(April 2): Australia’s central bank will act to ensure enough liquidity is available to keep the financial system running smoothly as billions of dollars of bonds it bought during the pandemic fall due, according to Assistant Governor Christopher Kent.

The Reserve Bank of Australia (RBA) will shift to having “ample reserves” as the balance sheet shrinks back toward pre-pandemic levels, Kent said in a speech at the Bloomberg Australia Briefing on Tuesday.

“I want to emphasise that this decision has no implications for the current or future stance of monetary policy,” said Kent, who oversees financial markets at the RBA.

“Rather, it is only relevant to the way in which we will achieve the desired stance of monetary policy through our operations. Nor does it have a bearing on the board’s current approach to quantitative tightening.”

The Bank of England, the European Central Bank (ECB) and the Swedish Riksbank have announced plans to make a similar pivot of operational frameworks as bonds they purchased during the pandemic to support financial markets mature. The ECB said its review of operational framework preserves its current system of steering interest rates while giving banks more say over how much liquidity they need to operate.

Kent’s remarks come as the RBA’s balance sheet is set to shrink by more than A$100 billion (RM308 billion) with bonds purchased during the Covid-era now maturing. A cheap funding facility provided to lenders during the pandemic expires at the end of June while a bond used for the yield-target programme during Covid will mature this month.

Under this framework, which the RBA board favoured over the current “floor” system or returning to a “corridor” approach, the RBA will provide a full allotment repurchase agreement or repo auctions for open market operations, Kent said.

The next steps the RBA will decide on include the pricing, frequency and other aspects of the repos, as well as what other instruments it might use to supply reserves, the assistant governor said.

The RBA signalled at its meeting last month that it has likely concluded its policy tightening campaign after raising the cash rate to a 12-year high of 4.35% in a series of steps since May 2022. When asked about monetary policy, Kent on Tuesday reiterated that “the interest-rate path that will best bring inflation down in a timely manner is uncertain”.

The RBA’s transition to “ample reserves” reflects a fundamental shift in how central banks implement monetary policy as they try to strike a balance between operating with a smaller balance sheet and reducing their footprint in financial markets, while avoiding liquidity shortages that may hurt financial stability and impair monetary transmission.

Huge amounts of cash are still sloshing around — excess liquidity in Australia is still more than A$300 billion, according to the RBA.

As the transition to the new system occurs, the RBA expects to see cash market activity increase, perhaps with some rise in the cash rate, and potentially some pressure in other money markets, Kent said.

“By design, however, any such pressures should, to a large extent, be tempered as banks naturally respond to higher market interest rates by borrowing more at OMO repo at the price set by the RBA,” he added.

The RBA raised rates 13 times between May 2022 and November last year. At the same time, its balance sheet remains sizeable, mainly due to the unconventional policy deployed to support the economy during the pandemic.

But a large proportion of the central bank’s A$527 billion in assets is now gradually rolling off — as the table below shows.

Kent said the RBA board sees a number of advantages with the planned new approach:

• Since the supply of reserves from the RBA will respond to changes in demand, it does not need to accurately estimate demand nor control the quantity of reserves; in short, it is simpler to operate than a scarce reserves or excess reserves system
• An ample reserves system reduces the risk of unnecessary volatility or disruption to conditions in money markets
• It is more resilient to any future expansion in the RBA’s balance sheet
• With the supply of reserves just sufficient to satisfy underlying demand, the RBA’s balance sheet will be no larger than it needs to be in order to implement monetary policy, and its footprint in financial markets will be smaller than in an excess reserves system