NAB Monetary Policy Update – January 2021

QE to continue, RBA to grapple with ending YCC.

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  • The RBA’s 6-month $100bn quantitative easing (QE) program will currently cease at the end of April. As such, the RBA will need to provide guidance early this year for its plans for QE, with an announcement likely in March.
  • NAB expects the RBA to extend QE, with Governor Lowe to signal this as early as February. While the outlook has improved, the pandemic has still been a large hit to the economy such that exceptionally easy policy is warranted. We think an extension in the ballpark of an additional $50bn over another 6 months is likely, broadly in line with our estimate that $143bn worth of purchases would be required to get the unemployment rate down to 5%.
  • A more significant issue is the yield curve control (YCC) program, where the RBA has tied its 3-year target explicitly to its expectation that the cash rate will not increase for “at least 3 years”. At some stage the RBA is likely to become unable to maintain this position as the recovery unfolds– we think the RBA will reach that point around mid-2021. Further, we note that at the current rate, under YCC the RBA will own nearly all April 2024 government bonds by mid 2021, which will interfere with the 3-year yield as a market benchmark.
  • As such, we expect the RBA will outline an exit strategy by mid 2021, while being mindful that ending YCC is likely to see yields rise across the curve as the market interprets the RBA’s shift as a signal for higher rates in the future. In our view, the RBA should name a bond line which YCC will not extend beyond, i.e. Apr 2024, and use its ongoing QE program to help smooth out any sharp rise in yields in response to its exit strategy.
  • To be clear we see the cash rate on hold until at least mid-2024, in line with RBA guidance. However, note the trajectory of our forecasts point to some risk of a gradual normalization of the cash rate beginning shortly after.
  • Finally, the RBA is likely to let the term funding facility (TFF) end at its scheduled date of June 2021. The program has provided significant liquidity to banks, supporting credit. Borrowing costs remain extraordinarily low, such that the RBA is unlikely to see an extension to the TFF as necessary.