Transcript of Question & Answer Session The Review of the Bond Purchase Program

Thank you for your time, Michele. My name is Swati and I write about the central bank and economics at Bloomberg. Michele has a hard stop in about 20 minutes time, so I’ll jump straight into questions. From what I understand, Michele, the hurdle for deploying unconventional policy in Australia again is pretty high, unlike, you know, for the Fed [US Federal Reserve] or the BoE [Bank of England], is that right? Are the chances close to zero?

I wouldn’t say they’re absolutely zero, but one of the conclusions the Board has drawn from the experience is that it’s only for use in extraordinary circumstances and it’s only for use when, in particular, the cash rate has absolutely run out and we’ve got no gas left in the tank. So I wouldn’t categorically rule it out, but I would say that the bar is very high, yes.

Right. Later this month, we’ll have the first monthly inflation report, so everybody is pretty excited to see what the numbers are going to be. Do you have expectations around what the number will be, and is there a certain figure that will really worry you?

No, we don’t. I think there’s a little bit of water under the bridge to go with the monthly CPI numbers. I think everyone will be looking at them and trying to figure out what is the noise and what is the information in the monthly figures. So I’m not so sure that, quite immediately, we will be looking at monthlies. What I would say is that our forecasts for inflation are to peak at about 7¾ per cent to eight per cent towards the end and early into next year, so those are the numbers we’re currently working with. We’ve got new forecasts coming out soon in the November Statement on Monetary Policy. But that’s our current expectation and that’s what we’re working with.

So it will not … these monthly figures, these won’t have monetary policy implications for the October meeting.

I think it’s unlikely because at the moment there needs to be a little bit of water under the bridge with the monthly numbers to see what sort of information content is in them, because they’re not the full CPI.

Right, right. In Australia, there’s a bit of a debate going on around that we will have a soft landing or a hard landing driven by the current tightening cycle, and the RBA has said that, you know, it is seeking to cool inflation, but it is also looking at keeping the economy on an even keel. Do you think the cash rate is already close to restrictive territory?

That’s a very difficult question. This gets into debates about what people think about the neutral rate, and that’s typically the way people define it, in terms of the neutral rate. In real time, I would hesitate to give a guess as to what the neutral rate might be. I’m not sure it’s necessarily in restrictive territory yet, but it certainly was evident that we needed to get it up from the very low levels that it was. And the Board and the Bank are focused on, really, the outcomes that we’re seeing in terms of inflation and employment, and we’ll be looking to see whether or not there are opportunities to taper a bit and slow the pace, but we haven’t got a pre-set path. I think we’ve said that a number of times, there is no pre-set path on this yet.

Right. The Fed [US Federal Reserve], the Bank of England and some of the major central banks are, you know, telling us that they are determined to crush inflation at the cost of economic growth. The RBA is an outlier there, right, with Governor Lowe recently saying that outsized interest rate hikes may be coming to an end, and that has also stalled a lot of debate in the market and, you know, around market pricing. What I want to ask you is: what are the key differences that set us apart? Is it the household debt that, you’re worried about, or is it something else that the monetary policy path in Australia is looking different from other countries?

There’s a couple of reasons. The first is that inflation isn’t as high here as it is elsewhere, that’s number one. And you would see, in the UK and the US, the inflation rate there is much higher and the core rate of inflation is much higher in those countries than it is here, and it’s for different reasons. In Europe and the UK, there’s a big element of energy prices, in the US there’s a big demand/overstimulus issue going on. The second reason is that wages here have not responded as they have overseas. So, if you look at the US, and the UK in particular, wage rises are actually up around five per cent, six per cent. So there’s much more of an underlying momentum, if you like, in the inflation psychology in those countries. Now, that’s not to say that there isn’t a little bit of a shift in inflation psychology here. I think the concern is that there is a little bit, and that’s why we’re raising interest rates. We want to make sure that an inflation psychology doesn’t get set. But, at the moment, there’s at least a few reasons why we are in a slightly better position, I think, than some other countries in terms of inflation.

Right. I’ll just sneak in a couple of questions before I open to the floor. With all the collateral damage across global markets from the USD’s strength, is there a case for coordination among central banks to stop or manage this surge?

Well, you’re going back many decades, I think, towards suggesting that. Exchange rates can play a very positive role and, at least in Australia, we’ve typically thought of it that way because it gives us flexibility and the ability to run our own policies, to a large extent, without necessarily having to follow what others are doing in other countries. We’re not entirely immune, but it does give us more flexibility. I think it’s of more concern possibly for some of the emerging economies and, for those reasons, for many of those countries quite a few particularly in Latin America, they have issues with much of the debt that is issued in US dollars, which has implications potentially for financial stability in those economies. Most of our debt is issued in Australian dollars, we’re not beholden to the US Dollar in that sense. So I don’t think, necessarily, coordination is the right thing here. I mean, in a sense, the US dollar is responding to relative economic conditions and inflation and interest rates in the US relative to many other countries, and that’s what you would expect.

