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Reserve Bank paves the way for interest rate hikes as early as 2022

November 3, 2021

Reserve Bank paves the way for interest rate hikes as early as 2022

Australia’s central bank held rates flat at yesterday’s meeting, but changes to a lesser-known program mean interest rates could start climbing next year.

Australia’s central bank held rates flat at yesterday’s meeting, but changes to a lesser-known program mean interest rates could start climbing next year.

The Reserve Bank of Australia held the national cash rate at its historically low rate of 0.1% at Tuesday’s monetary policy meeting, with RBA Governor Philip Lowe noting Australia’s economy is “well-placed to continue its expansion”.

Mr Lowe said labour markets are proving resilient and although inflation is slightly higher than it has been in recent years, the country is not wrestling with the kinds of surges seen in other countries.

“This increase largely reflects higher oil prices in global markets, higher prices for residential construction and strained global supply chains,” he said.

“Looking forward, we are expecting a further, but gradual, increase in underlying inflation. Our central forecast is for underlying inflation of 2.25% in 2022 and 2.5% in 2023.”

Against this backdrop, the RBA decided to keep the cash rate steady and continue with its current government bond buying scheme until at least the middle of February.

Under this scheme, the RBA purchases $4 billion of government debt each month. 

The RBA did, however, make some changes – specifically, it called off the yield curve control program it first introduced last year in a bid to keep interest rates lower for longer.

This program was intended to keep interest rates close to 0.1% until April 2024. 

Without this program, many experts expect interest rates will start climbing as soon as next year, with AMP Capital chief economist warning next November could mark the start of the increases

What is yield curve control, anyway?

Yield curve control is also sometimes called an ‘interest rate cap’ and is effectively a process central banks can use to take control of longer-term interest rates.

Traditionally, central banks influence monetary policy by targeting shorter-term interest rates like the bank overnight rate used by financial institutions to lend money to each other in overnight markets.

When central banks like the RBA push these short-term rates down, banks lower the interest rates they offer to borrowers in turn – making it easier to borrow money and helping to stimulate the economy.

In rare cases this is not enough and central banks instead try to target longer-term interest rates in the hopes that keeping rates lower for longer will give the economy the shot in the arm it needs. 

Yield curve control differs from quantitative easing (another type of central bank debt-buying process) because it targets prices, rather than volume

In other words, a central bank with a yield curve control program will buy as many of its target bonds as necessary to push prices to a predetermined level, while a quantitative easing program will simply buy a predetermined amount of bonds.,

Both programs typically force borrowing rates down.

The RBA first implemented its yield curve control policy back in March 2020, trying originally to keep three-year bond yields at 0.25%.

More recently the RBA had been targeting a rate of 0.1% – in line with the official cash rate – with plans to hold yields at that level until 2024.

The past week saw this plan begin to fall apart, as traders continuously pushed the yields on bonds due to expire in April 2024 up above the target

By October 29 this year, yields on those bonds were five times higher than the RBA wanted, but rather than stepping in to buy more (therefore pushing the price of the bonds up, and their yields down) the RBA did not place any bids for the assets.

JPMorgan rate strategist Ben Jarman last week cautioned that the RBA looked about ready to ditch the program.

“If so, this is a startling about-face,” he told Reuters. “Dropping yield curve control is a strong signal, so we bring forward our expectation for the first hike from late 2023 to the fourth quarter of 2022.”

 

Sources:


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