Analysis: Why the RBA is likely to stick to its taper decision in September

The hurdle for the Reserve Bank of Australia to backtrack on the bond-buying taper decision remains high and keeping it elevated would be the rapidly accelerating pace of vaccinations, and easy financial conditions.

CB-Intel wrote on August 18 that at the September board meeting it is likely the RBA would stick to its decision to taper bond purchases to a weekly pace of A$4 billion following the end of the current bond-buying program.

Any additional support from the RBA is more likely to come in the form of extension of the A$4 billion weekly bond-buying until at least February. Perhaps there was a hint of this in the minutes of the August board meeting when the RBA said, “the bond purchase program” will continue to be reviewed in light of economic conditions, and the health situation, and their implications for the expected program towards full employment and the inflation target.

ANNOUNCEMENT IN SEPTEMBER?

One option for the RBA could do is make this announcement at the upcoming September board meeting to put to rest continued speculation on what adjustment it would make to the bond purchase program in November.

In CB-Intel’s view, the biggest hurdle to reverse the tapering decision is that once the RBA continues with the A$5 billion pace in September, it would be difficult to taper in November and the earliest opportunity to taper after that would be February.

CB-Intel’s view has always been that the risk to maintain elevated level of weekly bond-buying is that it would be difficult to cut the pace abruptly, should signs of market dysfunction emerge. Adding to the risk is the government bond issuance is still less than A$2.0 billion a week.

Australia is the only market where the pace of central bank bond-buying is significantly higher than the rate of new government bond issuance.

A better option is to buy at a slightly lower weekly pace and retain the option to continue it for longer, or scale back if needed.

ALL ABOUT VACCINATION

Another view is that the RBA had always been a reluctant entrant to Quantitative Easing, and the only reason it decided to do bond-buying was because other central banks were doing it. This also means the RBA’s preferred option would be to end the program when major central banks – mainly the Federal Reserve – end their programs. Staying on that path is important given expectations the Fed would taper its QE early next year, or even before the end of this year.

All this doesn’t mean the RBA would be ignoring news of rising Covid-19 cases in Sydney and Melbourne, and the extended lockdowns. But it is likely its focus is on the pace of vaccination, and this is providing confidence that there would be quick bounce-back in economic activity once the lockdowns ease.

It is worth noting that in the August Statement on Monetary Policy, the RBA’s upside scenario was based on support from a sharp acceleration in the vaccination program.

While the upside scenario is unlikely to come to pass because an important element – spread of virus being brought under control – will not be met, the higher-than-expected pace of vaccination means there is less worry about the downside scenario.

Also interesting was the emphasis on vaccination in the SOMP, including this statement:

“In a number of large economies, the very substantial fiscal and monetary policy response, together with vaccinations and the associated relaxation of containment measures, enabled a rapid recovery with less economic scarring than previously feared.”

LOWER YIELDS, LOWER AUD

The RBA’s decision to stick to taper would also be helped by fall in bond yields, and lower exchange rate.

For example, on Monday the RBA bought A$983 million of April 2026 government bond at a weighted average yield of 0.4453%. This was the lowest since early February, and importantly, lower than 0.5690% yield on August 9 when it bought A$1.5 billion of the bond.

In case of June 2031 bond, the RBA bought A$605 million at 1.1525% and while this was higher than 1.1150% on August 5, it was still lower than mid-February.

The Australian dollar is currently around $0.725 and is slightly lower than the level in early August. In trade-weighted terms, the exchange rate is around 60.7, compared with around 61.7 in early August.

--Contact: Sophia@centralbankintel.com