By Sophia Rodrigues*
The Reserve Bank of Australia introduced a 0.25% target for Australian government bonds in March and everyone called it Yield Curve Control.
Everyone, except the RBA.
Many also called the RBA’s bond-buying to achieve the three-year yield target and correct dislocation in the market as Quantitative Easing. But not the RBA.
All that is likely to change in November when the RBA is likely to announce QE and YCC.
What is interesting is that the YCC will likely be in addition to the three-year yield target, making the RBA the only central bank to have both a yield target and the YCC.
FORWARD GUIDANCE TOOL
The RBA has always regarded the three-year yield target as part of its forward guidance tool.
At the time it was introduced, the RBA debated yield target versus QE but settled for the yield target because it was not prepared for the challenges in calibrating the required size of bond purchasing program. The yield target was also a more direct way of achieving its main objective of low funding costs.
The yield target also offered the added advantage of reinforcing the forward guidance with respect to the cash rate.
The RBA has achieved reasonable success with the three-year yield target, buying a total of A$63 billion of government bonds and semis since March, though some of the purchases were done solely with the aim of correcting market dislocations.
Now the RBA is preparing to ease monetary policy further and at its November 3 board meeting, it will cut the cash rate target and the interest rate on Term Funding to 0.1% from 0.25%.
The RBA is also likely to lower the three-year yield target to 0.1%, and to reduce the interest rate on Exchange Settlement balances.
In addition to this, the RBA is likely to announce QE and YCC.
This would be similar to the Bank of Japan’s monetary easing program, though BOJ also has a “qualitative” aspect to its easing framework.
But unlike the BOJ which targets the 10-year bond, the RBA is likely to target the five-year government bond for the purpose of YCC. This would be accompanied by a QE program where the RBA would undertake regular purchases of bonds.
The RBA could do this by announcing a program of say A$100 billion with buying at regular intervals.
SIMILAR BUT DIFFERENT
While the three-year target and the five-year target might look similar, they are meant for different purpose.
The three-year target is closely aligned with the cash rate target and while it could go down with a decline in the cash rate target, the RBA will only increase it when it is confident the cash rate target
is headed higher. In other words, the yield target will rise before the cash rate target and would serve as an important signaling tool then.
The five-year target, on the other hand, would be part of QE program and its aim is to control the yield curve or more specifically flatten the curve.
Importantly, there would be flexibility with the target. The RBA could lower the target without reducing cash rate target, or increase the target if it judges the yield curve needs to steepen a bit.
The main aim of the QE is to flatten the yield curve which the RBA would be hoping to achieve by targeting five-year yield and then buying bonds in the 5-10-year range.
The RBA’s expectation is that a flattening up to the 10-year part of the curve would lead to yields declining at the long end. So, while its buying would be in the 5-10 year range, the RBA is likely to monitor its impact on the entire yield curve.
*All views, opinions and insights are those of Sophia Rodrigues, an RBA watcher and reporter and 3rd party guest contributor to InTouch Capital Markets