OPEN MARKET OPERATIONS

The Reserve Bank of Australia is responsible for the formulation and implementation of monetary policy. In Australia, the stance of monetary policy is expressed in terms of a target for the 'cash rate' – the interest rate on unsecured overnight loans between banks. The Reserve Bank Board determines the target cash rate at its monthly monetary policy meeting. The Board's explanations of its monetary policy decisions are announced in a media release, which is distributed through electronic news services and published on the Reserve Bank's website at 2.30 pm on the day of each Board meeting. Any change to the cash rate target will take effect from the following day. The RBA's open market operations are designed to ensure that the actual cash rate remains close to the target rate.

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On a day-to-day basis, deviations in the cash rate around the target are determined by the supply and demand for exchange settlement (ES) funds. These funds are held in accounts at the RBA by banks as well as a number of other institutions, and are used by these account holders to meet their settlement obligations to each other and to the RBA. The daily aggregate net settlement obligation between ES account holders and the RBA can be very large. This is mostly because the RBA acts as banker to the Australian Government. Expenditure by the Australian Government results in funds flowing into ES accounts, while the payment of federal taxes has the opposite effect. Similarly, purchases of Commonwealth Government Securities (CGS) from the Government by investors reduce ES balances while redemptions of such securities increase ES balances. The daily aggregate net settlement obligation between ES account holders and the RBA also reflects transactions by the RBA's other customers (mostly other official institutions) and by the RBA itself. The latter include the purchase of currency notes by banks from the RBA (which reduce ES balances) and transactions undertaken by the RBA with market participants (including the unwind of repurchase agreements – see below – arising from previous operations).

The RBA's domestic market operations determine the aggregate supply of ES funds and are designed to ensure that supply equals demand at the target cash rate. If the supply is too high, holders of ES funds will wish to lend their excess funds in the overnight market, putting downward pressure on the cash rate. If the supply is too low, they will wish to borrow, putting upward pressure on the rate.

The RBA does not place any restrictions on the amount of ES funds that an individual institution holds (other than that the institution cannot go into overdraft). Moreover, unlike central banks in a number of other countries, the RBA imposes no reserve requirements. Because ES balances earn an interest rate below the cash rate, ES account holders generally attempt to minimise overnight ES balances. Nevertheless, most ES account holders maintain modest precautionary balances in their ES accounts overnight. Over 2006/07, aggregate overnight ES balances have averaged around $750 million.

The RBA's open market operations, together with other elements of the framework used for the implementation of monetary policy in Australia, have proved very effective when measured by the stability of the cash rate around the target. Over the 2006/07 financial year, the average absolute deviation of the cash rate from its target was less than one basis point (Graph).

Open market operations are undertaken almost every business day. At the start of the day, the RBA estimates the aggregate net settlement obligation between the RBA and ES account holders for that day. This represents the likely change in the supply of ES funds that would take place in the absence of RBA market operations. The RBA publishes this estimate at 9.30 am on the various electronic news services, together with its dealing intentions for the day. The latter indicate whether the RBA is looking to buy or sell securities and its preferred terms for repurchase agreements (see below).

If ES balances are expected to fall in the absence of market operations, the RBA would typically announce an intention to buy securities. When the RBA buys securities, it pays for them by crediting the seller's ES account, adding to ES balances. If ES balances are expected to rise in the absence of market operations, the RBA would normally sell securities to reduce ES balances. Sales of securities by the RBA reduce ES balances as buyers pay for the securities from their ES accounts.

After the 9.30 am announcement, market participants have 15 minutes to approach the RBA with any bids for, or offers of, funds. These bids/offers are ranked in order of attractiveness according to yield for a given maturity, and sufficient deals are undertaken to achieve the desired supply of ES funds. The dealing is completed by around 10.00 am, when participants are informed by telephone whether or not they have been successful. The RBA publishes the results of the operations through the electronic media at around 10.15 am each day. Settlement takes place over the course of the day.

The RBA undertakes both outright transactions and repurchase agreements in its open market operations.1 Until the middle of the 1980s, the RBA's open market operations were conducted exclusively through outright transactions in CGS. Through the 1990s, repurchase agreements became an increasingly important instrument. Now almost all RBA open market operations in domestic securities markets are implemented using repurchase agreements (Table).

Since the mid 1990s, the Reserve Bank has gradually widened the range of highly-rated securities that it is prepared to accept under repurchase agreements in response to the decline in CGS on issue and to take account of the changing structure of financial markets.  The current list of securities acceptable for repurchase agreements includes Commonwealth Government securities, securities issued by State and Territory borrowing authorities, AAA-rated securities issued by certain supranational and foreign government agencies, bills, certificates of deposit and certain longer-dated securities issued by Authorised Deposit-taking Institutions (ADIs) which hold an ES account at the RBA, and certain AAA-rated Australian dollar residential mortgage-backed securities (RMBS) and P-1-rated asset-backed commercial paper (ABCP).

The RBA has also broadened the list of securities it will purchase outright through its daily open market operations to include short-dated issues by State and Territory central borrowing authorities. The Reserve Bank will also purchase long-dated issues of these securities (and CGS) on an outright basis in separate operations to its daily market transactions (see Long-dated Liquidity Operations in the Operational Notes page).

These developments are reflected in changes in the composition of the RBA's portfolio of domestic securities (Graph).

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Despite the broadening of the range of domestic securities in which the RBA is willing to deal, the strong growth in the RBA's balance sheet coupled with greater seasonal concentration of flows between the RBA and the private sector has meant that the RBA has had to augment its open market operations with foreign exchange swaps.2 Such transactions may be unwound within a very short period or rolled forward on a short-term basis.

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Turnover in Foreign Exchange Swaps ($ billion)

1997/98	1998/99	1999/00	2000/01	2001/02	2002/03	2003/04	2004/05	2005/06	2006/07
33	52	67	90	90	90	139	106	157	211

Further information on this topic is provided in a recent Bulletin article, The Reserve Bank's Open Market Operations. Daily and monthly data on open market operations can be found on the RBA website and in the Reserve Bank Bulletin.

The RBA also provides ES account holders with facilities to access ES funds on an intra-day and overnight basis. Further details of these facilities can be found in the Liquidity Facilities page.

Footnotes

1. Repurchase agreements involve a purchase or sale of securities with a simultaneous undertaking to reverse the transaction at an agree date and price in the future. (back to text)
   
   
2. These can be thought of as repurchase agreements in foreign exchange rather than government securities. For example, the RBA can enter into a swap to buy foreign exchange from banks for Australian dollars, with an agreement to sell the foreign exchange back, at an agreed exchange rate, at a specified time in the future. The RBA pays for the foreign exchange by crediting a bank's ES account with Australian dollars (which increases aggregate ES balances). When the swap matures, the counterparty bank's repayment of Australian dollars to the RBA is effected by a debit to that bank's ES account (which reduces aggregate ES balances). (back to text)