July RBA minutes set up for QE-taper reversal

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As was foreshadowed by AFR Kehoe’s article, the July RBA minutes confirm that the 6 July decision to taper bond purchases was a close run thing. It follows that they open the path for a QE-taper reversal the their 3 August meeting.

The minutes note that “an argument could be made to retain the pace of bond purchases at 5bn per week, given that economic outcomes were still well short of the Bank’s goals for inflation and unemployment” (my emphasis). The upgrade won the day, and the bank decided to slow the pace of purchases by 1bn per week to 4bn per week — but the linking of the taper to the upgrade makes it straightforward to unwind the decision when they downgrade in August.

Given the current COVID outbreaks, and consequent lockdowns, the upgrade in the August SOMP that seemed almost certain on 6 July has become a downgrade, as Q3 GDP will be negative.

My confidence in this is rising: as I write, Victoria has extended their current lockdown for a week and South Australia has started their own lockdown (an initial seven days). So the negative in Q3’21 is likely getting larger.

The minutes also lay out the case for freezing YCC at the April 2024 bond. The logic was entirely economic and (importantly) can be played in reverse.

Given the economic upgrades, the envelope of potential cash rates paths had widened, such that it was more likely that the cash rate would rise in 2024.

It follows that sufficiently large downgrades would compress the envelope of likely cash rate paths (around zero) in 2024, and that an extension to November 2024 may then occur. The necessary condition seems to be that the probability of the cash rate increasing during the YCC period is “extremely low”.

The downside case in the May SOMP would have been consistent with a YCC extension to November 2024. Should the current lockdowns deliver an economic outcome that’s in the ball-park of that scenario, an extension of the YCC bond to the November 2024 bond would make sense.