The Reserve Bank is making changes to its open market operations, its mechanism for proving liquidity to the banking system, switching to floating rates, changing the hurdle rate and shortening tenors.
RBA assistant governor Christopher Kent outlined the changes in a speech to the Australian Financial Association yesterday, saying the RBA was no longer targeting the quantity of liquidity provided through OMO and had switched its focus to the price of OMO liquidity.
The RBA made changes to the OMO in 2020 as part of its COVID response, increasing the size and lengthening repo terms.
The repo book grew from around A$20 billion in early 2020 to $100 billion by June of that year. Since then it has fallen to around $10 billion, which is below pre-pandemic levels.
Kent said: “This decline in the demand for liquidity from OMO makes sense. Exchange settlement balances rose significantly as a result of the Term Funding Facility and the bond purchase program.
“This substantial rise in banking system liquidity means that banks have less need to obtain short-term funds and much greater capacity and willingness to lend them.”
He said demand for liquidity from OMO is likely to remain low because TFF maturities run until June 2024.
Kent said: “Given the high level of system liquidity at present, most market participants find it relatively easy to source short-term liquidity without needing to use OMO. In this environment, it makes sense for the hurdle rate for OMO to be set above prevailing market rates in order to encourage market participants to use their existing liquidity or to tap into private markets instead.”
The RBA has already reduced the frequency of OMO activity from daily to weekly and shortened its preferred terms to between one and three months. The average term to maturity of new repos is currently around seven weeks.
The new floating rate will be based on the average cash rate target prevailing over the term of the repo. The RBA will consult with market participants before making the change.
The hurdle rate will change from the current cash rate target to the rate on term-matched overnight indexed swaps plus a spread. Initially the spread will be around 5 basis points and will be subject to change depending on market conditions.
Kent said: “Looking ahead to the time when short-term money market rates eventually rise, it will no longer be appropriate to continue with a repo rate that is determined based on the cash rate target prevailing on the day of the OMO.
“If the OMO repo rate were to be below short-term money market rates of an equivalent term, demand for liquidity at the Bank's OMO would rise noticeably, potentially leading to destabilising moves in other markets.
“The move to base the OMO repo rate first on OIS plus a spread, and in time to a floating rate based on the cash rate target, will avoid such a situation.”
The maximum tenor will typically be four weeks, although longer terms may be offered.
The shortening of tenors will take effect immediately, the new hurdle rate from the end of March and the move to a floating rate is yet to be determined.