RBA governor Philip Lowe has revealed that the central bank does not expect to increase the official cash rate for “at least three years”, or at least until there is a lower rate of unemployment and a return to a “tight” labour market.
Speaking after delivering the November cash rate decision, in which the board of the Reserve Bank of Australia (RBA) decided to reduce the cash rate to a new record low of 0.10 per cent, governor Lowe outlined the rationale for the move to cut the rate and move to a broader quantitative easing program.
The moves announced by the RBA on Tuesday (3 November) entailed:
- A reduction in the cash rate target, the three-year yield target and the interest rate on new drawings under the term funding facility to 10 basis points (down from 25 basis points);
- A reduction in the interest rate on Exchange Settlement balances to zero (down from 10 basis points); and
- The introduction of a program of government bond purchases, including the purchase of $100 billion of government bonds over the next six months (purchasing bonds issued by the Australian government as well as by the states and territories).
According to Mr Lowe, its actions “are lowering the cost of government finance” and “lowering the cost of finance for all other borrowers in Australia, whether they are a household buying a home or a business wanting to expand”.
“This lower cost of finance for everybody is supporting the recovery from the pandemic,” he said.
While revealing the thinking behind the move, Mr Lowe also outlined that he did not expect the cash rate to rise until 2023, at the earliest.
Noting the impact of the coronavirus pandemic on the Australian economy (which entered a recession for the first time in nearly 30 years earlier this year), Mr Lowe acknowledged that the recession had “not been as bad as was earlier expected or experienced in many other countries”. Indeed, he revealed that the central bank would be releasing a revised economic outlook on Friday (6 November), which will contain an upgrade to the near-term economic outlook.
However, he outlined that while the upgrade to the near-term outlook was “clearly welcome news”, he added that the pandemic had “inflicted significant damage on our economy” and that “it has become increasingly apparent that there will be long-lasting effects, including high unemployment”.
Mr Lowe said: “It will take time to repair that damage, and it is highly likely that the recovery will be uneven and drawn-out. In particular, we face the prospect of a long period of higher unemployment and underemployment than we have become used to.
“In the RBA’s central scenario, job creation is slow over coming months and the unemployment rate is still around 6 per cent at the end of 2022. One consequence of this is that wages growth and inflation are both likely to stay very low. In each of the next two years, we are expecting annual wages growth of less than 2 per cent. And inflation, in underlying terms, is expected to be just 1 per cent next year and 1.5 per cent in 2022.
“Given this outlook, the board judged that it is appropriate to take further steps... to support the economy. Unemployment is a major economic and social problem that damages the fabric of our society. So, it is important that it is addressed. The board recognises that, in the context of the pandemic, the responsibility for job creation falls mainly on the shoulders of business and government. But the Reserve Bank can, and will, make a contribution too.
“[This] policy package does that and it builds on the contributions from our policy measures earlier in the year,” he said.
‘Lowering the whole structure of interest rates in Australia’
“Together, these three elements represent a significant package. The lower interest rates and our plan to buy $100 billion of government bonds over the next six months will help people get jobs and support the recovery of the Australian economy,” Mr Lowe continued.
“The package combines the price-based target at the shorter part of the yield curve that has been in place since March with a quantity target at the longer part of the yield curve. In doing so, it will lower the whole structure of interest rates in Australia. This lower structure of interest rates will work to support the economy through the normal transmission mechanisms, including lower borrowing costs, a lower exchange rate than otherwise and higher asset prices.
“To be clear, the inflation target remains the cornerstone of Australia’s monetary framework. Even so, the priority over the next couple of years is jobs, with inflation risks remaining low. The RBA has a broad legislative mandate for price stability, full employment and the economic welfare of the Australian people. [This month’s] decision reflects that broad mandate.”
The RBA governor said the board expects that this new lower level of interest rates will be in place “for an extended period”.
He commented: “The board will not increase the cash rate until actual inflation is sustainably within the target range. It is not enough for inflation to be forecast to be in the target range.
“For inflation to be sustainably within the target range, wage growth will have to be materially higher than it is currently. This will require a lower rate of unemployment and a return to a tight labour market.”
He concluded: “On the current outlook, it will take some years to get there. Given this, the board is not expecting to increase the cash rate for at least three years.
“It remains the case that prior to any increase in the cash rate target, the board intends to remove the three-year yield target,” Mr Lowe said.
‘Little to be gained’ from negative interest rates
The RBA governor concluded: “In terms of interest rates, I think we have gone as far as it makes sense to do so in the current environment.
“There has been no change to the board’s view that there is little to be gained from lowering the policy rate into negative territory. While a negative rate might lead to a helpful depreciation of the Australian dollar, it could impair the supply of credit to the economy and lead some people to save more rather than spend more. Given this assessment, the board continues to view a negative policy rate in Australia as extraordinarily unlikely.
“But monetary policy is now about more than just short-term interest rates – we have returned to a world in which quantities matter too. In this world, it is certainly possible for us to increase the size of our bond purchases.”
Mr Lowe said: “Given this, we will continue to closely monitor the economic situation and the impact of our purchases on market functioning.
“If we need to do more, we can and we will.”
[Related: RBA makes Melbourne Cup rate move]