(Bloomberg) -- Australia’s central bank deployed its remaining conventional interest-rate ammunition and will target three-year government bond yields to support an economy spiraling toward its first recession in almost 30 years.

Reserve Bank Governor Philip Lowe cut the cash rate to 0.25%, its effective lower bound, according to a statement released in Sydney Thursday following an emergency meetings. Key measures would include:

• A target for the yield on 3-year Australian government bonds of around 0.25%, with purchases made in the secondary market. It will announce its intentions for debt purchases at 11:15 a.m. local time each day and will also purchase semi-government securities to “address market dislocations”
• A term funding facility of at least A$90 billion ($50 billion) for the banking system, with particular support for credit to small and medium-sized businesses

“The various elements of this package reinforce one another and will help to lower funding costs across the economy and support the provision of credit, especially to small and medium-sized businesses,” Lowe said.

In a complementary program, Australia’s government will invest up to A$15 billion to allow smaller lenders to support consumers and smaller businesses during the coronavirus outbreak, according to a statement from the Treasurer. Prime Minister Scott Morrison is developing a follow-up spending package to expand on the A$17.6 billion program announced last week.

The combined fiscal-monetary salvo aims to keep firms open and workers in jobs. In just the latest example of the hit to the economy, Qantas Airways Ltd. on Thursday furloughed most of its 30,000-strong workforce and scrapped all international flights.

Forward Guidance

Joining developed world peers, Lowe also set out forward guidance, saying the board “will not increase the cash rate target until progress is being made towards full employment and it is confident that inflation will be sustainably within the 2–3% target band.”

In a speech explaining the moves, the governor said the board expects “the cash rate will remain at its current level for some years, but not forever.” Once the economy improves, Lowe said he expects that the yield target will be removed before the cash rate is increased.

In a move to relieve the margin squeeze facing banks, the RBA said it’ll pay lenders 10 basis points on funds deposited with it overnight, rather than the usual 25 basis point discount to the cash rate. It’s trying to avoid the type of stress banks in Japan and Europe have faced in a low-rates world.

By targeting a flat yield curve over three years, the RBA is hoping to put more cash into the pockets of households that tend to have variable mortgage rates. It’s also seeking to lower borrowing costs so businesses will be tempted to expand again once the worst of the virus shutdown passes.

The RBA’s quantitative easing approach differs from the Fed and ECB, which pledge to buy a certain amount of government securities to keep yields down. By directly targeting the yield instead, the RBA isn’t committed to any set amount of purchases -- an approach adopted by the BOJ in 2016, though its target spans 10 years.

By saying it’ll also buy semi-government securities, the RBA aims to avoid a blow out in yields on state government debt relative to commonwealth bonds. It will make purchases “across the yield curve” to achieve its target and avoid dislocations.

The yield on Australian government three-year bonds tumbled after the policy statement and traded about 16 basis points lower at 0.33% as of 4:33 p.m. in Sydney. The Aussie dollar retained losses from earlier in the day, down 3.5% to 55.70 U.S. cents.

What Bloomberg’s Economists Say...

“Just as China’s response to the virus afforded the rest of the world time to prepare, the RBA has taken several days to follow responses from a chorus of central banks around the world. Responses elsewhere have been more fulsome. The RBA’s targeting of the 3 year yield may need to be extended to longer maturities over time.”

--James McIntyre

Australia’s credit markets are stressed and the RBA has been pumping liquidity into the financial system in recent days to help calm them. On Monday, it said it was ready to purchase Australian government bonds to support the smooth functioning of that market.

“We are expecting a major hit to economic activity and incomes in Australia that will last for a number of months,” Lowe said in a speech after the decision. “We are also expecting significant job losses. The scale of these losses will depend on the ability of businesses to keep workers on during this difficult period. We saw during the global financial crisis how flexibility in working arrangements limited job losses and this benefited the entire community. I hope the same is true in the months ahead.”

As the economic outlook darkened ahead of today’s announcements, economists revised their forecasts. Australia & New Zealand Banking Group Ltd. says efforts to contain the coronavirus could result in unemployment climbing to 7.8% by year-end, a level last seen in 1998. