RBA can’t – and shouldn’t - cover up their costly bungling

Andrew Brown

On 21 September 2021, the Reserve Bank of Australia released its “Review of the Bond Purchase Program”*, an internal review of the RBA’s decision to purchase ~$281billion of Australian Government ($224 billion), State Government and territory  bonds ($57billion) between November 2020 and February 2022.

The aim of this program was to lower yields on bonds – interest rates - right across the maturity spectrum out to 10years, providing stimulus to the economy by reducing the price of money; the program was initially a considered response to economic difficulties caused by the authorities’ response to the rolling impact of various COVID strains.

In my opinion, the “considered” response evolved into something far less controlled, and resulted in a Reserve Bank Governor (Dr. Phillip Lowe) becoming far more unjustifiably interventionist than seen in decades.  Rather than letting the markets set the price of money, Lowe decided the RBA knew best – but then helped to precipitate an asset price boom – notably property – which is having dramatic social consequences, the outcome of which is not yet fully known. 

I was not alone in mid-2021 in noting that the requirement for the RBA to continue these measures didn’t exist: residential property prices surged by 6.7% in the June 2021 quarter and a further 5.0% in September 2021 to record an annual growth of nearly 22%.  This bubble is rapidly unwinding, and as any economist will tell you, trying to estimate the wealth effect – plus or minus - is fraught with difficulty. 

Whilst the Russian invasion of Ukraine exacerbated a number of inflationary impulses such as freight rates and supply shortages, these were already evident in many countries.  US CPI measures – which were above 5% in August 2021 had galloped to 7% by 2021 year end. 

As 2021 evolved, in my opinion, Dr. Lowe (and the RBA Board and internal advisers) started to become far more intransigent and defensive in their views – which have ultimately turned out to be misplaced.  For example, in a 16 November 2021 speech^, Dr. Lowe especially focused on the lack of wages growth in Australia versus elsewhere as not providing an inflationary pulse, and reinforced: 

“I would like to repeat a point I made a couple of weeks ago – that is, the latest data and forecasts do not warrant an increase in the cash rate in 2022. The economy and inflation would have to turn out very differently from our central scenario for the Board to consider an increase in interest rates next year. It is likely to take time to meet the condition we have set for an increase in the cash rate and the Board is prepared to be patient.”

Of course, for reasons utterly divorced for the obsession with wages growth, the economy and inflation turned out way differently to the erroneous “central scenario”: annual CPI growth of 3.7% to December 2021, 6.1% to March 2022 and 6.1% to June 2022.

The tenor of Dr. Lowe’s comments during 2021, in my opinion, became increasingly disturbing – culminating in the misjudged 16 November conclusion to his speech.  I would attribute the reason for this to his frustration at the divorcing of market views from those of the RBA, reinforced by his internal advisers.  Groupthink? Ultimately, of course, the market won hands-down. 

The cost to the country is significant, but as is the case with an institution under pressure, there is a significant amount of “backside covering”; the Review of the Bond Purchase Program is full of internally generated RBA academic econometric guff to justify the benefit to the economy from its losses.  There are areas (below) it dare not touch.  

The most transparent loss for the RBA was its decision to maintain the 3 year bond rate at 0.1% via the purchase of the April 2023 and April 2024 Government bonds; under market pressure, this was discontinued on 2 November 2021.  By that time, the RBA owned over 60% of the April 2024 bond and close to 40% of the April 2023 bond.` On my estimates, their average entry price for bonds which are redeemable at $100 was $110 for the 2023 bond and $108 for the 2024 bond.  The capital losses on these bonds amount to around $2.7billion (before coupon interest offsets).  At least the RBA fessed up to:

“The target was met for the bulk of the period, but the exit in late 2021 was disorderly and associated with bond market volatility and some dislocation in the market. This experience caused some reputational damage to the Bank”. ^^

The RBA’s methodology of calculating the cost of the total bond purchase program concedes a loss of $19billion from purchase price of the bonds versus redemption, after accounting for coupon income, plus the future cost of funding the program as the bonds gradually wind down to maturity by 2033, which depends on interest rates.  The mid-point of the RBA’s various scenarios suggests a forecast loss of ~$46billion.

The two RBA reviews rightly point to the lower interest rate benefit of the bond buying programs and yield curve control.  But in my opinion, the lower rate “benefit” was far too large, was sustained for too long and as it has unwound into a scenario the RBA did not contemplate, has caused significant pain for borrowers as rates have risen sharply.  

That the word “property” does not feature even once in this recent review, suggests the conclusions reached by the RBA are unsatisfactory and arguably self-serving. To not even contemplate that they assisted in causing a residential property asset bubble of immense proportions, suggests to this correspondent that a review of the institution is well overdue. 

The latest RBA review, as does much of the work emanating from RBA in the past two years, drips with “groupthink”.  Any business school student of recent years knows the standard example for discussing and identifying groupthink: The Space Shuttle Challenger Disaster of 1986.  Let’s hope that not the outcome for our residential property market. 

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Andrew Brown is Executive Director at East 72 Holdings Limited. This is his opinion only and does not necessarily reflect the view of ausbiz or its employees.

* Available at rba.gov.au

^ “Recent Trends in Inflation” to Australian Business Economists 16 November 2021 by Dr Philip Lowe

` “Review of the Yield Target” RBA 21 June 2022 (available at rba.gov.au)

^^ ibid