Sunday, 28 Nov 2021

What will the Reserve Bank do with $55b in NZ Govt bonds now that QE is over?

The Reserve Bank’s quantitative easing (QE) bond-buying programme finished in July, so what will the central bank do with the $55 billion in Government paper it picked up in the process?

The central bank embarked on QE for the first time ever in March 2020, having earlier cut its official cash rate to 0.25 per cent from 1 per cent as the country went into its first Covid-19 lockdown.

The objective of QE – also known as money printing – was to put downward pressure on long-term interest rates at a time when the required fiscal response would likely have done the opposite.

The Reserve Bank stopped buying in July, but the bonds purchased have maturity dates going out as far as 2041.

ANZ strategist David Croy said that while the time-frames are very long, the portfolio will need to be managed, and how that is done will be important for the financial markets.

In August, the Reserve Bank’s Monetary Policy Committee directed staff to come up with an operational strategy to manage the large-scale asset purchase (LSAP) portfolio, and the bank may update the market on this matter at Wednesday’s monetary policy statement.

Croy expects the next step to be the publication of a broad-based “principles” document.

“We expect this to outline the order in which unconventional policy will be unwound, and how that will occur,” Croy said in a research paper.

The key issue for financial markets will be whether the Reserve Bank intends to sell down its bonds, let them mature, or partially reinvest the proceeds.

Croy says that for a variety of reasons, the risks look skewed towards combinations of the latter, and that’s likely to place less stress on the bond market going forward than a sell-down.

“Unwinding the LSAP portfolio will have to be done in a flexible and pragmatic manner, with decisions dependent on how the economy and bond markets evolve.

“These are unknowns at this point, and as such we are not expecting any firm commitments until late 2022 or early 2023.

“We don’t think the LSAP portfolio will be a permanent feature of the markets landscape, but it could be with us for some time, with the global experience suggesting that getting out of QE gracefully is a lot harder than getting in,” he said.

Unwinding QE, known as quantitative tightening (QT), tightens financial conditions, and may thereby also reduce how high the official cash rate needs to go, Croy said.

“QE helped ease financial conditions, made it easier for the Treasury to issue bonds, likely kept the exchange rate lower than it might have been otherwise, and importantly, added significant liquidity to the banking system,” Croy said.

“In our view, these are bonds that it would ideally not own.”

In a “proper” functioning financial system, no central bank would ideally be a long-term holder of government bonds or find itself financing the government directly or indirectly.

“However, given the size and term of the bond portfolio, running it down isn’t something that can be done quickly,” he said.

Croy expects the Reserve Bank to be flexible in its approach to running down the portfolio.

Last August the committee said its separate Funding for Lending Programme (FLP) – which allows banks access to funding at the prevailing official cash rate – will remain in place under its current terms until the drawdown window expires next year.

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