Transcript of Question & Answer Session The Term Funding Facility, Other Policy Measures, and Financial Conditions

Thanks, Chris. There are a number of audience questions coming in; I’m just trying to start my video, but it’s not coming up at the moment. I don’t think anyone needs to see me, anyway. If you can hear me, that’s good enough. As I said before, you can ask questions through the live Q&A screen on the right-hand side of the session, but there are plenty of people who have worked out how to do that. I’ll start from the top. Chris, does the RBA expect to see bank funding costs rise immediately following the end of the TFF?

I’m not sure why the end of the drawdown phase would lead to that. I mean, the banks are still in possession of cheap funding at a fixed rate of 10 basis points for three years, and any earlier funding they took out still has a while to run under the initial allowance. So, I don’t see how that will be the case.

Fair enough. The next question is, is the RBA reading anything into banks increasing their fixed rate mortgage pricing ahead of the end of the TFF, and was this something you anticipated?

Well, I think as I described just a few minutes ago, that that really reflects the rise in the swap rates, which are the key benchmark for fixed rates for banks. That was happening because markets were looking ahead to the possibility of a future increase in the cash rate, a few years out; and so in response to that, it’s not entirely surprising that banks have raised their fixed rates. But the increase has been pretty modest, and variable rates still remain very low, and indeed fixed rates remain extremely low.

Sure, thank you. We’ll stay on the TFF for now. The questions at the moment that are coming in mostly fall into TFF related and inflation related. There’s a number on inflation, which we’ll come to in a bit, but staying on the TFF, what conditions would need to arise for the TFF to be extended?

Well, as I suggested, the TFF was put in place originally when funding markets for banks had become very disruptive, and that was in the early days of the pandemic. So, not only was the TFF there to provide low-cost funding, but it was to provide funding at a three-year term, to give the banks confidence that they’d have access to the funding they need to extend credit. So you’d have to imagine that you’d need a sharp deterioration in economic conditions, and possibly even a sharp deterioration in the state of financial markets that were underpinning the original motivations for the TFF.

Sure, thanks, Chris. Another one on the TFF, I guess more forward looking even than the last, how does the RBA view the risk to bank funding cost posed by the maturity pillar of bank TFF obligations in financial 2024?

Well, I mean, in a way it’s a good thing that there’s going to be a lot to refinance, because it means in the meantime banks have taken advantage of very low-cost funding. The banks will have to plan that carefully, and I’m sure those plans and much thought has been given to those, and they’re already in place. They can of course start to raise funding in advance. It’s hard to know exactly what the costs of funding will be in three years’ time, but my suspicion is that funding rates will still be very low. So, naturally as they switch away from TFF and pay those funds down, and go back to wholesale markets, one imagines to replace that funding, they’ll be facing a gradual uplift in their outstanding costs of funding. I think it will be quite manageable. That’s a time when the economy will be in much stronger shape, one hopes.

Sure, thanks for that, Chris. We’ll move on, I think, a little. There’s a question come in on a different topic, but relating back to something that was already asked about fixed-rate mortgages. What do you think the implications are of greater fixed rate borrowing from households? Does this potentially extend monetary policy lag?

I think households are just responding, as you might imagine they would, to the pricing incentives, which are very, very low fixed rates. If you remember one of the charts I showed, they had previously been above variable rates, and they moved a long way below them; so it’s understandable many households made a decision to lock in those lower rates. The fact that they’ve locked them in means that they’ll be paying low rates for quite some time. Eventually, when those terms run off, yes, maybe they’ll face higher rates; but again, I think that’s going to be occurring at a time when the economy is stronger, one hopes wage growth is a bit stronger then, and inflation has picked up. At least that’s our forecast.

It’s probably a perfect moment to take some of these questions on inflation, Chris, and I guess in tune with the theme of the day, and the theme of what markets are talking about, that they sort of revolve around the idea of challenging the idea of low inflation. The first one is definitional. Does the RBA have a definition of what it would consider transitory inflation?

I’m not quite sure how to answer that. I mean, we’ll know it when we see it. One thing that we flagged quite clearly is headline inflation is going to be picking up in year-ended terms to something in the vicinity of three in the coming release or two. That’s got a number of influences behind it, but partly it’s the unwinding of some of the things that were put in place in the depths of the pandemic at the outset. The classic example is childcare; when childcare was made free, that was a huge price drop. When childcare was then starting to be charged for again, that price drop unwound, and there was a big price increase. So in year-ended terms, we’re losing those low price increases, those lower-inflation readings, and then they’re being replaced by higher ones. So it will temporarily be up for a bit. I think the key point I’d make though is wages in Australia are very low still; they have a long way to pick up before inflation is sustainably within that two to three per cent range. So, until we see that rise in wages of a substantial amount, and see it persist, I don’t think we’re likely to see enduring inflation in the two to three per cent range.

Thanks, Chris. As always, you’re doing a great job of introducing the next question. I think you sort of halfway answered anyway, but let’s carry on. What is the RBA’s current read on tightness in the labour market? Does this imply a higher-than-expected inflation trajectory?

