• The Reserve Bank of Australia (RBA) is meeting on Tuesday, and is expected to make a major policy decision.
• Governor Philip Lowe is due to take the irregular step of speaking at 4 pm, and is anticipated to explain a change in the RBA’s strategy amid Australia’s developing recovery.
• With Sydney still in lockdown, analysts expect the RBA to avoid rolling back easy monetary policy too quickly, but instead announce greater flexibility in its quantitative easing (QE) program.
• Visit Business Insider Australia’s homepage for more stories.

The Reserve Bank’s experiment with ‘unconventional’ policy tools has run for almost 18 months, but it cannot keep the monetary party going forever.

The official cash rate sits at just 0.10%, while the central bank is buying up billions of dollars worth of bonds each and every month, flooding the economy with cash via its program of quantitative easing (QE).

The easy money has helped equity and property markets boom, and cut households some financial slack, freeing them up to spend and stimulate businesses further.

In a bid to shore up confidence, it has promised to keep the good times rolling for years to come. But with the RBA due to meet on Tuesday, and with Governor Philip Lowe to speak shortly after, markets are sensing a major change is coming.

“With the labour market improving rapidly and global markets beginning to look ahead to central bank tightening, there are increasing expectations that the RBA will need to move away from the current level of very easy monetary policy settings earlier than expected,” ANZ economist Adelaide Timbrell said.

“At the same time, the recent lockdowns in major Australian cities highlight the downside risks of premature tightening.”

RBA expected to change its QE approach

As a result, the RBA is expected to try and keep its options open and strike an optimistic note as threats to Australia’s recovery begin to grow again.

“The RBA has a natural incentive to sound dovish to avoid tightening financial conditions, given rising COVID-19 lockdowns, closed borders and abating fiscal tailwinds,” Morgan Stanley’s equity strategy team wrote in a note.

Analysts largely agree that Tuesday’s meeting will see the RBA looking to become increasingly flexible on how it implements an open-ended QE program.

“The RBA is also anticipated to announce a shift from a multi-month bond buying commitment – i.e. $100 billion over 5 months – to a more flexible monthly commitment – i.e. $20 billion per month, or $5 billion per week – which would be more in line with the [US Federal Reserve’s] current approach,” BetaShares chief economist David Bassanese said, noting “Australia’s low vaccination rollout makes the economy now more vulnerable to COVID than the United States.”

“Like the Fed, this will give the RBA scope to glacially slow the rate of bond purchases over time, with hope that this will also feel to the market like it’s being flogged with a wet lettuce leaf.”

ANZ economists meanwhile agree bond purchases will be made flexible, but anticipate the amounts will remain unchanged until being reviewed later this year.

All eyes meanwhile be on Lowe’s irregular Q&A session, which is expected to be more telling than the monthly monetary statement.

Interest rates to be raised – but not yet

While no one expects the RBA to hike rates this week, few anticipate it will actually be able to hold on until 2024 to do it, as the bank has suggested.

It has already begun adjusting its monthly messaging around that pledge, as the probability increases of an earlier hike.

“The RBA has been calm and projected medium term smooth sailing. That will be until it isn’t,” global fund manager Van Eck said in a new note published on Monday. “The RBA has a track record of sitting on a view, then turning suddenly over two months. Investors should be cognisant of this.”

It demonstrates how little control the RBA has at the moment, as its decision making is buffeted by sporadic lockdowns, whatever tact the US Fed takes overseas, and the size and value of the Australian property market.

The RBA has helped inflate the housing market

Coupled with the RBA’s mentality of ‘treading softly’, it’s unlikely the central bank is going to do anything especially drastic on Tuesday.

But nor can it maintain the current policy settings forever, as the symptoms become more and more pronounced. Record lending and property prices have helped fuel each other to new highs.

An OECD report last month found Australian households have more mortgage debt than almost any advanced economy. As property prices continue to soar, outstripping wages by a factor of ten to one, and interest rates rise, the major concern is whether Australians will be able to service it or whether some will be forced to default instead.

“Alongside forced savings, fiscal largesse and rock bottom interest rates have, unsurprisingly, triggered another whopping housing bubble. The RBA continues to publicly proclaim themselves comfortable but it’s hard to believe they would be so positive in private,” global fund manager Van Eck noted in a note issued on Monday.

“Either way, they’ve done nothing publicly to hose it down. Indeed, they’ve gone the other way, claiming loan quality is fine so there’s nothing to see here.”

Although significantly it has also laid the groundwork for a possible intervention, issuing warnings via the Council of Financial Regulators (CFR) that behind closed doors it is at least considering next steps.

How rising interest rates might impact the market

Again, the RBA is cautious not to move too quickly, concerned not to startle the market or abruptly cut off credit to Australia’s $8.1 trillion golden goose.

But there is no question over the fact that the central bank will have to raise rates again at some point, with Commonwealth Bank economists tipping the cash rate to hit 1.25% by the third quarter of 2023.

Currently, households are spending 3.1% of their income on interest payments versus a decade average of 4.9%. CBA expects an interest rate of 1.25% would see this jump back to 5%.

At any rate, fixed mortgage rates are already rising without the input of the RBA, and are likely to only continue rising in the coming months.

“There have already been some subtle changes to fixed rate mortgages, this at the margin should slow the demand for new loans which will take a little heat out of the housing market and house prices,” CBA economist Belinda Allen said.

“We have also seen some banks move to lift the floor interest rate on which new loans are tested against. The highest new floor rate is 5.3%. This could start to see the amount new borrowers can receive start to fall, although most borrowers do not borrow to capacity.”

Allen note this represents “another developing headwind for the housing market” and could potentially help ease pressure on financial regulators to intervene.

However, Allen does not expect real interest rates will rise in the short term. She argues that rising rates will be offset by the fact that around one in three loans are now fixed, versus one in five prior to the pandemic, according to CBA.

Many new loans are fixed under 2%, giving many borrowers a decent runway before they’ll have to face the consequences of rising rates. So too will rising wages and savings buffers offset interest rate pressure.

But the fact remains that they, and all of Australia, will eventually. The RBA looks set to slowly be acknowledging this reality, as it begins to rejig policy and reconsider its options.

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