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Reserve Bank of Australia Delivers Surprising Stimulus Package

Posted: Thursday, November 5th, 2020

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To the surprise of many, the Reserve Bank of Australia further eased the monetary policy this week. Just a few hours ahead of the Presidential vote in the United States, the central bank delivered a dovish message for the Australian economy and, to some extent, for the world.

Despite better than expected growth in the last three months, the central bank felt the need to ease some more. This week it did more than cutting the rate.

First, it announced a cut in the cash rate. Second, an increase in the quantitative easing program. Third, it announced improved lending conditions under the Term Funding Facility.

More importantly, it strengthened its forward guidance. It warned of tough times ahead, although the country managed to contain the spread of the COVID-19 virus.

Is there a message the Reserve Bank of Australia sends to the world? If it feels it must deliver such a stimulus package with its economy open, what should the European Central Bank do? After all, most of the European economies are in lockdown as the virus’ spread reaches new highs.

Reserve Bank of Australia

Details of the November 2020 Reserve Bank of Australia Stimulus Package

Right from the start, the central bank announced that it had cut the cash rate. This alone represents a surprise.

Many investors believed that the cash rate had reached the lower boundary at 0.25%. However, the Reserve Banks of Australia delivered a further cut of 0.15%, leaving the cash rate to 0.1%. Can it go negative? Anything is possible, although unlikely during 2020.

Next, the central bank increased the Quantitative Easing (QE) program by AUD100 billion. The explicit increase, though, refers to government bonds with maturities between 5 and 10 years. On top of that, the bank announced that it lowered the yield target for the 3-year Australian Government Bond (AGB) to 0.1%.

Moreover, it reserves the right to purchase unlimited 3-year AGB in its efforts to reach the 0.1% yield target. In other words, by constantly buying the 3-year bonds, the bank’s bidding pushes the prices up, and the yields down. As a result, it creates favorable conditions for businesses to borrow at lower yields.

Faced with the zero-level boundary on their interest rate policy, many central banks in the developed world use QE to ease the monetary policy. While an unconventional monetary policy, central banks agreed that QE works better in easing the conditions when rates are close to, or below zero.

The Term Funding Facility interest rate on new drawings was lowered to 0.1%. Thus, the Reserve Bank of Australia further supports the supply of credit to the economy.

Perhaps the most important message was the economic forecast. The bank warned of uneven recovery, despite some improvements.

Can investors expect similar packages from other central banks in the time left of 2020?

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