Australia and New Zealand’s central banks are pondering what until recently seemed unthinkable: deploying the types of extreme monetary policies that were spawned globally by the 2008 global financial crisis. Bond-purchase programs and negative interest rates were for years seen Down Under as the preserve of countries that had gorged on risky derivatives and been reckless with debt. There’s been a sharp change of tune, however. Now, the two central banks are at the forefront of what appears to be a race to the bottom -- where even interest rates at zero may not be far enough.
1. What’s changed?
Only last year, the RBA and RBNZ signaled their next rate move would be up. But China’s slowing economy, its damaging trade dispute with the U.S. and the darkening global outlook mean Australia and New Zealand may need to find extra stimulus. The central banks have cut rates to historic lows of 1%, around the same level the U.S. Federal Reserve and Bank of England had when they turned to asset purchases -- known as quantitative easing -- to support their economies following the financial crisis. Both the RBA and RBNZ have left the door open for further reductions, leaving little in the way of conventional ammunition -- particularly if they need to respond to an external shock. With that in mind, RBA Governor Philip Lowe and his RBNZ counterpart Adrian Orr have said it’s prudent to discuss unconventional options now -– but made it clear they won’t necessarily have to use them.
2. What have they said?
New Zealand has sounded slightly more gung-ho than Australia, especially after shocking markets with a half-point rate cut in August. The RBNZ says nothing is off the table after canvassing options including negative interest rates, loans to banks, forward guidance and quantitative easing. Lowe still insists he doesn’t think the central bank will need to go down the unconventional route. Nevertheless, his board had its first official discussion of such options at its August meeting, where it reviewed the experience of overseas peers. The main topics of interest were similar to New Zealand’s, including foreign exchange intervention. The ever-cautious RBA reminded central-bank watchers that it couldn’t yet undertake a full evaluation since many of the measures were still playing out.
3. What might they do first?
New Zealand’s Orr has focused heavily on negative interest rates, suggesting that’s his non-standard policy of choice. With sub-zero rates already in place in Japan, Sweden, Switzerland and Denmark, New Zealand’s Treasury Department estimates the official cash rate could go as low as minus 0.35%. For the RBA, the board noted in August how overseas experience showed that a package of measures tended to be more effective than s ones.
4. When might all this begin?
Don’t hold your breath. RBNZ has said it would only go unconventional if, after exhausting standard policy, inflation was still a long way below 2%. Right now, there’s little prospect of that happening. It’s also stressed that its recent half-point cut should reduce the need for such policies. Still, most investors and economists expect another RBNZ cut in November, taking interest rates to 0.75%. While RBA’s Lowe reiterated this month he doesn’t think unconventional policies are likely in Australia, the bank’s most recent forecasts baked in market expectations of two more cuts by mid-2020, which would leave the cash rate at just 0.5%. Still, he’s unlikely to wield more drastic weapons simply to redouble efforts to boost inflation and would rather keep them in hand to confront a serious downturn. Both countries’ domestic economies aren’t in terrible shape, so the trigger would likely be a dramatic slowdown in global growth.
5. Has this stuff worked elsewhere?
The broad consensus is yes, but to an extent. Borrowing costs have been lowered and financial conditions eased in economies that went unconventional, though the impact diminishes the longer the measures remain. The Fed’s forward guidance is generally viewed as having been effective in supporting the U.S. economy, while quantitative easing’s impact on interest rates, bank lending and company behavior suggest it largely helped stimulate activity. And while there were fears that negative rates would prompt savers to pull their cash out of banks and stuff them under their mattresses, this hasn’t come to pass. The experience in Japan has been less convincing. While prices are rising again, inflation remains a long way short of the central bank’s 2% target and negative side effects such as strains on regional lenders are piling up. But as the RBA has noted, much of this global experiment is still in progress and it’s tricky yet to draw a firm conclusion.
6. Is there a downside?
It wouldn’t be economics if there weren’t. One potential fallout is that, as central banks lap up bonds, any subsequent squeeze on yields might encourage a move toward riskier assets. Very cheap money can also lead to inflated valuations -- real estate is a classic example -- and set the stage for a later sharp correction. Critics have also warned that the more central banks become involved in multiple objectives and policy instruments, the more exposed they are to political interference. A broader question is whether future policy will ever return to the conventional status quo, with more than half of central bankers in a recent survey expecting QE to stay around.
--With assistance from Matthew Brockett.
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