Right, yes. A question about China, how concerned are you about what’s happening in China’s economy? What are the biggest risk factors that you’re seeing at the moment? Is it commodity prices, people flow, is it the financial market conditions, the housing market there? All of that?

Well, in one word, yes, concerned about China. It’s only one of three sorts of concerns internationally, I suppose. The other being the US and Europe, and it’s all for different reasons. China, I think the main concern or two main concerns. One is their apparent zero-COVID approach, which means that it’s likely to continue to be a little bit volatile, impacts on supply chains, impacts on demand, so there’s that. The second issue is the property market, and that still has not worked its way out. I know that the government, and local governments in particular, are trying very hard to support the Chinese property market. It accounts for about a third of the economy. It is huge, so it’s very important for the health of the economy, it’s also important for steel demand and hence for iron ore. So concerns about China are really around the zero-COVID and the property market and what that potentially means for growth in China and hence the flow-on to ourselves.

So what is the biggest risk for us then?

Internationally, I think it’s not just China. I think the biggest risk is that you have rising interest rates in Europe and the US. The US has, as I said, I think it’s got excess demand and it’s trying very hard to bring that down, and it’s interest rates are continuing to go up quite sharply. Europe has got its own problems. It’s got inflation, but it’s also got a massive energy shock which is going to impact their production. So with those two things, plus China, I think the outlook for the world economy is looking quite uncertain and quite worrying, and that obviously has implications for us because of the tendency to flow through to commodity prices. So this is something at the moment that I think is very uncertain and it’s on a bit of a knife edge.

Right. On that sombre note, I’ll open it to the floor. Okay, let’s start. We have a moving mike. Please introduce yourself, your name and which organisation you’re from.

Thank you. Eric Johnston with The Australian. Thank you for the speech, it was really, really interesting. My question, I guess, is in two parts related to the speech, the first being, as we get into a more uncertain environment, is there mechanically anything that the Reserve Bank can or cannot do with a negative equity position? And also the second part, I guess, is the tenure of the bonds on the books, should we assume that, as they mature, that’s the period when it’s going to start getting into positive?

I didn’t catch the end of the last question.

That’s, should we assume, as those bonds mature—the average tenure of those bonds—is that when the Reserve Bank will start getting into a positive equity position?

On the first question, no, we don’t believe that we’re impacted at all in our ability to operate. As I said, we can create money. That’s what we did when we bought the bonds, we created money and bought the bonds. So we can do that. It would be good to get back, and it is important to get back, to a position of positive equity at some point because I think it’s important that we have a solid balance sheet. But we can absorb volatility over time, and that’s one of the advantages. As to when we start to get back to positive equity, that isn’t just dependent on when the bonds mature, it’s also dependent on how far interest rates rise, when they rise, when they come back, because that’s going to affect underlying earnings and profits, and that’s the other chunk. So there’s going to be two parts to it, and how quickly it comes back will depend on both those things.

There’s the gentleman at the back there. Oh, sorry, yes.

Thank you, Michele. As well now, the board has decided to not sell the bonds. But I had a quick check—please correct me if I was wrong—it may take five years, because the bank board’s bonds are broadly across three to ten years, so it will take five years to let maybe half of them to mature and eventually ten years to let all of them, you know, come. So my question will be, will the RBA worry about if it’s too long, and in which circumstances can the RBA see that you sell the bonds? Thank you.

You’re right, it runs off, and the last bonds won’t run off until 2032, so ten-year bonds. In the next couple of years though, there is a big chunk that’s going to run off and that’s the Term Funding Facility. So the Term Funding Facility, we’re lending at 0.1 per cent to the banks, and our assets are obviously not earning. Well, they’re paying us 0.1 per cent, and that’s not going to offset what we’re having to pay for exchange settlement balances. Once that runs off in the next couple of years, that’s actually going to make a big difference. It’s not just the bonds that we bought through the bond purchase program, the run-off for that program is going to have an important impact on that as well. If you go to the bond purchase program paper, the review, you will see that there’s a graph in there which shows you how the bonds run off. And the way mechanically it will work is that there’s sort of a tipping point where they run off enough that we’re making enough valuation gains, realised gains, now on the maturing of those bonds that are running off, and it’s enough to offset the losses, including our underlying earnings from the fact that we’ve still got the banknote seigniorage. So you think of it as a bit like a tipping point, there comes a point where the positives start to outweigh the negatives on underlying earnings.

