The Australian dollar jumped as the Reserve Bank of Australia (RBA) stuck to its bond taper plan despite the ongoing COVID-19 lockdowns.
The RBA held interest rates at a record low 0.1% today and reaffirmed it will cut purchases of government bonds to $4 billion a week in early September from the current rate of $5 billion.
The Australian dollar to US74 cents from US73.7 cents on the news. This is because the market was expecting our central bankers to stick to the bigger bond buying program for longer due to the economic impact of the lockdowns.
QE taper lifts the Aussie but not ASX shares
Bond buying, or Quantitative Easing (QE), by the central bank stimulates our economy but puts pressure on the Australian dollar. The curtailing of the program from next month is supporting the Aussie this afternoon.
By the same token, the S&P/ASX 200 Index (Index:^AXJO) lost ground after the RBA issued its decision. ASX shares and other risk assets thrive on high levels of monetary stimulus.
But the RBA's confidence should help calm investor nerves about weakening growth rates.
RBA interest rate decision unaffected by looming economic contraction
Queensland has joined our most populous state, New South Wales, in imposing harsh restrictions on movement due to rising cases of the more contagious delta-variant of the virus.
Australia's economy will almost surely contract in the September quarter, but the RBA is unfazed.
This is despite the fact that our monetary gurus have upgraded their inflation expectations. It even went a step further to flag the risk that their jobs forecast is wrong.
Inflation ticking up
"In underlying terms, inflation is expected to be 1¾ per cent over 2022 and 2¼ per cent over 2023," said RBA Governor Philip Lowe.
"One source of uncertainty is the behaviour of wages and prices at the low levels of forecast unemployment, including because it is some decades since Australia has sustained an unemployment rate around 4 per cent."
It was only last month that the RBA's central case was inflation to hit 2% in 2023. Still, the RBA thinks inflation won't sustainably return to its target band of between 2% to 3% until 2024.
Inflation risk vs. growth risk
Inflation has been a bigger source of uncertainty than the COVID lockdowns. Global bond prices have fluctuated wildly as inflation fears played tug-of-war with growth concerns due to delta.
But the RBA is striking an optimistic tone. It pointed out that Australia's economic recovery is stronger than expected – notwithstanding the rolling lockdowns.
"The experience to date has been that once virus outbreaks are contained, the economy bounces back quickly," said Dr Lowe.
"Prior to the current virus outbreaks, the Australian economy had considerable momentum and it is still expected to grow strongly again next year."
RBA taking glass-half-full view
The central bank believes Australia's gross domestic product (GDP) will grow by a little over 4% in 2022 and 2.5% the year after.
The RBA also pointed to the fast-rising residential property market. This is probably another reason why it wanted to taper its bond program in September.
Its optimistic view on the economy is predicated on Australia hitting its vaccine target. This target of around 80% is essential to permanently end the rolling lockdowns that everyone has grown tired of.
Let's hope the RBA is right!
