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Australia's continual need for QE

Following the RBA's reduction of the cash rate to 0.1%, they were running out traditional ammunition to support the economy through COVID, as such implemented quantitative easing through yield curve control (YCC), targeting the 3 year AGS. After some early problems when the market questioned the credibility of the RBA’s commitment to QE, the policy has increasingly become a striking success. Before the RBA launched QE, Aussie 10-year interest rates were more than 30 basis points above US 10-year rates. At one point, that excess jumped to around 45 basis points. Today the difference has fallen back into the single-digit range.

This has helped keep the Aussie/US dollar cross (trading below US76c) and Australia’s trade-weighted exchange rate about 5 per cent lower than they would otherwise be, which is helping both exporters and local producers that have been struggling due a combination of being outcompeted by comparatively cheaper imports and ongoing restrictions imposed due to the continual trade war.

However according to experts, it's resounding success has been accompanied by a series of potential problems regarding the long term stabilisation of the Australian economy. In the process of YCC, the central bank currently holds about half of pandemic debt issued by the federal government, causing it become involved in both fiscal and monetary policy. Furthermore, due to the aforementioned lack of traditional monetary policy ammunition, long term stabilisation will have to be driven by fiscal policy. However, this comes into conflict with the government's target 3% of GDP budget deficit by 2023, as this target will require a decrease of 8% of GDP ie a contractionary stance. Therefore, the combination of monetary and fiscal policy have small wiggle room to implement the changes required to further accelerate the economies recovery, consequently increasing the importance of changes in unemployment and wage growth.

In the minutes of March's RBA meeting, members discussed the current state of employment in the economy. Employment had continued to recover to be around ½ per cent below its pre-pandemic level. However, much of the increase in employment in preceding months had been in Victoria following the easing of pandemic-related restrictions. The end of the JobKeeper program was seen as unlikely to result in a sustained increase in the unemployment rate. The number of people working zero hours in Australia had declined significantly in recent months to be close to pre-pandemic levels. In addition, some JobKeeper recipients, including the self-employed, were more likely to suffer a decline in income than lose employment at the end of the program. Many firms in receipt of JobKeeper subsidies had already reduced the size of their workforces and were not planning on another large round of lay-offs. Therefore, whilst unemployment is well on the way to recovering to pre-Covid levels, wage growth remains lower than it looks as wags continue to recover to pre-Covid levels.

In conclusion a third round of QE is all but certain in October this year with the high-probability case that the RBA maintains the current run-rate of buying $100 billion of bonds every six months. Any diminution of the RBA’s commitment to QE is likely to force the Aussie dollar much higher which will only negative impact the economy. Long term stabilisation will remain a gradual process as unemployment and wages recover.

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