Transcript of Question & Answer Session The Committed Liquidity Facility
Michael Heath
Good morning, everyone. Im Michael Heath, Im the economics reporter for Bloomberg in Sydney, and Chriss annual interlocutor, it seems. I was just going to start off in terms of questions with a couple on the CLF, and then well probably switch across to more macro, but if you do have any CLF questions, feel free to ask them, and then Ill open to the floor as well. So I guess well open, Chris. Im not big on acronyms, so Ill sort of spell it out.
Christopher Kent
Please do.
Michael Heath
With authorised deposit-taking institutions, do they primarily hold high quality liquidity assets to meet their liquidity requirements, or do they use a mix of the high quality assets and the committed liquidity facility?
Christopher Kent
So its a mix. Ive got it here somewhere. The bulletin article that Ill commend you to has a lot more detail than in my speech. Its got a lovely table in there which answers exactly this question. Its a mix. The CLF accounts for a little over half of their liquidity needs, but that need has decreased a little bit over the past five years because as I suggested, the HQLA stock has increased somewhat, and yet their needs have been little changed for liquidity. So, theyve used a little bit more HQLA and a little bit less of the CLF over time. Thats why we saw a reduction from 275 billion or close to, to about 250 in the CLF.
Michael Heath
Sure. And obviously, the governments projecting a surplus, which sort of raised again this issue of a fall in bonds, and obviously high-quality liquid assets. I mean, does this create issues in terms of ADIs … sorry, authorised deposit-taking institutions, meeting their liquidity requirement if this comes to pass?
Christopher Kent
Well, of course, I think in … its worth remembering in earlier times when, in circumstances where net public debt was very, very low, and this was a concern; it was recognised by the markets, by regulators, and by the government of the day, the value of maintaining a pretty healthy bond market. And so, it was also recognised you can have low net debt, but still issue a healthy amount of bonds for use, exactly for these sorts of purposes, and other purposes to which they put. So I think thats worth remembering.
Even so, I think were some way away from that point, but if we were to get there, well, the CLF operates already somewhat flexibly. So if we were to see a decline in the stock of AGS and semis, not just the Feds bonds, the government bonds, but the local state and authorities, if we were to see that, then because what we say is the banks will be, in time, able to hold up to 30 per cent, its not an absolute amount, its a share. So theyll just hold a smaller share, a smaller absolute amount if that market does contract.
Michael Heath
Now, the CLF obviously is for authorised deposit-taking institutions, which are regulated by APRA. What about shadow banks? Where do they go in the event of a liquidity squeeze?
Christopher Kent
Right. Well of course, almost by definition, theyre shadow banks, so theyre not taking deposits. So one hopes their liquidity needs are a little bit more modest. But even so, they may have well have important liquidity needs, and they need to attend to those. They can do that by just holding HQLA themselves, right? And then use that in various markets to obtain liquidity at short notice, just as the banks can.
They could also go to a bank and get a committed line of credit. Theyll have to pay for that, but thats the point. They have to pay for their liquidity needs and insurance just like anyone else. I think the other point to recognise though is that they can do all of those things without disrupting those markets or being a big influence, because theyre still relatively small in the scheme of things.
Michael Heath
Sure. Okay. Lets get to the good stuff. So the Governor has repeatedly said when hes referred to easing monetary policy, the key transmission channel now, when theres this discussion on how much traction you get with rate cuts now, is through the exchange rate. Now the Aussie appears to found a base on both the twine against the US dollar, and particularly given other major central banks are turning dovish, how much of an issue is this turning into for the RBA?
Christopher Kent
Well, its an issue we in every central bank play close attention to, because the exchange rate is an important part of the transmission mechanism. I think its been broadly working as you would expect, that is, other things equal, the reductions in the Aussie cash rate that youve seen of late will have tended to put downward pressure on the Aussie dollar. But other things are never equal. And the other things that are not equal, well, theres a couple of them.
One, commodity prices are continuing to sort of hold up in a way that hadnt been fully appreciated by forecasters, us included, and thats a welcome and positive thing for the economy, very much so. And the other thing is, other central banks as you suggested, have turned more dovish, but I think the thing to remember is that that doesnt mean the reductions in the cash rate here have not had their effect on the exchange rate in the normal way. Its just that there are other forces possibly working the other direction but you could say, well, absent those reductions in the cash rate here, the Aussie dollar might have been higher than otherwise.
Michael Heath
Right, okay. But is there any degree of frustration that youre still seeing it above 70 cents after a couple of cuts? Or not much you can do about it?
