When the Reserve Bank increased the cash rate target to 35 basis points earlier this month, the interbank overnight cash rate rose to 31 bps in response and that is where it has stayed.
RBA assistant governor (financial markets) Christopher Kent addressed this issue in a speech yesterday at the KangaNews DCM Summit, where he detailed the central bank’s move from quantitative easing to tightening.
Kent said one of the consequences of the RBA’s bond purchasing program and other policy measures in response to the pandemic, is the abundance of exchange settlement balances.
These are held by commercial banks and other financial institutions at the RBA and are used to settle transactions between banks. Banks can also lend them to others in the overnight cash market, with those transactions determining the cash rate.
Kent said: “As expected, the abundance of ES balances led to a noticeable decline in the demand to trade cash overnight. It has also been unsurprising that the cash rate has traded slightly below the cash rate target since late March 2020.
“While ES balances will decline as the various monetary policy measures adopted during the pandemic unwind, that process will take a number of years.”
He said the RBA board has considered options to reduce ES balances more quickly, giving the banks more incentive to borrow funds overnight and causing the cash rate to trade up to the target rate.
“The benefits of reducing ES balances more quickly were judged to be modest compared with the risks, including the potential to create volatility in a range of financial markets. In the current environment, the modest difference between the ES rate and the cash rate target helps to ensure effective control of the cash rate.”
Under the bond purchasing program, the RBA acquired around A$224 billion of Australian government securities and $57 billion of semi-government securities. By February 2022 it held around 35 per cent of Australian government securities on issue.
Kent confirmed that the RBA will not sell bonds, rather holding them to maturity. By April 2024, about $47 billion worth of bonds will have matured and the last of them will mature in 2033.