Yesterday afternoon the Reserve Bank of Australia announced that it will hold the official cash rate (OCR) at 0.1%. The rate has remained at this record low for 4 consecutive months now.
RBA's justification for holding rates
As outlined in the statement provided by RBA Governor Philip Lowe, the global economy is now in a more promising position than it was a few months ago. The ongoing rollout of vaccines is creating less uncertainty looking forward.
Governor Lowe also acknowledged the increase in global trade and commodity prices. However, the recovery remains highly contingent on COVID-19 and global monetary support.
The improving unemployment rate and increased spending also indicate a strengthening economy for Australia. Lowe also expects the recovery to continue, enabling gross domestic product (GDP) to return to pre-COVID levels by the middle of this year.
On the flip side of the coin, wages and pricing are expected to remain dampened. Governor Lowe provided further comments on wages and the job market:
Further progress in reducing spare capacity is expected, but it will be some time before the labour market is tight enough to generate wage increases that are consistent with achieving the inflation target. In the central scenario, the unemployment rate will still be around 6% at the end of this year and 5.5% at the end of 2022.
The continued low rate environment has aided in a booming property market. In February, property values experienced their fastest growth in 17 years, as reported by The Australian Financial Review. This illustrates the tight rope the RBA is attempting to walk. On one side it is trying to provide liquidity to markets to avoid collapse. While on the other hand, it is attempting to hold rates down to postpone an increase in financing costs.
Buying bonds like it's going out of fashion
The RBA clarified it maintains its current $200 billion bond-buying quantitative easing program. This comes after the RBA recently provided additional liquidity to the bond market to assist with proper functioning during a sell-off. The concern with bonds selling off is the declining price results in a higher yield. As a result, the 10-year bond yield shot up to 1.95%.
To ensure that the real rates yield conformed to the RBA's intended low rates, the central bank doubled down on Monday. This resulted in the purchase of $4 billion worth of bonds.
Further comments in Governor Lowe's statement indicated that the bank would be prepared to make further adjustments as needed. Bond yields swiftly jumped following the statement yesterday afternoon.
Bond yields rise in response to RBA suggesting it could do more… pic.twitter.com/3NZwMSWyua
Alex Joiner (@IFM_Economist) March 2, 2021
Astoundingly, by the end of August, the central bank is expected to hold $221 billion in bonds. This would represent around 25% of the total outstanding bond market.
Rising rates could hit shares hard
As we reported earlier this morning, billionaire investor and head of Magellan Global Fund (ASX: MGF), Hamish Douglass, voiced his concerns about rising rates. The gist of Mr Douglass's concerns centres around the market having priced in record-low rates for a long time.
That fact is, with near-zero returns from the cash market, many investors have shovelled their funds into the share market. If rates were to rise, the willingness to pay historically high earnings multiples for shares would likely diminish. In plain terms, it wouldn't be pretty. Mr Douglass provided cautionary by commenting, "If you raise interest rates to head off a real inflation threat, then hang on to your chairs."
However, the RBA remains steadfast that real rates won't be allowed to rise until 2024.