Christopher Kent
I wouldnt focus particularly on any given level. And I wouldnt describe it as frustration, because I think the thing to remember is, when the major central banks around the world ease monetary policy, thats an easing of global financial conditions. And one of the things its intended to do is to support stronger inflation to soak up the spare capacity that there is in the global economy, and thats kind of a positive thing for Australia. It has less of an effect through our exchange rate than you otherwise might like, but were not in the business of trying to dial up a particular exchange rate.
Michael Heath
Okay. To the floor, has anyone got any questions … hand up the back there.
Matt Zaunmayr (KangaNews)
If the banks end up holding the 30 per cent stock of AGS, has there been any work done on what the effect on the liquidity of those instruments might be, if they reach that upper threshold?
Christopher Kent
Well, I think thats a very hard thing to do with any science. I think what we have done though, is just looked at that market and realised it has become increasingly liquid over time as I suggested, partly because non-residents are acting a bit less like the buy-and-hold investors that they were, and theyre willing to sort of provide these assets back into the market for various purposes. So I mean, our assessment is, you might be concerned to see a rapid increase in the banks holdings of HQLA, of AGS, and semis from 25 per cent to 30 [per cent] in one short go. Thats why weve staged it, gradually just 1 per cent a year, but I think that markets shown itself to be quite liquid, and increasingly so, and thats why were confident that we can require the banks to hold a bit more as part of their liquidity needs.
Michael Heath
Anyone else?
Jason Miller (ANZ)
What about the impact of the RBA holding bonds on repo to that calculation of the 30 per cent? Does that play a factor in your assessment of the availability of the amount that banks should hold?
Christopher Kent
Not so much, but I think what youre suggesting is the banks themselves through our open market operations are providing this collateral in the form of repo, so they can obtain cash over a short period of time.
Jason Miller
Yeah, youre funding those bonds, thats how I …
Christopher Kent
Yeah, I mean, I dont think thats sizable enough to sort of … I mean, thats part of the market, an important part, but that sort of action helps to in fact, convince people that these, amongst other things, not that they need convincing, but thats part of the act of them being liquid assets, right? We take them, everyone else takes them, under repo. So, you know if youre holding these assets, you can provide them to many people, including the banks who will happily take them, and then they can use them exactly for the purpose youre suggesting. So I think that, if anything, is contributing to the liquidity in the market rather than somehow withdrawing liquidity from the market.
Michael Heath
Anybody else at this stage? Bill Evans?
Bill Evans (Westpac)
Chris, youve talked about the … weve had two rate cuts. Weve had two rate cuts, and theres a lot of talk about looking at other parts of the world with regard to the use of quantitative easing. Is there any sort of guideline that the bank would use in terms of deciding when to switch from rate cuts to quantitative easing, if it was seen that the economy needed more stimulus?
Christopher Kent
I think the first thing Id say about quantitative easing, or the broader sort of term of unconventional monetary policies, is that I still think were … its a very low likelihood event. Were a long way away from something like that. Having said that, of course its prudent for us as good central bankers to sort of be thinking about these things, and what weve been doing of course, is looking at what others have done, and their experience, and what we can learn from that. I think what you can learn from that is that perhaps one of the most important lessons is, you need to tailor these policies to your own circumstances, to your own economic circumstances. In most cases, these were policies that were started in the depths of the financial crisis when the credit system was quite impaired. Thats not the sort of thing I think people have at the back of their minds here.
The other thing you have to do is tailor it to your unique circumstances of your financial system. Whats the structure like? How much of a banked market do you have? So those are the things were sort of looking at and thinking about. Again, I come back to emphasise, we see this a pretty unlikely event.
Michael Heath
Chris, obviously, the Fed is expected to cut later this month. I mean, it was put to the Governor I think, after the first cut, what it meant, and things were a little bit less probable then, what it might mean for Australia if the Fed does choose to ease, particularly with the currency, and I think he mentioned it would make things more complex and more complicated, something along those lines. I mean, how much pressure would it put on you if they do cut it more than once, cut it a couple of times? Does that really put the onus back on you to then act as well again?
Christopher Kent
Well, the markets are fairly convinced that the Fed is going to reduce rates. I guess the question is of course still how much theyre going to do, and is part of this expectation accounting for some of the downside risks. So theyre not central, theyre not the central projection. Having said that, I mean, the markets including the FX markets should already encapsulate that information in the exchange rate. Fine. That doesnt mean that the exchange rate wont react, if and when the Fed does cut rates, particularly if it has implications for peoples expectations, even further down the track as to how much they might do, assuming they get started with the first one soon.
