It’s been just over a month since the Reserve Bank of Australia (RBA) enacted drastic changes to its monetary policy framework and approach. In this note, we review the changes that were made, and provide some insights into the likely implications of the new policy framework.
What has happened to the cash rate?
The RBA reduced its target for the cash rate by 25 basis points on 19th March 2020. The new target cash rate is 0.25 per cent, and this is its terminal value. In making their final conventional policy easing on 19 March, RBA Board members were clear: "Members also agreed that the cash rate was now at its effective lower bound. Members had no appetite for negative interest rates in Australia."
If we are at the effective lower bound, why are bank bills trading under the cash rate?
For over 20 years, the RBA's approach to monetary policy implementation has been to use its domestic market operations to ensure that the actual overnight interest rate traded in the cash market was in line with the Board's guidance. However, one side-effect of its recent policy framework changes was a large increase in excess liquidity for the banking system as a whole. This excess liquidity has placed downward pressure on short-term market-determined interest rates, including the overnight cash rate, bank bill yields, and government bonds. The RBA no longer intervenes to ensure that the actual overnight cash rate trades around its target level. As we had expected, the actual overnight cash rate and BBSW have both tended to gravitate towards 0.10 per cent, which is the deposit rate that the RBA now pays banks on their excess cash.