It doesn’t. I think what we have seen in quite a series of data – and this point has been made in the past by us, including by the Deputy Governor Guy Debelle fairly recently in a speech – we and others who are in the business of forecasting have been surprised by the strength of the rebound in the Australian economy, and that’s a very good thing. It’s manifested in the form of GDP maybe being a bit stronger than we had otherwise thought. Employment is another one. Employment has been stronger than we thought, and it’s really good to see that employment is above where it was prior to the pandemic. Unemployment rate has come down by much more than we had originally forecast.

So, all of those things are very good, but those are what I call surprises on the real side of the economy, if you like. Meanwhile, what we’ve seen on the other side of the economy, the nominal side, is an absence of those surprises. So, wage growth has been low, and that’s not surprising, because there’s still quite a bit of spare capacity out there, as evidenced for example by the unemployment rate being above where we would like to see it in the longer term. So, we haven’t had surprises on the wage front, we haven’t had them on the inflation front. So I don’t think our forecasts are inconsistent with the data that we’ve seen of late, on that front.

Sure, thanks, Chris. Next one, still on inflation, but a global perspective. It’s an interesting question. Is it possible that inflation in the US accelerates ahead of the rest of the world, including Australia, leading to US interest rate rises; and if that did happen, what consequences could it have for RBA policy?

Well, it’s always possible. I don’t think it’s the Fed’s central case. They also are seeing some temporary bounce back in inflation as a result of the unwinding of the circumstances that led to the recession and the pandemic. They still think it’s fairly temporary. It doesn’t mean it couldn’t be a bit higher than expected, and a bit more persistent. The more important point is though that if that is the case, and if it does lead to the Fed stepping back a bit from some of their various stimulatory policies, I think monetary policy would still be very stimulatory. But if that did, well, that presumably would lead to a slightly stronger US dollar, and that’s not a bad thing for an economy like Australia if currency is a bit weaker as a result.

Sure, thanks, Chris. Let’s try and take at least a couple more, so I’ll just give a quick advance warning to the panellists who are going to be joining this same call in three or four minutes’ time, to be ready to go live. I’ll carry on with Chris for now. There’s a question here about shrinkflation, which I must admit is the first time I’ve heard of it. I’ll read the question as posed. How does the RBA think about and account for shrinkflation, where the price of a product remains unchanged but the volume or quantity decreases?

Oh, I understand, yes. So, the Mars bar you bought today is not the Mars bar you would have bought for the same price 20 years ago. Look,that should be captured by the ABS, who are aware of that, and would presumably care about the quality of the product you’re buying, and measure that in the case of the Mars bar that I just suggested by weighing that Mars bar, and not being fooled by the size of the packaging.

Sure, okay. I’ve been fooled by plenty of Mars bars in my time. Again, just as well my video’s not working, quite frankly. Let’s ask this one about migration; it’s a really interesting issue, I think, and there’s all sorts of political connotations about the fact that for a long time, basically all sides of politics have been saying that net inward migration doesn’t produce downward pressure on wages, for reasons I’m sure everyone on the line understands. But there’s a question here, could the current lack of immigration lead to a substantial tightening of the labour market, faster than currently expected, which could in turn become inflationary faster than expected?

Well, thinking about advice I gave my son today – he’s doing an economics exam about the labour market – if you think about supply and demand, if there’s a bit less supply, then one imagines that the price of that product should go up a little bit; and this product in this case is labour, and therefore wages would be a bit stronger than otherwise. The trouble is that’s a very partial analysis. You have to think also about what’s happening on the demand side, including the fact that immigrants contribute to higher demand. At the margins, maybe it might lead to slightly higher wages than otherwise, but what matters I think is how long we’re in the situation where migrants are not able to come into this country in the way that they were in the past, and that’s still uncertain.

Just a point of order, is the RBA modelling around what the treasury provided in the budget, which I believe is mid-next year before we have wider border opening?

Yes, but there’s so much uncertainty around that, and we broadly are consistent with the treasury on this, and look for guidance. We don’t make up our own forecasted population and immigration. If there’s a slight difference there in terms of timing of when this all kicks off, the bigger issue probably is the magnitude of it, and a small difference in timing and magnitude of the early days of restarting an immigration program isn’t going to make a huge difference to something like aggregate wage growth in the economy. It might have some effect, but my point is, a small variation in the exact timing and the exact magnitude, in the scheme of things over the next few years, won’t make a huge difference, I would imagine.

Sure, thanks, Chris. Chris is going to stay on the line and join the panel that we’re just about to start. I am going to attempt to orchestrate this pivot. I’d like to ask the panellists, who I hope are all on the line, to turn their videos on, and then I will hand over to Helen Lofthouse from one of our sponsors, the Australian Securities Exchange, to take over moderation of the panel, introduce the panellists, and lead us through the follow-up questions. So, over to you Helen, with my fingers crossed.

Here I am. Thank you very much indeed, Laurence; and Chris, thank you for the very interesting speech. So, just to introduce my panellists, first of all Chris Kent; thank you for staying on to join the panel with us, much appreciated. Then I have Anthony Kirkham, who you can see on screen now. Anthony is the Head of Investment Management and Australian Operations at Western Asset Management. Thank you for joining us, Anthony. In a moment hopefully we’ll have appearing Bill Evans, who is the Chief Economist at Westpac; and also Prashant Newnaha, who is the Asia Pacific Macro Strategist at TD Securities. Hello everyone, and thank you for joining us today, and welcome.

