19th March, it was confirmed that there would be a new
monetary policy target for the yield on three-year
Commonwealth Government bonds, of around 0.25 per cent.
This decision was made in order to anchor a second risk-free
interest rate on the Australian yield curve, in addition to the
overnight cash rate. Targeting both of these benchmark
funding rates is the Australian version of yield curve control.
The three-year tenor was chosen "given its importance as a
benchmark rate in financial markets and its role in funding
much of the Australian economy". It was also chosen for its
strong signaling effect: that the RBA Board would keep short-
term risk-free interest rates at very low levels for several years.
The RBA implements this new yield curve control policy by
purchasing government bonds in the secondary markets. The
objective of these bond purchases is to reinforce the policy
guidance around 0.25 per cent, and "to add to the
downward pressure on funding costs for financial institutions,
households and businesses".
Does this mean that the RBA will purchase only 3-year
government bonds?
No. The RBA Board has authorised the Bank to purchase
Commonwealth and State Government bonds across the
entire yield curve, if it so chooses. Purchases of three-year
maturity debt will be made to ensure that the yield curve
control target of 0.25 per cent is being enforced, but
additional purchases of different maturities will be made with
the broader objective of facilitating a smooth functioning
bond market.
What has the RBA purchased so far?
At the end of April 2020, the RBA had acquired around $44
billion of Commonwealth Government bonds, and over $10
billion of State Government bonds. These volumes represent
over 8 per cent of the nominal Commonwealth Government
bonds on issue, and 4 per cent of the domestic benchmark
semi-government lines.
Charts 3 and 4 place these bond purchases in context:

The new policy has been very successful, with the three-year
government bond yield trading consistently around 0.25 per
cent since yield curve control was implemented.

Chart 2: Yield Curve Control

0.60

0.50

0.40

0.30
%

0.20

0.10

0.00
27 Feb 20 13 Mar 20 28 Mar 20 12 Apr 20 27 Apr 20
3 year government bond RBA YCC target

Source: UBS, RBA, Bloomberg Finance LP. Data as at 30 April 2020.

2
Chart 3: RBA Purchases of Commonwealth Government Bonds

50,000 30%
45,000 27%
40,000 24%
35,000 21%
30,000 18%

Central Bank Ownership

Face Value ($ million)

25,000 15%
20,000 12%
15,000 9%
10,000 6%
5,000 3%
0 0%
5.75% 15 May 2021

2.25% 21 May 2028

2.50% 21 May 2030

1.25% 21 May 2032

2.75% 21 May 2041

5.50% 21 April 2023
2.75% 21 April 2024

3.25% 21 April 2025

4.25% 21 April 2026
4.75% 21 April 2027

3.25% 21 April 2029

4.50% 21 April 2033

3.75% 21 April 2037

Total Nominal ACGBs

1.75% 21 November 2020

5.75% 15 July 2022

2.25% 21 November 2022

0.25% 21 November 2024

2.75% 21 November 2027

2.75% 21 November 2028

2.75% 21 November 2029

3.00% 21 March 2047

1.50% 21 June 2031

2.75% 21 June 2035

3.25% 21 June 2039

2.00% 21 December 2021

Outstanding (LHS) Purchased by RBA (LHS) % held by RBA (RHS)

Source: UBS, RBA, AOFM, KangaNews. Data as at 30 April 2020.

Chart 4: RBA Purchases of Semi-Government Bonds

12,000 12%

10,000 10%

Central Bank Ownership

Face Value ($ million)

8,000 8%

6,000 6%

4,000 4%

2,000 2%

0 0%
2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035+ Total
Semis
Semis Purchased by RBA (LHS) % Held by RBA (RHS)

Source: UBS, RBA, KangaNews, Bloomberg Finance LP. Data as at 30 April 2020.

Is the RBA directly financing the Government? volumes. Competitive tenders have then ensued, with auction
No, the RBA has not purchased any bonds directly from either results released to the market immediately thereafter.
the Australian Office of Financial Management (AOFM) or the
various State Government borrowing authorities. Its The RBA Governor put it thus in a recent speech ("An
purchases of Commonwealth and State Government bonds Economic and Financial Update", 21st April 2020):
have been made through auctions held in the secondary
market, where the RBA has nominated the specific bonds that "While we are not directly financing the government, our
it wishes to purchase on any given day and the maximum bond purchases are affecting the market price that the

3
government pays to raise debt. Our policies are also affecting of repurchase agreements (repos). Under these repos, the
the price that the private sector pays to raise debt. In this way, RBA provides loans to banks and other eligible counterparties,
our actions are affecting funding costs right across the which are secured against collateral, such as government
economy as they should in the exceptional circumstances that bonds. These loans are the standard means by which the RBA
we face. But our actions should not be confused with the has provided liquidity to financial institutions and markets for
Reserve Bank financing the government". decades, and there was nothing unconventional in their
usage.
Is the RBA going to cancel the Government's debts?
No, the RBA has now become a strategic investor in The strains that were evident in Australian funding markets
Commonwealth and State Government bonds, and these late in Q1 can be gleaned from the magnitude of daily
investments represent major assets on its balance sheet. liquidity provision by the RBA before it commenced outright
Regular interest payments will be made to the RBA from the purchases of government bonds. Chart 5 illustrates the point
various Commonwealth and State Treasury departments, and by showing that the amount of repo funding being asked of
all governments remain liable to repay the RBA at full face the RBA during this period was much higher than the
value upon maturity. Government bonds are a core part of 'normal' liquidity operations that were needed to simply
the assets that the RBA uses to back its issuance of Australian sterilise net payment flows between the private sector and
currency, its key liability to the non-bank public. the government.

