The rate that stops the nation

In a result that was easier to predict than today’s Melbourne Cup winner, Reserve Bank of Australia (RBA) Governor Philip Lowe has today announced a raft on conventional and unconventional measures to help support the economy through the devastation that has been caused by the COVID-19 recession. In terms of conventional monetary policy, the RBA lowered the Cash Rate to an historic low of only 0.10%. In terms of unconventional monetary policy, the 3-year government bond yield target has been reduced to 0.10%, the $200bn Term Funding Facility fixed rate has also been reduced to 0.10%, and Exchange Settlement balance interest rates were moved to zero. Lastly, but certainly not least for markets, the RBA will buy $100bn of government bonds of maturities of around 5 to 10 years over the next six months.

Today’s easing was well flagged to markets following a number of speeches from RBA officials in recent weeks. Extraordinarily, RBA Governor Lowe changed the RBA’s inflation target in September to actual (not forecast) CPI. In addition, there is now greater emphasis on the labour market, with Lowe recently stating that the RBA Board wants to “…see more than just ‘progress towards full employment’.” This shift in the inflation target confirms a significant shift in the RBAs approach to managing the economy through monetary measures, indicating interest rates will remain at ultra-low levels for a considerable period of time.

Geographically, Australia is an island, but when it comes to the Australian economy we are firmly entwined with the prospects for global growth. As Covid-19 cases have accelerated offshore and lockdowns have begun to be implemented across the world, central banks have continued to ease monetary policy further, resulting in an unwelcome rise in the Australian dollar. Australian bond yields have also been elevated relative to international peers, reflecting the RBA’s hesitancy until today in pursuing a specific dollar target for government bond purchases of a longer maturity. Essentially, the RBA has been dragged along to the unconventional monetary policy party, and it isn’t happy to be there.

There are a number of significant implications for investors as a result of today’s announcement. Firstly, the RBA’s balance sheet is likely to expand significantly, underpinning the government bond market and putting further downward pressure on yields. Secondly, funding costs for State Governments will also likely fall significantly, enabling State Governments to undertake further fiscal easing. Thirdly, the Australian Dollar will likely weaken in the months ahead, providing support to the medium-term recovery of the Australian economy.

In an environment of historic-low bond yields and ultra-easy monetary policy, investors are being encouraged into riskier asset classes to reach for returns. Whilst it isn’t clear what the impact will be on consumer price inflation, international experience with quantitative easing suggests that the appetite for riskier financial assets will be maintained. This will likely support Australian equity valuations, and additionally encourage investors to look for opportunities in emerging markets and Asian equities in the global hunt for returns.

This material is issued by FIL Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 (“Fidelity Australia”).  Fidelity Australia is a member of the FIL Limited group of companies commonly known as Fidelity International.

Prior to making an investment decision, retail investors should seek advice from their financial adviser. This material has been prepared without taking into account your objectives, financial situation or needs. You should consider such matters and seek professional advice before acting on the information contained in this material. While the information contained in this material has been prepared with reasonable care, no responsibility or liability is accepted for any errors or omissions or misstatements however caused. This document may include general commentary on market activity, sector trends or other broad-based economic or political conditions that should not be taken as investment advice. This material may contain statements that are "forward-looking statements", which are based on certain assumptions of future events.  Actual events may differ from those assumed. There can be no assurance that forward-looking statements, including any projected returns, will materialise or that actual market conditions and/or performance results will not be materially different or worse than those presented. Reference to ($) are in Australian dollars unless stated otherwise.  This material may not be reproduced or transmitted without the prior written permission of Fidelity Australia.

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