So, first of all, let’s talk a little bit about the TFF, given that that’s the initial topic du jour. So, Chris, on the TFF you’ve said that 145 billion has been drawn down of the 200 available. We’re expecting the eligible banks now to move pretty quickly to draw down the majority of what remains by the deadline of the 30th of June, and we’re not expecting to see the TFF to be extended further. Chris, maybe just start with you, if you could talk about how important the TFF has been as a transition mechanism. You’ve obviously highlighted there’s been a range of different monetary policy tools; what’s the importance of the TFF in that toolkit?

I think it’s been very important. I mean, it’s been pretty substantial. We’re heading towards 180 billion plus being drawn from that facility at very low rates, and that’s contributed to historically low bank funding costs, and that has been passed through to business and household borrowers, who are enjoying the lowest rates they’ve ever seen on their borrowings. I think it was an important part of the package, and the point of the package was these were all reinforcing mechanisms. So it tied in very much with the bank’s forward guidance that ranks would stay low until we saw inflation sustainably in the two to three per cent range; it tied in with the three-year yield target, which was at the same rate. So I think it was an important part of the package as a whole. It was consistent with the rest of the elements, provided a lot of funding, and led to very low funding costs through the economy.

I do think it helped particularly the incentive for lending to business, and especially to small and medium size enterprises. Just very briefly, because I hand off on this one, even though the aggregate lending to SMEs across the economy has been pretty flat right throughout this time, a number of banks have managed to increase their lending to small and medium size enterprises, and they have benefited by extra TFF allowances, and so what that suggests to me is it’s quite possible and wouldn’t have been surprising absent the TFF; that maybe lending to SMEs might have actually declined. That would make sense in the context of the substantial decline in activity and the recession that we experienced. The fact that that didn’t happen, maybe the TFF made a significant contribution, helping to provide that incentive. Thanks, Helen.

Thanks, Chris. So, really part of a group of strategies, but when were one of the unique impacts that you’re really highlighting is that impact for SMEs, which does make sense. Maybe I can turn to Bill and ask you, what are the likely consequences now of the withdrawal of the TFF on the economy? What do you expect to see post-June?

As Chris pointed out, the cheap funding is still there for the banks, and will be there for three years; it’s just that we’re not getting additional cheap funding. So, I expect that to continue to support the very low housing and business loan rates as we go forward, but I think the key issue around the TFF in the initial introduction was the concerns about the disruption in global financial markets, and banks’ restrictions in being able to fund themselves. We all remember what happened during the GFC. So, I think once we realised that that factor wasn’t there, then the other aspects of the TFF in keeping rates very low can be transferred now to the normal policies which are in place anyway, such as the guidance on the outlook for rates, and of course the 0.1 per cent cash rate. So it’s a natural transition, but the important point is that the cheap money isn’t disappearing; it’s still there for three years, and it’s just that it won’t be there for any longer than three years.

So, it sounds like you are expecting a reasonably smooth transfer here, and no particularly immediate impact from the TFF finishing. Maybe just continuing a little bit on the TFF, Anthony, Chris had talked about some of the indirect impacts of the TFF, and particularly in things like the increased nonbank issuance that we’ve seen at lower yields. Is that something that you’ve observed, and if so, what’s the impact of that change from your perspective as an investor?

It definitely is having impact on other issuance, because obviously you’ve had a big issuer, i.e. the banks, basically being taken out of the market. So, that meant that obviously there was a new pricing point in regards to the major bank funding, and then everything relative to that obviously contracted as well, because there were less major bank paper out there, people were fighting to get what was still there, pushing those spread levels down; and then of course other issuance came through, and that became a bit of a benchmark, I guess, for other funding costs. So, I think Chris ran through it; definitely RMBS was impacted by that. We’ve seen those spreads definitely come in. I think you could also say that tier two has been impacted by it, because people do this relativity between major bank paper and tier two, and so have used that; and then definitely other corporate credit that’s come through once again has been priced off that lower spread that we’ve seen on the major bank paper. So, it’s definitely had a broad impact to markets as a result.

Then from an investment perspective, how do you then think about that change when you’re considering the investment portfolio? How do you kind of true that, consider and flex that?

I think you have to be mindful of the fact that as highlighted, obviously the package is going to roll off at the end of June. Not disappearing, as once again highlighted, that that funding is still there; but we do have to start to normalise our thinking around what the cost of major bank issuance will be, moving forward, or the spread. So, as we move forward, you need to once again think about the relativities that you’ve used as the benchmark for that other funding, and possibly expect that that will move a little wider as well. So you need to be mindful of the impacts that it’s had, and what it will have, slowly, as it unwinds.

That makes sense. Thank you. I might move onto an interesting piece that we’ve certainly observed, which is that post the pandemic, we’ve seen this massive increase in exchange settlement balances; those balances that historically have tended to be quite low, and have generally been preferred that way. But now we’re seeing enormous balances. I think last time I checked, it was 235 billion of balances in those exchange settlement accounts, and of course those are paying zero. So, I’m curious whether the panellists have a sense of what’s driving those huge increases in balances, and what the outlook is for that phenomenon. Maybe Bill I’ll come to you on that one initially.

