It’s been a long time since the Reserve Bank of Australia met to discuss offical interest rates and there was this much intrigue.
Why? Because on Friday it quietly stepped away from a promise it had made to millions of Australians.
When the pandemic hit, the RBA decided to not only fix overnight interest rates at record lows, but extend that mandate to interest rates with a three year maturity by buying up government bonds in a strategy known as yield curve control.
Essentially the policy – and the very public promise – was to keep official interest rates at record lows until 2024.
“For the past 18 months that policy had been working well,” said Dr Isaac Gross, an economics lecturer at Monash University who previously worked at the RBA. “The target was credible and relatively easy to achieve.”
Until suddenly it wasn’t.
On Friday the market began selling off the three year treasury bonds and the RBA wasn’t there to buy them up to keep a lid on yields, and therefore interest rates.
“The market began to doubt the RBA’s commitment,” Dr Gross told Yahoo Finance.
“When no more purchases were forthcoming, the market basically took that as a signal the target was over and sold off the bonds en masse and the yield spiked substantially higher,” he said.
The RBA “basically went AWOL”.
What does that mean for borrowers?
The actions by the RBA last week amounted to a de facto abandonment of its target to suppress interest rates, Dr Gross said, because the Australian currency issuer is likely worried about inflation as expectations of price rises spiked to a seven-year high last week.
“I would say the reason they chose not to defend their target is because they were worried if they kept interest rates at zero percent until 2024 … then they might risk inflation going too high.”
Ahead of the RBA’s board meeting on Tuesday, Dr Gross said an acknowledgement it is ditching the yield curve control “will be because they want the flexibility to raise interest rates because the economy has bounced back quicker than most people had anticipated.”
On Tuesday afternoon, that was officially confirmed.
“The Australian economy is recovering after the interruption caused by the Delta outbreak. As vaccination rates increase even further and restrictions are eased, the economy is expected to bounce back relatively quickly,” RBA governor Phillip Lowe said in a statement.
“The decision to discontinue the yield target reflects the improvement in the economy and the earlier-than-expected progress towards the inflation target.”
Expectations that the RBA will rise official rates sooner has already resulted in flow-on effects in the real economy.
“Banks are putting up their fixed three year mortgage rates,” Dr Gross said. “Mortgages are going to get more expensive and I think that’s going to continue.
“That’s going to occur for a wide variety of loans, not just mortgages but potentially also business loans as well.”
The Australian dollar will also rise, which is bad news for exporters.
“It’s going to have a meaningful effect on tapering down economic growth,” Dr Gross said.
That being said, the RBA owns the printing press. “They can always buy as many bonds as they want.”
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