The RBA’s 4 pandemic-response policies: Did they work?


Monetary Policy in this cycle

Since the start of COVID-19, the RBA has helped the economy in a number of ways. Initially they provided 'liquidity' to the banking system and financial markets (to make sure there was enough money splashing around to pay the bills). They also acted to reduce financial market volatility. Both policies were short-term in nature, designed to buffer the economy and financial markets from the initial pandemic shock.

To counter the subsequent economic downturn the RBA implemented four policies:

  1. In February, they reduced the cash rate to 0.25%, with a further reduction to 0.1% in October.

  2. Implemented 'Yield Curve Control' (YCC). Practically that meant keeping the 3-year federal government bond rate at around the same level as the cash rate. Three-years' was chosen as it is the length of period that the majority of (business) borrowing is done.

  3. Implemented Quantitative Easing (QE). This is where the RBA buys 5-10 year federal and state government debt with an aim to keep longer-term interest rates low.

  4. Instituted a Term Funding Facility (TFF), a term for allowing banks to borrow cheaper from the RBA than they could in the financial markets. The Facility was structured to encourage lending to SME's.

RBA's February 2021 Board meeting

Which brings us to the February 2021 Board meeting. The RBA announced that they would end the TFF at the end of June. This was always going to be the first of the policies that the RBA would end as they prefer not to provide direct financing to the private sector (apart from extreme events such as when financial markets are excessively volatile). The short-term impact of the announcement will be negligible (banks can still borrow cheaply until June and credit growth is currently only modest). But in time it does mean that banks will again need to borrow from financial markets. And this will put some upward pressure on interest rates.

The RBA also made a change to its YCC policy. Formerly it had said that it intended to keep the cash rate unchanged 'for at least three years'. At its February meeting that changed to a nominated time ('2024 at the earliest'). By making the change the RBA has provided a little more certainty as to how long interest rates may remain unchanged.

Thoughts turning to rate hikes are understandable given the greater confidence about the economic outlook. The timing of the RBA's first move will be down to how the economy performs. In particular, how long it will take for inflation to sustainably get above 2.25%, the unemployment rate below 5.5% and wages growth above 2.5%.

Foreign Exchange

The AUD has had a strong start to the year, up over 3% against the USD. But it is not the only currency to have made a fast start against the 'big dollar'. All the other major commodity currencies ($NZ, $Canada) are also up. As are many of the 'emerging market' currencies (notably the Turkish Lira).

There have been a number of factors that has kept the AUD strong. Investors have become increasingly confident about the economic outlook. Global central banks have made it clear that they intend to keep interest rates very low for some time yet. There is a (further) big fiscal stimulus on the way in the US. And there is plenty of government spending still on the drawing board in Europe. All of this has helped push most commodity prices (notably iron ore) up, a big plus for the AUD.

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