Well, obviously it reflects the Reserve Bank’s balance sheet, so it’s bought about 120 billion of government bonds, and so that’s a new asset, so it has to have a liability; and the liability is the exchange settlement account balances, which are deposits that the banks hold with the Reserve Bank. So, that’s the mechanism. The issue is whether there’s some sort of limit on how large the Reserve Bank’s bond portfolio should be. When we look at the Reserve Bank’s bond portfolio as a proportion of GDP, it’s only about 10 per cent. That’s much smaller than other major economies. In our view, there will be another 150 billion by the time we finish QE2. That will still have it at about 18 per cent of GDP, which will still be quite small. It’s the size of the bond portfolio that’s important as a measure of stimulus for the economy. Even in terms of a share of bonds on issue, we expect it will be up to about 36 per cent by the middle of next year. That’s also relatively low compared to most other economies, with the possible exception of the US Federal Reserve, given the huge blowout in their budget. So, it’s a natural response to the need to boost the economy.

We’ve been really surprised in terms of the level of commodity prices and the Aussie dollar; that gap is as wide as I’ve ever seen it, so I’m trying to think what might be doing that, and obviously one of the factors has to be QEs, that the Reserve Bank has been helping hold down the Aussie dollar even in the face of these high commodity prices. So, my view is that it’s a sensible policy. It’s got further to run. Rest of the world is doing it. The problem of how you unwind the central bank’s balance sheet at some stage way down the track is obviously a difficult one; we saw the Fed try to do it a few years ago, and created all sorts of volatility in the market. So that’s a problem the central banks will have to deal with, but it’s not one that we need to think about, possibly in the case of some of us around the table, in the period of our careers. Thanks, Helen.

Lucky you, Bill.

Just on that, I think that we’re going to expect those balances to be incredibly high for at least the next few years, and as highlighted by Chris, these programs are going to run for that period. Certainly in regards to TFF, it’s very unlikely that you’re going to see banks send the money back; they’re certainly going to use it for that period. As Bill highlighted, the next QE program will assist those balances to rise again, most likely; and then it’s sort of a gradual unwind, because of the different programs that were used to cause that excess in balances. So, it’s going to be with us for a time, but that’s by design, and I think that is fine.

Chris, maybe I can just turn to you on that for a moment, and just check in with you. How does the RBA view those very high exchange settlement valances? Is that something you kind of view as an expected outcome of the set of policies currently in place?

Very much so. Just echoing what Bill and Anthony said, it’s an intended outcome from the bank’s expansion of its own balance sheet through the TFF, through the bond purchases. Of course, just counter to Bill, maybe he’s telling us something about his retirement plans; but some of it will start to roll off as early as September of 2023 when the initial drawing deadline of three years rolls around, and then in three years from the end of June of this year, when the TFF funds are repaid. So, that will be a chunk that will come off at those times. Then, yes, maybe it’s going to take longer for the bonds that we’ve purchased under the bond purchase program to roll off; but again, maybe Bill’s making a comment about his retirement plans. He can illuminate us on that later.

It doesn’t look like Bill is sharing any further details on that. Prashant, I think you were going to jump in there. Do you have any further comments on that?

I was just going to mirror pretty much the similar comments. The exchange settlement balances that are sitting there at the Reserve Bank are essentially the deposits of the banking system, and they’re going to increase, and they’re going to increase because the term funding facility is going to be drawn down. As Chris said earlier on, there’s probably another 60 billion or so to be drawn down. So, we’ve already got 255 billion or so sitting in the Australian settlement balances; add to that another 60, and then by the end of QE2, we’ll have another 60 billion on top of that, with the remaining QE2 to be drawn down.

So, essentially you’re looking at a scenario where exchange settlement balances could be close to around 380 billion by the end of August. Now, where the exchange settlement balances go from there really comes down to what your view is on the QE outlook. We expect a minimum QE after QE2 of around 100 billion; it could come in two instalments of 50 billion in QE3 and QE4, but essentially what that means is, by the end of June 2022, we could have around 500 billion dollars sitting in the exchange settlement balances, and it’s going to be this, it’s going to be the rate on exchange settlement balances which determines the actual cash rate, not the target cash rate. As Chris said, these are going to remain flush for quite some time, so it’s going to be really driven by the maturity drawdown of the bonds that roll off from the RBA, and that’s going to be quite some time; and then the repayments on the term funding that were actually drawn down as well, which is going to be June 2023 and June 2024.

So, overall, essentially what we’re going to have is a situation where there’s going to be a lot of money sitting in these balances which is earning nothing, and it’s going to be looking for a home. We’re already starting to see the impacts of that now in the markets. We’re already seeing T-note yields trade to zero, or even below zero. We’re going to see bank bill yields trading very low as well. I think with the prospect that bond supply actually falls, you’re going to see bonds outperform possibly versus [IOS]. So, there is going to be a flood of money looking for a home, and it probably argues for lower yields.

