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RBA cuts cash rate and kick-starts quantitative easing

The Reserve Bank of Australia (RBA) has cut the official cash rate to an all-time low of just 0.25% – in turn, initiating unconventional monetary policy in Australia. What does this mean? Senior Investment Manager George Lin explores.

    Written by George Lin
Senior Investment Manager | Colonial First State
   

WHAT HAPPENED?

At an emergency board meeting on Thursday 19 March, the Reserve Bank of Australia (RBA) cut its official cash rate to a new low of just 0.25% – initiating unconventional monetary policy for the very first time in Australia following two decades of uninterrupted economic growth.

 

Following the meeting, the RBA announced that it would adopt the following measures:

  1. A reduction in the cash rate to 0.25%, which the RBA has stated it “will not increase” until “progress is being made towards full employment” and until the central bank “is confident that inflation will be sustainably within the 2–3% target band”.
  2. A bond yield target and the establishment of a target for the yield on 3-year Australian Government bonds of around 0.25%. This means the RBA will be prepared to purchase government bonds in a sufficient quantity – whatever the level may be –in the secondary market to drive the yield on these bonds to around 0.25%. The RBA has said that “purchases of government bonds and semi-government securities across the yield curve will be conducted to help achieve this target” as well as “address market dislocations” commencing today (Friday 20 March).
  3. The establishment of a term funding facility for the banking system, “with particular support for credit to small and medium-sized businesses”. The RBA will provide a three-year funding facility worth $90 billion to authorised deposit-taking institutions (ADIs) at a fixed rate of 0.25%. However, ADIs will also be able to obtain initial funding of up to 3% of their existing outstanding credit and will also have access to additional funding if they increase lending to businesses – especially small and medium-sized businesses.
  4. Exchange settlement balances at the central bank will be remunerated at 10 basis points, rather than zero as would have been the case under the previous arrangements.

MARKET REACTIONS

  • The reduction of the target cash rate to the effective lower bound (ELB) and the commencement of quantitative easing came as no surprise to financial markets. The reference to full employment and inflation targets reinforces that the RBA will maintain a low cash rate for “a prolonged period of time”. In fact, RBA Governor Lowe said that the 3-year bond yield target would likely be removed before the cash rate is increased above 0.25%. The adoption of a 0.25% target for these bonds should “anchor” the short end of the yield curve. As expected, the 3-year bond yield plunged from 0.43% to 0.32% after the announcement. Perhaps the bigger question now is whether the long end of the yield curve will follow?
  • Following the central bank’s announcement, Prime Minister Scott Morrison announced that Australia would close its borders to all non-citizens and non-residents in an expanded Coronavirus travel ban. It is also believed that the Australian government is working on a second stimulus package that will be “significantly bigger” than the last – worth nearly $18 billion.
  • The ASX 200 closed the day’s trading at just 4,782 points – taking losses to roughly 14% for the week. The Australian Dollar traded as low as 0.55 US cents.
  • Elsewhere, US share markets edged slightly higher overnight, indicating some confidence from investors following economic and financial measures announced worldwide. At the close of trading, the S&P 500 was up 0.5%, the Nasdaq finished up 2.3%, while the Dow Jones ended the day up nearly 1%. However, while share markets made small gains, the yields on US 10-year Treasuries declined marginally to 1.16%.
  • Across Europe and the UK, share markets also rose – with the UK FTSE up 1.4%, the German Dax up 2% and the Stoxx Europe 600 index rising 2.9%.

INITIAL OBSERVATIONS

  • The establishment of a term funding facility is more of a surprise to markets, and has been modelled after a similar measure used by the Bank of England following the Global Financial Crisis. Lenders will be able to draw on the initial facility until September 2020, and it is intended to encourage lenders to increase financial support to businesses, especially small and medium-sized businesses.
  • Overall, the RBA’s initiatives are as aggressive as one can reasonably expect. It should help in alleviating the cash flow problems faced by many businesses over the next few months due largely to the economic flow-on effects of the Coronavirus.

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Unless otherwise specified, this document has been prepared by Colonial First State Investments Limited ABN 98 002 348 352, AFS Licence 232468 (Colonial First State) based on its understanding of current regulatory requirements and laws as at the date of publication. While all care has been taken in the preparation of this document (using sources believed to be reliable and accurate), to the maximum extent permitted by law, no person including Colonial First State or any member of the Commonwealth Bank group of companies, accepts responsibility for any loss suffered by any person arising from reliance on this information. Colonial First State is the issuer of interests in FirstChoice Personal Super, FirstChoice Wholesale Personal Super, FirstChoice Pension, FirstChoice Wholesale Pension, FirstChoice Employer Super offered from the Colonial First State FirstChoice Superannuation Trust ABN 26 458 298 557. It also issues interests in the Rollover & Superannuation Fund (ROSCO) and Personal Pension Plan (PPP) offered from the Colonial First State Rollover & Superannuation Fund ABN 88 854 638 840. Colonial First State also issues other investment products made available under FirstChoice Investments and FirstChoice Wholesale Investments, other than FirstRate Saver, FirstRate Term Deposits and FirstRate Investment Deposits which are products of the Commonwealth Bank of Australia ABN 48 123 123 124, AFS Licence 234945 (the Bank). Colonial First State is a wholly owned subsidiary of the Bank. The Bank and its subsidiaries do not guarantee the performance of FirstChoice products or the repayment of capital from any investments. This document provides information for the adviser only and is not to be handed on to any investor. It does not take into account any person’s individual objectives, financial situation or needs. You should read the relevant Product Disclosure Statement (PDS) before making any recommendations to a client. Clients should read the PDS before making an investment decision and consider talking to a financial adviser. PDSs can be obtained from colonialfirststate.com.au or by calling us on 13 18 36.

 

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