Reserve Bank of Australia Abandons Key Stimulus Tool
Central bank says it will end use of yield caps that keep interest rates low
SYDNEY—The Reserve Bank of Australia said it would stop using yield caps and abandoned a view that its benchmark interest rate won’t rise until 2024, joining other central banks that are tightening policy as inflation risks mount.
The RBA’s policy decision follows a hawkish shift by the Bank of Canada, which last week ended its government-bond-purchase program and moved up the time frame for when it might first raise its benchmark interest rate from its current near-zero level. The Federal Reserve is this week likely to begin winding down its $120-billion-a-month asset-buying program with an eye toward ending those purchases by next June.
Central banks around the world have grown concerned about stubbornly high inflation, but a move to tighten policy carries significant risks as it intersects with data pointing to slowing growth in some major economies, including China. Some governments that also unleashed stimulus spending early in the pandemic to support their economies are now seeking to dial back those programs to keep debt in check, presenting another headwind to global growth.
On Tuesday, the RBA kept its interest rate unchanged at a record-low 0.10%, where it has stood since late-2020. The bank said a key condition for rates to rise—a labor market that’s tight enough to spur significantly faster wages growth—wasn’t likely to be met for some time. Gov. Philip Lowe said an interest-rate increase in 2023 was now plausible, but stressed that the central bank was prepared to be patient, in part because of uncertainty over whether current supply-chain disruptions will persist.
Still, Mr. Lowe said the central bank would stop targeting a three-year government bond yield of 0.1%, a tactic that it had used to soften the Covid-19 pandemic’s impact on the economy. Yield caps are a monetary policy tool in which a central bank buys enough government securities to prevent their yields from rising above a certain level or to pin yields at specific levels.
“Given that other market interest rates have moved in response to the increased likelihood of higher inflation and lower unemployment, the effectiveness of the yield target in holding down the general structure of interest rates in Australia has diminished,” Mr. Lowe said.
Maxime Darmet, an economist at Fitch Ratings, said ditching the yield-curve target marked the RBA’s first step toward normalizing policy.
Other stimulus tools remained in use. The RBA said it would continue to buy government bonds weekly at the rate of 4 billion Australian dollars, equivalent to around $3 billion, until at least mid-February. Some analysts expect the RBA to then scale back bond purchases before ending the program later next year.
Economists had widely predicted that the RBA would adopt a more hawkish policy approach after the central bank surprisingly opted against defending the 0.1% target on the April 2024 government bond last week. Still, the RBA risks making its response to future crises less effective by pulling its commitments at such short notice, said Ben Jarman, an economist at J.P.Morgan Securities Australia Ltd.
Mr. Lowe identified last week’s data showing higher-than-anticipated third-quarter core inflation as key to the policy shift, as well as Australia’s economic recovery.
Core inflation of 0.7% for the three months through September comfortably exceeded the 0.5% implied by the RBA’s forecasts and lifted the annual trimmed mean rate to 2.1%—back inside the RBA’s 2%-3% target band about a year earlier than expected.
Australia’s border closures to limit the spread of Covid-19 have contributed to a labor shortage in industries including mining, while stretched global supply chains have reduced the availability of products including chips and timber. Rising house prices have also contributed to higher rents in many cities.
Yields were already being moved by global central banks signaling they could taper quantitative easing earlier than previously expected, rising inflation, and rate increases in countries including New Zealand.
The implied yield on three-year Australian government bond futures due for expiry in December 2021 rose from 0.332% in mid-September to 1.185% ahead of the RBA’s November meeting. The local equities market has stalled since hitting a record in August.
“While inflation has picked up, it remains low in underlying terms,” Mr. Lowe said. “Inflation pressures are also less than they are in many other countries, not least because of the only modest wages growth in Australia.”
Australia’s economy bounced back from last year’s short-lived recession—its first in 30 years and initiated by the shock of the Covid-19 pandemic—but has been battered hard by outbreaks of the virus’s Delta strain since June.
With lockdowns in Sydney and Melbourne ending in recent weeks, some economists anticipate a recovery as pent-up demand is unleashed. Restaurants have reopened for indoor dining and Australia on Monday allowed more international travel to restart. More than 80% of adults in the country’s relatively densely populated southeastern states have received two doses of Covid-19 vaccine.
However, external headwinds could drag on the recovery. China’s slowing economic growth has led to steep falls in the price of iron ore, Australia’s No. 1 export. China accounts for more than 40% of Australian exports.