A fascinating point you make there, Prashant. We’ve got ES balances currently at 235; as you point out, with all of the further easing, they could go up as far as 500. I really like the point that you made there, that actually it’s the rate that’s being paid on those balances that’s really determining the actual market rate, rather than the target cash rate. That’s certainly I agree something we’re seeing in those short-term funding markets, so it makes a lot of sense. Maybe a little bit as Chris mentioned earlier, the story of the [inaudible] that we have seen economic growth in Australia, we’re seeing consistent upward revisions, and so the economic growth has been stronger than anticipated; so I think March quarter GDP of 1.8 per cent, 12-month growth 1.1 per cent, so seeing consistent and quite strong recovery. Bill, do you want to talk maybe about your latest forecast, and I’m particularly interested to hear whether you think the risks at this stage are really at the upside or more at the downside of that growth.

Helen, we’ve recently slightly revised up our growth forecast for this year; 4.5 to 4.8. But there’s been a big rebalancing within that story. We’ve slowed down our consumer spending forecast from 5.8 to 4.7, but lifted our business investment numbers from 3.7 to 6.7. So, we saw that in the March quarter national accounts, and we’ve seen that rebalancing going through the economy at the moment. The lockdown in Melbourne of course I think is going to take the edge off how people feel about the economy, and the slower consumer … I was a bit surprised that we didn’t see a bigger fall in the savings rate in the first quarter. So, the consumer seems to be a little more cautious than we were expecting. We only saw consumer spending up 1.2 per cent, whereas business investment up 5.3. Yesterday we saw once again really strong evidence of business investment.

So, I think that picture of strong growth, but a rebalancing between the consumer and business, will be important. But of course, we have to remember that business will only really remain confident as long as it sees its sales as capacity starting to come under some stress. That does always get back to the consumer. So, I would say that whilst we’ve lifted our numbers modestly, I would say that the risks are probably relative to our forecasts, slightly to the downside, given these issues that we’re starting to see around the consumer.

So, really with the forecasts, you’re starting to factor in some of that stronger growth than we’ve expected, but we’re flagging that things like the downside risk around the lockdowns and so on could change that. Prashant, anything to add there in terms of how you’re seeing that in your forecasts?

In terms of our outlook for the Australian economy, we’re pretty much in line with what the RBA is forecasting in terms of their forecasts. When the forecasts from the RBA came out in the Statement on Monetary Policy, ours were a touch lower. But overall, we were surprised at the sense of optimism amongst the RBA officials in what was in their forecasts. I guess one of the issues that we’re concerned with, we’ve noted that there’s been a decent pick-up in business investment and capex; our question is that one of the things that the TFF was supposed to do was that it was actually supposed to incentivise businesses, particularly small and medium enterprises, to actually increase their level of borrowing. We didn’t really get that. Well, that was my impression; we didn’t exactly get that.

So, that’s one of the risks that we’re considering in terms of the outlook, whether business investment does actually pick up. But I think overall, the outlook looks fairly positive. As long as the vaccine and the public health risks are contained, there should be some strong pent-up demand, which should actually drive consumer spending going forward.

Great. So, just on that point though, in terms of one of those downside risks, vaccine rollout, you make a really good point there. We’ve obviously had a pretty slow vaccine rollout so far, and there are obviously concerns about vaccine hesitancy. How do you see those issues affecting your forecasts? Maybe I’ll pop that back to you, Prashant, initially.

Obviously the pace of vaccinations has been very slow in Australia compared to the globe, but I don’t think that it necessarily is a negative for the forecasts. I think ultimately what it comes down to is that the virus is contained and it doesn’t pose a public health risk. To the point that it doesn’t actually force lockdowns for a longer period of time, then I think that’s pretty much in line with what the RBA is expecting. So, I’m thinking that even though the vaccine rollout might be slower, it’s not really going to have that much of a dent to the forecasts. Unless, of course, it results in sharp and longer lockdowns.

Right. So, really, as long as the lockdowns are contained, and the strategy of containing the virus itself is successful, then you see less downside risk around the vaccine rollout. Bill, what’s your take on that one?

Well, it’s a big challenge for the Australian economy, because our great success in dealing with the virus last year could become our liability his year, if we see reluctance to take the vaccine. Because if we have a low level of vaccination, then the challenge for governments to have to deal with ongoing leakages from hotel quarantine becomes ongoing. Now, we want to reach a point where the Australian population is fully vaccinated, and therefore any risks around hotel quarantine can be managed without lockdowns. At the moment, we’re a long way away from that, as we’re seeing in Victoria at the moment. So, I think it’s really important that we find a way to accelerate vaccination, and obviously we’ve seen a big pick-up and acceleration in Victoria in the last week or so; but possibly not so much in the other states.

So, I think we’ve got a long way to go before we can deal with the situation where governments feel comfortable to avoid lockdowns in the event that we see further leakages from hotel quarantine; and while that’s there, then the risks are that the economy doesn’t perform as well as we have been so optimistic about up until recently.

Right. Maybe to link back to that, I guess one of the challenges with a limited vaccine rollout is how long Australia therefore stays quite isolated. So, we’re seeing good economic growth without significant amounts of international travel; is there a point where economic growth is constrained by that limited international travel?