Do you have a question there?

Deputy Governor, I run a trading fund. I just want to discuss quantitative easing, so the various aspects of bond buying, your curve control and so forth. Do you consider those superpowers may be a little bit too nuclear to invest in one person to decide the timing and the quantum of applying them and removing them? And also, do you think appropriate measures, which is what the Reserve Bank Act really … do you think lawmakers really had any idea of what they were vesting in the Reserve Bank?

I didn’t quite catch the last question?

The last bit is, all I can see in the Reserve Bank Act is that appropriate measures will be used to achieve its charter, so do you think lawmakers really had any idea of the inflation potential of the powers that they’ve vested in the Reserve Bank?

No, I wouldn’t call them ’superpowers’and, in fact, they helped at the margin. But, really, it’s the policy rate that does the work for the bank - that is the main tool. I wouldn’t think of the other things as superpowers, I’d think they were just things that, at the margin, we were trying everything we could. Think back to March 2020, and people seem to forget it was, we were facing a disaster, 15 per cent unemployment; GDP was going to drop by 10 per cent; there was going to be a morgue in the Domain for all the dead people. You know, this was catastrophic. In those circumstances, these were things at the margin that we thought might assist to help the economy. Did the lawmakers understand that these sort of … no. I would think in 1959, when they drafted the Act, they didn’t have any idea of the sorts of challenges and the sorts of tools that the Central Bank might have to use.

One more question.

Good afternoon, Deputy Governor. Hans Lee of Livewire Markets I note in the review you guys released this morning there’s talk about how the ultimate cost of this program may not be felt until 2033. So I’m curious—well, two questions from me -I’m curious whether there was any consideration of a more active approach to quantitative tightening, like there is at the Federal Reserve, and, secondly, whether the RBA has, you know, best- and worst-case scenarios around how this will all, you know, develop and pan out and, if so, what are they?

Sure. So, yes, the board did consider the issue of whether or not to actively run down the portfolio. It decided in the end not to and, I think, for a couple of reasons. The first is, it’s at the margin really, as I said earlier. The main impact … we’re not constrained on the upside like we are on the downside, so we couldn’t lower the interest rate any further but we can move the interest rate up. So that is the main tool. And that’s why we haven’t categorically ’ruled out’, but we’ve said currently we have no plans to sell before maturity. So that would be the reasons for that. But, yes, it’s been actively considered. Sorry, your second question was …

Whether the RBA has, you know, a best-case scenario and a worst case scenario developed for this run-off process, this quantitative tightening process.

There’s a little bit of that in the Bond Purchase Program Review where we do the scenarios for various interest rates and what that might imply for earnings from the bond purchase program, and they’re the numbers that come out of—it might end up—it could end up costing anything, I think, between $58 billion in the worst-case scenario and $20-something billion in the best-case scenario for interest rates. One thing I would point out though is that, and I think this shouldn’t be underlooked—is that the economy, because of all these extraordinary measures, the economy has done very, very well. I saw this morning in the paper that the budget deficit is looking a lot better this year, and one of the reasons is because welfare payments are down and that’s because unemployment is at its lowest level in 50 years, and the bond purchase program as part of the package helped to contribute to that. So just considering the financial loss, if you like, in isolation, I don’t think is particularly helpful. I think you have to think about it across government and across the economy.

Will you take one more question?

I’ll take one more.

Okay, one more question, the last.

Deputy Governor . The bank is reviewing its communications with the Australian people at the moment. Should the RBA adopt what the US Federal Reserve does and have a press conference after every cash rate decision?

After every cash rate decision, meaning whether we do anything or not?

Correct, yes.

Okay. Well, that would be interesting. That would mean 11 press conferences a year and …

We’ll be there for them.

I suspect the quid pro quo of that is there’d be no speeches, because we’ll have already been out there completely overexposed. Look, ultimately, we do want to be accountable and we do want to be transparent. Our view at the moment is that it’s most appropriate for us to have press conferences when we have something significant and important to say but not just because. And that’s our view at the moment and I think we’d be putting that view forward, but there’s room for alternative views. And, as you know, there’s a review of the Reserve Bank going on at the moment, and that may well be something that they will consider.

You have had four 50-basis-point cash rate rises in a row though and no press conference, apart from one.

Yes, but we’ve had plenty of speeches.

Okay. Thank you so much, Michele. Thank you for your time and we look forward to hearing from you more and to hosting you again at our offices.

Thank you, everyone.