While the RBA has already cut rates to a record low of 0.50 per cent on Tuesday and UBS expects “moderate fiscal stimulus” inside of the next week, it likely won’t be enough to stop the RBA from cutting again in April as the economic fallout of the coronavirus outbreak continues to grow.
That will bring the bank – and the economy – one step closer to quantitative easing (QE), which the RBA has indicated it would consider if interest rates reached 0.25 per cent.
“The RBA didn’t explicitly cite QE was imminent – and they even removed their previous “forward guidance” (“it is reasonable to expect that an extended period of low interest rates”) – albeit added they “will ensure that the Australian financial system has sufficient liquidity”,” UBS wrote in a note.
“This, along with a stronger easing bias, and a likelihood of reaching their “effective lower bound” of 0.25 per cent at their next meeting, [raise] the probability of QE ahead (i.e. government bond buying). If the coronavirus is unresolved over coming months, then QE would become a base case.”
And while UBS stresses that a cut to 0.25 bp would not herald an immediate start to a potential QE program, the RBA might pursue both options simultaneously if conditions are “stressed”.
“We think the RBA will tread carefully with QE, due to the uncertain impact on the liquidity of ACGB and semi-government bond markets,” UBS wrote.
“With this in mind, we expect an initial package would be approximately 50 billion.”
UBS expects that the RBA would focus on secondary market buybacks of ACGBs and semi-government bonds (issued by the states and territories) if it were to pursue a QE program. That matches with a speech governor Philip Lowe gave late last year.
“If – and it is important to emphasise the word if – the Reserve Bank were to undertake a program of quantitative easing, we would purchase government bonds, and we would do so in the secondary market,” governor Lowe told the Australian Business Economists dinner in November.
“An important advantage in buying government bonds over other assets is that the risk-free interest rate affects all asset prices and interest rates in the economy. So it gets into all the corners of the financial system, unlike interventions in just one specific private asset market.”
Once considered an outside possibility, interest in QE spiked through 2019 as questions arose about where the RBA could go in the event that its successive rate cuts failed to stimulate the economy.