I think there’s a point there, just in regards to borders being closed, in that clearly that’s the skilled migrants immigration that we were used to using in many businesses that certainly, I think, will be a constraint. Initially, people can say, “Okay, actually, keeping those borders closed will actually help wages start to increase”, because that demand for labour will force that; but there’s actually going to be skilled jobs that won’t be able to be filled, and that’s a major issue. Because not all unemployment can obviously move into those sectors; you do need a skill base, and I think we’re already seeing that within some industries that are really struggling to get workers in. That’s actually going to impact our ability to continue to grow, continue to export, and therefore actually start to impact profits and other things.

So, yeah, there’s a limit to how long we can keep those borders closed. I think the border closing in terms of tourism, I think we all understand that Australians love to spend money, they’re happy to do it regionally; and in fact, we do head out more to the regions than international tourists do. So I think that’s not the biggest impact; it is more this other side which is going to be critical for business to continue to grow, and that will be the one that could actually impact our growth.

Right.

So, some of the sources of growth that we’ve enjoyed in the last 12 months – durable spending up 12.5 per cent, renovations up nearly 20 per cent - a lot of that is due to the lockdowns, and that won’t be sustained. So we have to move to the next stage, which is the reopening of the economy and the normal drivers of our growth. I agree with Chris, that the issues around wages clearly could become quite a big deal for Australia, but I think that businesses will be looking through the current shortages and anticipating the reopening of the borders. But if we started to see developments suggesting that that lift in supply was a lot further off, then that might create further panic amongst employers, and lead to unwelcome wage increases now that could trigger all sorts of dislocations in the financial system.

So, we’ve potentially got a couple of stages here, right; where we’re seeing some good economic recovery now, really supported by the fiscal measures, very accommodative financial conditions. The closed borders at the moment may help to support that fuller employment target, and potentially some of the wages growth that we’d like to see, too; but there’s a limit to how far that can go before the borders open and actually enable the economy to operate at full function, as it were. Chris, is that in line with your views from the RBA? Do you kind of see those two stages and that need for the international [inaudible]?

Yeah. Talking about risks, one of the things I think has surprised us on the upside, really, through much of the past year, have been the very positive health outcomes that we’ve enjoyed, compared to what we might otherwise have feared and was originally built into our forecasts. So, I think that’s part of the reason why the economy has bounced back so rapidly, as many of the panellists have suggested. That’s a critical thing from here on; maintaining those positive health outcomes and confidence in people to get out and about. So, there’s this challenge between ultimately getting a sufficient number of the population vaccinated, doing that effectively, and then managing a process of opening up the borders in a way that you can still maintain that confidence in health outcomes.

So, it’s definitely a thing we all need to watch very closely, and is a risk. It’s been very beneficial so far that we’ve had such good health outcomes; that’s why I think the economy is in such good shape. But it’s something we just have to watch carefully.

Great, thanks, Chris. I’m going to shift topic a little bit now, and talk a little bit about market conditions that we’ve seen, and the views on where those longer term yields will be. During February and March, we really saw some significant volatility, and I think a real push as the markets were really testing that central bank commitment to that three-year point. So, that I think was settled down, and the messaging was clear, and that calmed down for a period of time. Since then, the three-year bond yields, actually if anything they’ve been a little bit below the YCC target. Are we still seeing some of those pressures and some of those expectations in the curve? Prashant, maybe you can talk a little bit about that.

If you have a look at the curves for the last three months, they’ve done pretty much nothing but track sideways. Since March to around now, it doesn’t matter which part of the curve you look at, whether it’s twos fives, twos 10s, fives 10s, 10s 20s, 10s 30s, it’s been pretty much tracking sideways. That’s not just something that’s been evident in Australia; it’s pretty much evident across the globe. So, that’s what we’ve seen overall. I think one of the things that ended up driving that big back-up in yields in the month of February was this idea that the markets were beginning to embrace this whole reflation narrative. But what really accelerated it was essentially the market acknowledging the prospects of wider vaccine developments going ahead. So, what we’ve had is a massive selloff, and what we’ve found is that pretty much whenever bonds have sold off to the magnitude that we had back in March … so if we had a look at the US 10-years for example, their deviation versus the 200-day moving average was virtually near extreme levels. There are nine other cases in the last 30 years where it’s sold off that sharply, and virtually in every instance, bond markets either tracked sideways or yields actually headed lower.

So, I think at the moment we’ve come to a point where markets have felt fairly comfortable in this whole reflationary thinking. They’ve accepted that inflation is probably going to be up there on the horizon; the focus is really now shifting to the short end of the curve, and that’s what we’re thinking as well. If you have a look at the moves on the curves at the moment, you’re not getting that selloff in the long end of the curve, even though virtually every print that we’re getting is telling us that price pressures are brewing. So, the markets are starting to get a bit itchy now, and they’re looking for a bit of direction from the central banks in terms of what they’re actually looking to do in terms of interest rates at the front end of the curve.

