Episode Details

If Australia slips into a recession, it will mostly likely be the RBA’s fault. They have completely botched the management of interest rates to the detriment of borrowers, the economy, and the bond market. Here’s why…  

In its defence 

Firstly, in the RBA’s defence, is has been navigating uncharted territory over the past 2.5 years. There was a lot of uncertainty about what damage a once-in-a-lifetime global pandemic could cause. At the beginning, no one knew how long lockdowns would last for or whether pharmaceutical companies would ever be able to formulate a vaccine. There was a lot of uncertainty and no pandemic experience to guide decision making. 

Secondly, the RBA did react very quickly with some good initiatives as soon as Covid hit in March 2020, namely: 

§  It slashed the cash rate by 0.75% in March 2020 and then by 0.15% in November 2020, so that the cash rate was ostensibly zero (target rate was 0.10%). 

§  It launched its Term Funding Facility where it ended up lending $188 billion to the banks at a fixed rate of only 0.10% for 3 years. The banks used this facility to offer customers very cheap mortgage fixed rates – often below 2% p.a. – which gave borrowers confidence and improved household cash flow during what was a tumultuous period. The RBA closed this facility in June 2021. 

§  It also participated in what’s called yield curve control. This means it actively participated in the bond market to maintain the 3-year bond rate at 0.10% (the cash rate), often through buying government bonds i.e., QE.  

All three of these measures were appropriate, timely and necessary.

What it did wrong 

In my view, the RBA made three critical mistakes. 

Firstly, the RBA’s Governor, Lowe adopted the unusual practice of providing forward interest rate guidance. Up until last year, Lowe relentlessly assured Australians that the RBA would not raise rates until 2024. Yes, he did say that his prediction was conditional upon the RBA’s economic expectations, which did not include higher inflation at the time. But my point is that historically, the RBA says very little and lets the free market decide what the future holds. 

Secondly, it began raising the cash rate too late and it’s probably hiking it too quickly. I think it was obvious by the first half of 2021 that the Australian economy was very resilient. Sure, lockdowns did cause some economic pain, but as soon as they were lifted, spending bounced back strongly. It has now aggressively increased rates by 1.75% in only four months. The RBA has only done that once before where in 1994 it increased rates by 2.75% over 5 months. It’s aggressive. Perhaps too aggressive.  

Finally, without much warning, it abandoned its yield curve control which crashed the bond market! When the RBA first initiated yield curve control, it only took 11 days and purchasing $27 billion of government bonds to get the 3-year bond rate to equal the cash rate i.e., 0.10%. After that initial intervention, the RBA didn’t have to do much at all. However, in July 2021 it announced that it would be winding back its yield curve control and completely abandoned it in late October 2021. Consequently, between September and early November 2021, the 3-year bond rate increased 10-fold i.e., jumped from 0.10% to above 1.00%! This caused bond values to crash and increased borrowing costs for banks and corporates. 

Why Australia is different to the US 

It is true that other developed countries have been raising interest rates quickly too. The US Federal Reserve has hiked rates by 2.25% this year so far. And the Bank of England has hiked ra

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