The Reserve Bank of Australia (RBA) has admitted that the exit of the yield curve policy in November last year was “disorderly” and triggered bond market volatility and dislocation in the market.
“The experience caused some reputational damage to the bank,” the bank conceded in a report summarising its review into the use of the yield curve control policy, which was introduced in March 2020 as part of a comprehensive package to support the economy through the effects of the pandemic.
At the time, the bank announced it would keep buying enough government bonds to lower the cost of borrowing. This saw the bank peg the three-year bond rate to the cash rate target setting.
“The yield target was viewed as an extension of and complement to the bank's longstanding approach of targeting the cash rate, which forms the anchor point for the risk-free term structure, by targeting a risk-free interest rate further out along the yield curve,” the bank’s review said.
The RBA then abruptly dumped the policy in November 2021, signalling that it was moving towards lifting the interest rate from its record low 0.1 per cent.
“As a monetary policy tool, the yield target contributed to insuring against extreme downside risk by lowering funding costs and reinforcing the other key elements of the package of policy measures,” the bank said.
The RBA has now admitted that with the benefit of hindsight, the yield target could have been ended earlier.
“In retrospect, given the evolution of inflation and the labour market, an earlier end of the yield target would have been appropriate,” the bank said.
It conceded that the ending of the yield target was challenging for a number of financial market participants, including those that expected the target to be retained.
“As such, this experience could lessen the effectiveness of any future commitments of this nature by the bank,” it continued.
The RBA, however, seemingly defended its rash decision by reflecting on its global peers.
“Many other central banks have also been surprised by the strength in the economic recovery and inflation, with associated reputational costs and large movements in market prices as forecasts and the forward guidance based on them have not been met,” the bank noted.
Ultimately, it said, the degree of credibility and reputational cost from the yield target policy is likely to be determined by “longer-term outcomes” and “broader assessment of the package of policy measures and their effectiveness in contributing to attainment of the bank's goals”.
“The board views the probability of using a yield target again in future as low, but recognises that the use of a yield target might be appropriate in extreme circumstances, albeit in a form that incorporates the lessons learned from this experience,” it said.
‘Different choices in the future’
Speaking at an event hosted by the American Chamber of Commerce in Australia on Tuesday, the governor of the RBA, Philip Lowe, reflected on the bank’s decision, noting that while it did “help the economy recover from the pandemic", "these benefits did come with complications”.
“If similar circumstances were to arise in the future, the board would likely make different choices,” Dr Lowe said.
“It’s important to remember that at the time that the target was adopted there were credible forecasts that tens of thousands of Australians would die in the next few months, that the demand for hospital beds would exceed our capacity and that a vaccine would be years away. The unemployment rate was also expected to reach double digit levels, perhaps 15 per cent, and there were fears of a deep and long downturn, of scaring to the economy and that a generation of Australians would have years of lost opportunity,” Dr Lowe said.
But, he added, “in hindsight it can be agreed that there was too much focus on the downside risk to the economy.”
The RBA is expected to be subjected to an independent review shortly. Last month, some of Australia’s top economists penned a letter to Treasurer Jim Chalmers demanding that a review of the RBA be headed by an “internationally recognised foreign expert”.
“Full independence is crucial if the review is to make the most of this unique opportunity. No institution can be expected to independently or credibly review itself,” the group of 12 leading economists, including Deloitte Access partner Chris Richardson, leading independent economist Saul Eslake and Grattan Institute chief executive Danielle Wood said.
“A foreign perspective would bring valuable external scrutiny to the process and enable a benchmarking of the RBA against its overseas counterparts.”
The RBA has not been subject to a review since the early 1980s.
Maja Garaca Djurdjevic
Maja's career in journalism spans well over a decade across finance, business and politics. Now an experienced editor and reporter across all elements of the financial services sector, prior to joining Momentum Media, Maja reported for several established news outlets in Southeast Europe, scrutinising key processes in post-conflict societies.