I think a positive development for Australia at the moment is the fact that we’ve got the term funding facility drawdown coming through; so that should lend to a flatter curve, and it should actually prevent yields from significantly spiking higher. But I think the next piece of the puzzle really rests on the Fed, and the markets are looking to see any signal that they’re looking to taper. If they are looking to taper, then potentially I think what we do get is yields probably edge higher, but we do get a flatter curve in Australia.

Thanks, Prashant. Clearly we’ve got a big decision coming up. Chris, I know you’re not going to be able to indicate on this, but obviously there’s a big decision coming up about whether or not the yield curve target will be extended from the current April 2024 out to November 2024. Bill, I think you’ve recently changed your view on this; do you want to give us some comments on what you’re currently expecting to see there?

Yes, Helen. I was strongly of the view that there was a strong case to extend. It was very much based around the Reserve Bank’s forecasts, and my interpretation of the decision to extend would be that the conditions necessary to raise rates were not likely to be there in the first half of 2024. But, if the bank believes that extending means that you can’t raise rates until 2025, then I think that they’ll decide not to extend. I think the other issue that’s quite important is the technical issue that you mentioned before, about volatility in the market in March. If they were to extend, they would continue to have two of the four bonds in the three-year contract that would be fixed; if they don’t extend, then they’ll only have one bond of the four fixed, and that provides a better hedging device and a more liquid market. So, I think that might be quite an important technical reason why they don’t extend. So, I think the combination of those two facts make it very likely that they will not.

But the point of course is that if they don’t extend, the creeping tightening that we get will continue. So, as the length of the bond that is set at 0.1 becomes shorter and shorter, that’s effectively a tightening of monetary policy. So, extending would have had an opportunity to reverse the tightening that’s been going on since October last year, and of course if they decide not to do that, that means that there’s a degree of tightening going on in policy.

To what extent can that be offset by a next stage of QE?

Oh, undoubtedly QE is stimulatory, and that’s why I believe that we will see a more flexible approach to QE going forward; but I think the governor will be very committed to giving guidance when he does his press conference after the July board meeting, to indicate that the bank is not tapering. The bank is still heavily committed to supporting this program; it’s just that this is a natural evolution towards a more flexible approach, and of course that’s exactly the way the US federal reserve runs their approach, and I think it’s a more efficient way to run QE. I think the initial introduction of QE, where it was a new policy, and the Reserve Bank told the market, “Well, we’re only going to do 100 billion; it’s not an open-ended thing”, it gave the market confidence and certainty. We’re beyond that point now, and I think now to adopt a more flexible approach but with clear guidance – it doesn’t mean that there will be a tapering – will be a good outcome at the board meeting in July.

Right. So, if we think about the set of tools that the Reserve Bank has been using – the term funding facility, near zero interest rates, yield curve control, QE, and of course strong forward guidance – the impact of TFF, even if the drawdowns stop at the end of June, the impact of that as we’ve heard will continue for some time. If the YCC bonds slowly tightens, there’s still a set of other tools; I guess what I’m hearing from all of you, really, is that we expect to see those tools still very actively used.

I might just call for questions at this point. We’ve got about 13 minutes left of this panel, so I’m certainly keen to hear questions and plenty of them. We love to hear questions from the audience, and we’ll take some of those from here on in. Maybe while we’re just waiting for some of those, I have some earlier questions. Prashant, you earlier said that you hadn’t observed the TFF actually directly incentivising business investment, and that that’s one of the links that we might have seen. If low borrowing costs don’t create that business investment, what do we think actually will?

That’s the conundrum that every RBA governor for the last decade or more has actually faced, and it’s essentially reigniting the animal spirits within the Australian economy. One of the benefits from the TFF has been the refinancing activity, and that’s shot through the roof. That’s directly fed into household balance sheets. I’m sure that businesses have been able to take advantage of the lower loans as well, but I think in terms of the growth, we just haven’t seen that. So, I think what we essentially need, is we just need consumer demand to remain strong. The pickup in house prices, construction, your whole activity within that sector is fairly positive, and it should lead to positive outcomes throughout the rest of the economy; but to the extent that the economy still remains closed, it probably means that employment prospects are probably looking a lot more positive. Wages will probably go up as well, and I think once you start getting a set of reinforcing factors, that itself might actually provide the animal spirits that we need to reignite spending.

Great, thanks for that.

Helen, if I could just take a little bit of correction from Chris, my view is that the TFF didn’t do a lot to boost business lending. I think we’ve seen business interest rates have been incredibly low for a very long time, and it’s more a demand thing than it was a supply thing. So, as the economy recovered more quickly than business was expecting, so whatever pick-up we saw in business credit was more businesses being prepared to borrow, rather than lenders being prepared to lend. I think it’s been very much the reluctance of businesses to borrow for a number of years now that’s held back business investment, rather than the supply of very cheap funding. But I still believe the TFF was a great policy.

Can I just make one brief comment on that, Helen? I think there has long been a tightness of supply affecting the availability of credit to SMEs, and we’ve talked about that at length. I think Bill’s right though, to the extent that probably businesses for certainly much of last year and early this year, even in the small business space, overall didn’t need a lot of funding; partly because they weren’t wanting to do investment, but also remember their balance sheets were benefiting from significant support, including from the government. Things like JobKeeper and other measures that were put in place. So, if you looked at measures of funding on hand, a lot of businesses had sufficient funding on hand. The other fact we know is that it’s quite often the case that businesses undertake investment using internal funds first and then they go and get the credit. So, I tend to caution, people shouldn’t look at business borrowing as an indication of future investment. Rather, that borrowing picks up as investment does, after a while, with some lag.

