During this year, the Reserve Bank of Australia (RBA) has implemented extreme policy measures aimed at ensuring that the Australian economy recovers from the adverse impact of the pandemic. This has included targeting a 0.1% cash rate, purchasing government bonds (printing money) and targeting a 0.1% yield for the April 2024 Australian Government bond. With the Australian economy likely to improve materially over the next six months or so, the RBA recently announced that it has stopped targeting the bond yield. This article briefly discusses this policy change and its implications.
Chart 1 shows that the RBA has been generally successful in keeping the April 2024 bond yield at around 0.1% for most of the year. However, in late October, the RBA unexpectedly stopped defending this rate, allowing it to climb. The yield rose sharply recently to around 0.8% and Australian bond yields generally increased materially. At its 2 November meeting, the RBA indicated that it will no longer target the bond yield. This episode highlights that sharp moves in markets can occur when a central bank decides to move away from targeting a specified yield.
Why did the RBA stop targeting the bond yield? Chart 2 provides some clues. It shows two measures of inflation – headline inflation and a measure of underlying inflation. The chart shows that this is the first-time since 2015 that inflation is within the RBA’s 2% to 3% target band. The September quarter 2021 inflation outcome was also higher than markets and the RBA were expecting.
The RBA has indicated it believes that an interest rate increase in 2022 is unlikely, even though the market is pricing several increases next year. The RBA has suggested that a late 2023 rate rise is plausible.
In response to higher bond yields, some lenders have raised their fixed lending interest rates recently. In addition, APRA has indicated that it expects lenders will assess new borrowers’ ability to meet their loan repayments at an interest rate that is at least 3.0 percentage points above the current loan product rate. This compares to a buffer of 2.5 percentage points that was commonly used.
Higher interest rates and less borrowing capacity for home owners are expected to slow the housing market. Over the 12 months to 31 October 2021, Australian capital city house prices (5-cities index) increased by 23.8% according to CoreLogic. This is one of the largest ever increases in Australian house prices over 12 months.
Over the next six months, Australia is expected to move into a living with COVID mode. We anticipate that Australia will reach a very high level of vaccinations compared with many developed countries, which should materially reduce the chance of future lockdowns. Inflation is expected to remain within the RBA’s target range and eventually result in the RBA raising its cash rate from its current very low level. We anticipate that this will occur earlier than the RBA’s current guidance.
This information is general advice which does not take into account your personal financial objectives, situation or needs. Before making a decision about Vision Super, you should think about your financial requirements and consider the relevant Product Disclosure Statement issued by Vision Super Pty Ltd ABN 50 082 924 561 AFSL 225054 at www.visionsuper.com.au