Didn't the RBA print billions of dollars before it began The RBA publishes the maturity schedule of its liquidity
buying government bonds? operations, with most of these repos due to be repaid within
In the lead-up to its extraordinary policy meeting on 19th the next six months. With outright bond purchases having
March 2020, the RBA had expanded its balance sheet provided over $55 billion of additional permanent liquidity to
through the provision of temporary liquidity under the guise the banking system in the past month, it is likely that there
will be less call on RBA repos going forward.

Chart 5: RBA Liquidity Operations in 2020

14,000 140,000
RBA cuts cash rate to
0.25%, adopts yield curve
12,000 120,000
control, agrees to start
buying government bonds
10,000 100,000
Daily RBA Operations ($ million)

RBA Repo Outstanding ($ million)

8,000 80,000

6,000 60,000

4,000 40,000

2,000 20,000

0 0
02 Jan 16 Jan 30 Jan 13 Feb 27 Feb 12 Mar 26 Mar 09 Apr 23 Apr

Daily RBA Liquidity Injections (LHS) Initial RBA Dealing Intentions (LHS) RBA Repo Outstanding (RHS)

Source: UBS, RBA. Data as at 30 April 2020.

4
Will Australia have a "Taper Tantrum"?
RBA purchases in the early days of the new framework were
deliberately aggressive, with the Bank buying $4-5 billion of
government bonds per day. Since that time, average daily
purchases have been wound back gradually, and the RBA
now schedules auctions on just three business days per week:
Mondays, Wednesdays and Thursdays. The bonds to be
purchased, and the volumes on offer, remain entirely at the
discretion of the RBA. While the flow of bond purchases has
slowed, the RBA's balance sheet continues to expand,
although at a slower pace than during late March.
With yield curve control now in place, the RBA's operations
must be directed at ensuring that the three-year government
bond yield remains around 0.25 per cent. This is their key
performance indicator, and the benchmark against which any
taper tantrum needs to be assessed. With unlimited power to
intervene here, it is highly unlikely that any taper tantrum can
occur successfully in the three-year sector. Chart3 illustrated
that the RBA has already acquired a large amount of bonds in
the three-year sector, and we expect that they will increase
their grip on the 2024 lines progressively, as these bonds roll
down the curve.
The RBA has a secondary objective from its asset purchases:
to ensure that the bond market remains functioning for key
borrowers, particularly for the Commonwealth and State
Governments. However, it is not targeting the price of any
maturity bucket (apart from the three-year sector), and there
is no policy to resist any steepening of the yield curve, just to
ensure that bond supply can be met with demand.
When will monetary policy normalise?
It is expected that the current monetary policy framework will
remain in place for the next three years, at least. The RBA
Board has made a commitment not to increase the cash rate
target until substantial progress is made towards full
employment, and also until it is confident that inflation will be
"sustainably within the 2-3 per cent target band". With the
economy still in the early stages of the shock provided by
COVID-19, fulfilment of these twin macroeconomic policy
objectives will be several years away. In any event, the RBA
Board has indicated that it would first remove its yield curve
control over the three-year government bond before raising
the target for the overnight cash rate.
What are the implications of this new policy framework?
In its 19th March 2020 media release, the RBA Board noted
that the focus of its new package "was on ensuring that
funding costs were low across the entire economy and that
credit remained available to businesses and households".
The key take-aways from the new monetary policy regime are
as follows:
 Short-term funding rates will be anchored near zero per
cent for several years.
 The Commonwealth Government can expect to pay
around 0.25 per cent for three-year funding while ever
the yield curve control target remains in place.
 State Governments can also expect to be supported
when issuing additional debt, indirectly, as the RBA will
retain its secondary market purchases of semi-
government bonds "for the foreseeable future".
 Banks will have easy access to cheap funding, from a
number of sources, including from the RBA. The ultra-
low cash rate target will anchor BBSW and other market
funding rates, including RBA repo rates. In addition,
banks will continue to accumulate excess deposits,
stemming from the RBA's ongoing bond purchase
programme. A third source of cheap funding will come
from the RBA's $90 billion Term Funding Facility (TFF),
which has been made available to support credit to
businesses, particularly small to medium-sized enterprises.
 The major banks have already been nominated as part of
"Team Australia". They are expected to play a critical role
in the economy's support through, and its recovery from,
the economic shock caused by COVID-19. They have
become arms of government policy, like never before.
 Additional bond supply, stemming from fiscal support
measures, will need to be met by the market, and this
could be a technical force for steeper yield curves. The
RBA will retain a role in ensuring that there is an orderly
and functioning bond market, but it is not there to
guarantee any particular level of funding rates, apart
from its twin targets at the overnight and three-year
tenors. Periodic interventions in the bond market may be
warranted if liquidity deteriorates again, but the
application of yield curve control in Australia will be very
different to how it has been designed to operate in Japan.
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Licence No. 222605).

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