Makes sense. Thank you. One of the other questions I have is around TFF. Does anybody have a view on whether we expect to see banks starting to pay the term funding facility back early, or do we expect them to hang onto it for the whole three-year period? Anyone want to take that one?

Personally, I think they will hold onto it. It’s very cheap funding, and probably won’t be able to get anything like that sort of funding elsewhere. So, yeah, I would assume they’re going to hang on for the whole period. As it gets closer to maturing, maybe they will start to unwind it a little, just to break down the impact on the balance sheet; but definitely run close to the end, for sure.

Does that imply, perhaps, that there’s going to be something of a cliff effect, where suddenly there’s actually a huge funding replacement needed, and therefore a lot of people looking for a lot of funding in the market all at the same time?

I don’t think so. I think the banks are very good at prefunding, and will already be looking to term out their balance sheets and their funding curves. So, no, I don’t think we’ll have that. But you’re right; it could have occurred, but I just think the way that it’s been staggered, once again very cleverly, that we won’t have that impact.

So, we’ll probably see it sitting in the exchange settlement accounts all the way until the bitter end, potentially.

Yeah, exactly.

Great. Do others share that view? Does anyone have any different comments on that?

I definitely agree with that. The banks were able to borrow for a period of three years at below market interest rates. When you’ve got the cash at that low level of interest rates, there’s no real incentive to pay it back quickly; so I completely agree with what Anthony has said there. I think there’s always the risk that banks might actually look to pay back the loans early, but I don’t think so. I don’t think that’s really the case at the moment.

Thank you. I’ve got another question here, and this is probably more for Chris. Given that inflation targeting has not really worked for the last 10 years, is it time for central banks to consider other targets such as financial stability or employment?

Both of those are in our mandate, in any case. What we’re trying to do in achieving our inflation goals is to reach full employment, pull the unemployment rate down, and thereby increase pressures in the labour market that will lead to wage growth picking up, and hopefully that’s sufficient and substantial enough to push inflation into that two to three per cent range.

Maybe related to that, we’re starting to see some other central banks start to consider the housing market and housing pricing in their targets. That’s obviously not part of the RBA’s remit at the moment; is that a factor that you consider in your broader thinking?

Well, I think we’ve said quite a bit of this of late. We’re certainly very aware of what housing prices are doing. That does have a bearing on the outlook, through various channels, including the way it makes consumers feel, and their behaviours towards spending. But we’ve also said we do not target house prices, nor should we target house prices. The thing on the housing market side that we are looking at very carefully, in conjunction with other members of the Council of Financial Regulators, including APRA, is lending standards and trends in debt, and the growth of credit. So, we’re watching those things very carefully. We don’t feel that there’s been an untoward change in lending standards to date, but it is something we’re watching. We’re watching those trends in credit growth, and thinking carefully about those risks. But housing prices are part of all of that, but we don’t target them, nor should we.

Great. Thank you very much, Chris. I’ve got a question that’s come in for Prashant, and depending on how long this one takes, this might end up being our last question. Prashant, you mentioned that your expectations are for flatter Australian and US yield curves. What are you looking for that might make you reassess that view?

I think the outlook for flatter curves is probably something that will play out over the next one or two months, possibly. But then after that, I think what ends up happening is we have a lockstep, and the whole question is where we are in this whole inflation outlook. I think markets have grappled with the whole reflation concept. Growth is going to pick up, and prices are picking up, but the questions are really around how much they are going to pick up. I think that’s the second leg. So, I think the curves go flatter first, as they start to factor in the potential for other central banks, like the ECB, but more the Fed, to potentially taper. Once the markets have absorbed that, then the next leg is really the sticking phase, which is once again the price pressures being broadly spread out over the course of the economy. I think the pressures over it are starting to build.

If you have a look at COVID, there is pent-up demand from COVID. That’s the first thing. Second thing is that we are seeing price pressures pick up, and it’s very rare that once price pressures are actually increased, they’re very rarely given back. So, I think that’s the second thing. Then the third thing as well, and this is much bigger, is this whole idea of greenflation, which is environmental investment and factoring in the cost of pushing the economy towards a green future. I think that the costs of that are going to be quite large, and they’re going to be broad based across the economy as well. So, I think that’s something a bit further down the track, but I think initially, concept of tapering from other central banks draws the curve flatter as the front end lifts higher; but then once the markets are [inaudible], then the question is when do central banks begin raising rates. But before they actually start raising rates, curves will steepen first.

Prashant, thank you very much for that, and thank you to all of our panellists for joining me today. Thank you, Bill, Christopher, Anthony, and Prashant, for a really fascinating discussion. I really appreciate you taking the time to join us, and I’m going to hand back to you at this point, Laurence.

Thanks, Helen.

Thanks, Helen.

Thanks, Helen.

Thanks, Helen.