Ideas for unconventional monetary policy: Bill Evans

EXPERT OBSERVER

The minutes of the November monetary policy meeting of the Reserve Bank Board give us no significant reason to change our view that the next rate cut will occur in February.

While some forecasters have been promoting the idea of a move in December, the minutes provided the flavour of a Board that is in no hurry to make the next cut. The minutes conclude that “the Board would continue to monitor developments”. It also referred to “having already delivered a substantial monetary stimulus in recent months, there was a case to wait and assess the effects of this stimulus, especially given the long and variable lags”.

Nevertheless, the minutes do not want to leave the reader in any doubt that the Board continues to have a clear easing bias. The minutes concluded that the Board “was prepared to ease monetary policy further if needed” and also noted that “members reviewed the case for a further reduction at the present meeting”.

Some commentaries interpreted the latter remark as indicating that the Board was close to cutting rates at the meeting. However, my view is that it was used to emphasise a strong easing bias, particularly aimed at containing any upward drift in the AUD rather than any serious risk of an unexpected move in November.

The second important issue around the policy outlook is the “effective lower bound” (ELB) of the cash rate. Westpac has argued since July that the ELB will prove to be 0.50% and will be reached in February 2020. One factor that has been important to our thinking has been the response of the Westpac-MI Consumer Sentiment index to the rate cuts that began in June 2019. The index has been on a clear downward trend ( see Figure 1) since that first cut and the Board has recognised that by noting that “a further reduction in interest rates could have a different effect on confidence than in the past”. Put another way, the Board “recognised the negative effects of lower interest rates on savers and confidence”.

There are two elements to this downward pressure on confidence through these recent cuts; firstly the impact on consumers of the explanation behind very low rates and, secondly, the media coverage around the banks’ responses to ultra-low rates.

In that regard, the Board was informed that it appears that banks still have adequate scope to pass on future rate cuts. The minutes noted that “while close to a quarter of deposits were estimated to be earning interest at rates between 0-50bps, most deposits earned interest at rates over 1%”. The RBA reports that banks’ response to the cumulative 75bp reduction in the cash rate was to lower interest on at-call retail deposits by an average of 60-70bps.

As noted above, this reduction in deposit rates is affecting the confidence of savers, whereas the data also showed that borrowers had been repaying existing loans at a faster pace. This observation puts one of the most important channels of monetary policy, a boost to spending from the increased cash flows of borrowers, at some risk.

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