Id come back to … I mean, every central bank that faces inflation thats low, theyd like to see the unemployment rate decline to generate some more wage growth, to generate some more inflation. Thats the situation were in. Every central bank in that situation would like it if they could be delivered with a lower exchange rate, because thats a way of delivering that extra demand they need, to try and generate the extra strength in the economy that theyre looking for, but we cant all dial it up, theyre exchange rates. We cant all have a lower exchange rate, and were not in the process of trying to do that. The flexible exchange rate served us well.
So, is it a complication, maybe at the margins. But again, I come back to what I said earlier. This isnt easy, and global financial conditions, if it comes to pass, thats a strengthening in the global economy, other things equal.
Michael Heath
So coming out of that, the markets are sort of pricing in a pretty good chance that you guys will go again by the end of the year, as is Bloombergs poll. Is that a reasonable take on where things stand?
Christopher Kent
The good interest rate question, even more fun than the exchange rate question. Look, what Ill do is just emphasise, Ill replay what weve said very clearly after the board. The Governor said the board will continue to monitor developments in the labour market. Adjust monetary policy if needed. Id highlight the "if needed" part to support sustainable growth in the economy, and the achievement of inflation target. Id emphasise that, right? Were still trying to achieve the inflation target. Were not trying to achieve an unemployment rate target. Markets. I think before this came out, were pricing in the possibility of the cut that came to pass, and then a second cut of 25 basis points before the end of the year. Thats where they were before this, thats where they were after this. So, I think that they have interpreted this in that weigh-in.
Michael Heath
Ill come to Andrew in one second, but I guess the point being, as Bill sort of pointed out yesterday, that your forecasts on inflation and that sort of thing in next months monthly policy statement become a bit more significant perhaps in that sense then?
Christopher Kent
To a degree, but were always, every month, even though we might not be publishing full detailed forecast every month, were thinking about how the inflow of data is affecting the outlook for inflation for the labour market, for the economy more broadly. So I wouldnt get overly fixated on those months where we happen to sort of publish detailed forecasts in that regard.
Michael Heath
Okay. Andrew.
Andrew Ticehurst, Nomura
Let me take half a step back and ask you a slightly different sort of monetary policy question. Were clearly in an environment where global growth has slowed a little bit, global risks are more elevated, uncertainty around trade, and were seeing central banks in the region and all the major ones as were talking about, either cutting rates or signalling that they might. This is pushing yields on HQLA type assets to very low levels, and encouraging a search for yield, which is almost desperate. Maybe desperate is too strong a word, but my interactions with investors, I definitely get that sense.
So in an environment with more elevated risk, but because of central bank actions, very, very tight credit and risk spreads, is that an inevitable consequence of monetary policy as its currently being practised? Is that material negative side effect, is that something that concerns you?
Christopher Kent
I think you could turn the argument around the other way. If central banks had signalled the need for a bit more monetary stimulus by, you know, in our case, dropping policy rates, and thats whats on the cards for many banks around the world, and long-term bond markets didnt respond by lowering yields, then that would be of some concern. I think this is how monetary policy operates.
Weve said a little bit over various times as to why those long-term yields are very low. Theyre very low because people just dont see any upside risks from inflation. But central banks, part of their intent here, is to try and help increase inflation, and convince people that they can achieve their targets. So, one way they do that is through lowering the yield curve, and I think thats how monetary policy works. So I think, turn it around, youd be very worried I think, in a world where they were doing and saying what they have said, and bond yields went the other way, or were unresponsive. Then youd say they have no potency, theres no potency in monetary policy, whereas I think there is.
Michael Heath
Are there other questions around? Over here, please.
Christopher Kent
And theres one down there.
Will McInnes (Australian Financial Review)
If you did decide to commit to QE, what role would the CLF play within that?
Christopher Kent
Well, Ill start again by emphasising I still think thats a very unlikely event, but I dont see that it would play a substantial role. Im not sure here if by QE, people talk about the purchase by central banks of assets, Im not sure that that would necessarily have direct implications for the CLF. I think it would continue to operate as normal.
Sophia (Goldman Sachs)
Just a question on the labour market. Given the high participation rates that weve been seeing, could you give some colour on how the RBAs thinking about the trade-off between on the one hand, a higher participation rate, which is a sign of labour market strength, versus on the other hand a low unemployment rate, or an unemployment rate thats been kept high as a result of kind of a pure accounting identity? And to what extent is the RBA just going to bluntly target a low unemployment rate if we keep saying the part rate go higher?
