The Reserve Bank has conceded that its exit from its three-year government bond yield target in late 2021 was “disorderly” and caused the bank some reputational damage.
In a review of its yield target, which started in March 2020 as part its COVID-10 response, the RBA also accepted that purchases to defend the yield target came at a financial cost given the subsequent rise in yields.
And while it argues that the yield target contributed to insuring against extreme downside risk by lowering funding costs and reinforcing other key elements of its package of COVID policy measures, it said it could have been ended the program earlier.
In March 2020, the RBA introduced a target for the yield on three-year Australian government bonds of around 25 basis points. At the time, the three-year bond had a maturity of April 2023.
The yield target was viewed as an extension of and complementary to the cash rate target, and the three-year maturity was chosen because of its importance as a benchmark rate in financial markets.
In September 2020 the RBA said it would move the yield target from the April 2023 bond to the April 2024 bond, and in November the target was lowered from 25 bps to 10 bps, in line with a reduction in the cash rate target to that level.
In November 2021, the RBA discontinued the yield target.
In its assessment, the RBA said the forward guidance implicit in the yield target helped to ease financial conditions.
In its decision-making the RBA paid close attention to the downside risks to employment and inflation, with a focus on providing insurance against very bad outcomes.
“In retrospect, a greater focus on the upside could have led to a decision not to extend from the April 2023 bond to the April 2024 bond or earlier removal of the target,” it said.
“Its effectiveness as a monetary policy tool waned as market participants reassessed their views on the outlook for the cash rate. In the later part of the targeting period, the transmission of the target to other interest rates in the economy weakened, with market rates of similar maturity moving materially away from the target government bond rate.”
In describing its exit as “disorderly”, the RBA was referring to the fact that in October 2021 the yield on the April 2024 bond rose as high as 77 bps, as a stronger than expected inflation number, an increase in yields globally and an absence of RBA buying were taken as signs that the target would be discontinued.
“In retrospect, given the evolution of inflation and the labour market, an earlier end of the yield target would have been appropriate. Any yield target should be short enough to sustain very high confidence that the target can be maintained.”
The RBA said the likelihood it will use a yield target again is low but it might be appropriate in extreme circumstances.
“It is likely that in the future, bond purchases would be preferred to a bond yield target. While a bond purchase program may not be as effective