The Reserve Bank’s messy move last year to dump a policy aimed a repressing bond yields to nearly zero led to market dislocation and damaged the central bank’s reputation, a review has found.
The central bank on Tuesday released an RBA board review of an experimental policy targeting bond yields, which it introduced to shield the economy during the depths of the COVID-19 pandemic.
RBA governor Philip Lowe said in possible future shocks, the board would likely make different choices regarding a yield curve target.Credit:Louie Douvis
Under the policy, the RBA explicitly targeted a 0.1 per cent yield on three-year government bonds due to mature in April 2024. Alongside other “unconventional” policies, the target helped to drive down the cost of borrowing across the economy, including on fixed-rate home loans.
By late last year, however, the target lost credibility in the financial markets as bond investors bet inflation would force the RBA to raise interest rates earlier than expected. Yields blew out to far higher than the 0.1 per cent target, hitting a peak of 0.78 per cent.
In response to the surge in yields, the RBA ditched the target in November last year, arguing it did so because the economy was rebounding much more firmly than they expected.
Some have argued the episode dented the RBA’s credibility, and the central bank on Tuesday said this was an “open question,” arguing other central banks had also underestimated the strength of the economic recovery.
In a review of the program, the RBA said the policy had succeeded in driving down funding costs across the economy, pointing to the fall in fixed rates, and a jump in housing and business lending.
However, it conceded the exit from the program late last year had tarnished the RBA’s reputation and caused dislocation in the bond market.
“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 said.
The review comes as the RBA has faced criticism from some quarters over its moves to give much more explicit guidance about interest rates during the COVID-19 pandemic – including governor Philip Lowe repeatedly saying he thought the cash rate would stay at 0.1 per cent until 2024.
Amid surging inflation, Lowe dumped the guidance and has raised interest rates in the last two months, and signalled the RBA will increase the cash rate further this year.
In a speech on Tuesday, Lowe said that if the economy faced a similar future shock, the board would be likely to make different choices regarding a yield curve target, but it would not rule out using such a target again in some form.
“With hindsight, it can be argued that there was too much focus on the downside risks to the economy and the need to insure against them, and too little focus on the possibility that things could work out better than expected,” Lowe said.
“But in real time, in which decisions had to be made under great uncertainty, the review notes that the focus on the downside risks was understandable.”
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