Christopher Kent
Well, I dont think were going to, as I tried to emphasise before, not targeting an unemployment rate, but we do want to see it lower, and the goal there is to see spare capacity in the economy more generally, but also in the labour market to be reduced. So wage pressures, price pressures can lift, and we can get back to inflation thats consistent with our medium-term inflation target.
I think youre right though in characterising sort of the rise in participation rate as an element of strength of the labour market. Its being helped along by pretty strong employment growth. The employment growth has really been holding up. And thats fine, thats well and good, but when we look at something like wage growth, say the WPI, the last couple of readings which were a bit lower on a quarterly basis than the two prior to that, that says despite that strength in employment, rising participation, those sort of good elements of whats happening in the labour market, there is a lot more flexibility, a lot more spare capacity in the labour market than you otherwise might have thought. If you just look back at history and said, well where did we get wage pressures, at what levels of unemployment did we get wage pressures before, you would have thought maybe we would have started to see more sooner than we have currently.
So, higher participation, strong employment growth, thats an element of strength, thats a good thing. But theres a lot of spare capacity, which is not a bad thing, but we want to reduce that spare capacity by getting the unemployment rate down, eating into that, so people feel more confident with higher wage growth and more price growth as well at the same time, because theres spare capacity in the labour market, theres spare capacity in the markets for goods and services as well.
Michael Heath
Questions? Okay, good. The neutral rate. I just wanted to raise this. This obviously caused a bit of interest. I think it was 2017 when you released an estimate. In the minutes, you had a special research paper I think, that youd looked at the board meeting, and you were estimating the neutral rated at about 3.5 per cent, which I think people thought was quite high. My question I guess is, is that still the banks general view? And I ask in the context of Fed Chief J Powell saying this month, that the Feds was probably lower than it used to be, and that as a result, their policy had been a bit too restrictive, I think were his words, or words to that effect as well. I mean, is it something youre constantly monitoring, or is there … whats the take there now?
Christopher Kent
Constantly, would be I think a slight overstatement, but something we monitor regularly, yes. So as you said, so we had some research, and it was published in a bulletin article as well, which showed in 2017, that the nominal neutral interest rate was around 3.5 [per cent]. So that was a real rate of around 1 per cent in its … but Id emphasise, the thing about that publication is it also showed theres a wide range of uncertainty. And so, were sort of only reasonably confident that it was centred around 1, but plus or minus three quarters of a percentage point, so a lot of uncertainty.
And it had also come down over time, and that was not unique to us. Thats a global phenomenon, and theres lots of reasons for that, including a reduction in trend growth, productivity, and theres all sorts of other reasons, demographic included. Has it Fallen further? Maybe, but again, theres such a range of uncertainty around that, and its very hard to pin down some of these things that precisely. I wouldnt overestimate that.
In terms of what it means for us, I think it means with a nominal neutral rate of 3.5 [per cent], the cash rate at 1, were still clearly in stimulatory territory.
Michael Heath
Sure. This is obviously not an issue thats facing you now when people are talking about QE or very low rates, but we just had a tightening cycle in the US, which is sort of a rare beast. Have you taken any lessons from that? I mean, it seems extraordinary that their economy looks very strong on so many elements, and yet they didnt really manage to get rates up that high before theyre ready to cut again. I mean, are there any takeaways for you from that cycle?
Christopher Kent
Well, I think it comes back to the point you were just raising. The neutral rate is lower, and thats a global phenomenon. So in order for monetary policy to take effect in a tightening cycle, you might not need to see rates go up to where they were in the past, and thats really a story about the real rate, the real neutral rate being lower, because I still think its … and the Fed has showed, its possible to achieve your inflation targets, that many other advanced economies are doing that currently. The Canadians are just one example.
So, its not for want of lack of inflation, but central banks are concerned that inflation expectations might ratchet down if inflation stays a bit too low, and lower than their targets for too long. So, but I think that lower real neutral rate is a global phenomenon. Its going to be with us for some time.
Michael Heath
Okay. Last call, if anyone has any questions, please? Yes.
Matt (Sumitomo Mitsui Bank)
You mentioned in your speech about the transmission effect. In the current environment, would that have extended from, I guess, the theoretical, I think I remember it was nine months, or from rate cuts, and taking effect and seeing the effects of rate cuts like youve just done. Is that something that you think about, and has it extended or [inaudible].
Christopher Kent
I think its reasonable that … its always plausible that its changing at the margins, but I dont think we know exactly the speed of all of the different mechanisms that well. I dont see theres any reason why it would have shortened or lengthened particularly. It might be changing in slightly different ways, but I dont see the time element would have changed obviously, one way or the other.
Michael Heath
Last call. Anybody else? Okay, if we could put our hands together for Chris.