RBA statement reveals a problem of communication rather than policy

The RBA Board has now confirmed what has been playing out in the bond market over the past week; that the RBA has stopped its yield curve control policy and will no longer intervene in the short term bond market in an attempt to keep interest rates on hold until 2024. Inevitably this means the cost of borrowing is now set to rise.

Since the last RBA meeting, yields on 2yr and 3yr Commonwealth Government bonds have risen from 0.05 percent to 0.69 percent and 0.27 percent to 1.17 percent respectively; shifts that suggest the market now believes either 3 or 4 cash rate increases of 25 basis points will occur between now and the end of 2024.

While the cash rate remained unchanged at 0.1 percent, and is still expected to be maintained at this level for the next six months – possibly the next 12 months – it will not stop the cost of borrowing from rising from now on, as retail banks lift lending rates in response to higher wholesale market lending costs.

The RBA’s problem has been one of communication rather than policy. It is true that the yield curve control policy was never meant to be a permanent action, and that at some point the RBA was going to pull back from targeting short term bond yields. With the economy strengthening each day, as COVID restrictions progressively lift across the country, it is probably the right time for the RBA to start backing out of this activity.

But only a month ago the RBA was continuing to message to the market that it was going to maintain its targeting of the 3 year bond yields.

While it has been important for the RBA to send a strong message to the financial markets and economy at large that interest rates would be low for a long time, it is now equally important that it sends a credible signal to the market that the time for this support is over. It is over because the Australian economy has roared back to life faster and stronger than anyone had predicted, so there is no longer a need for highly stimulatory monetary policy for an extended period.

The risk surrounding today’s announcement is if the RBA’s guidance is reversed relatively quickly in the coming few months.  Should this “whipsaw” outcome eventuate then the RBA’s credibility – already being questioned – could be eroded still further if the project economy recovery stalls, or even fails, and bond rates then need to retreat again.

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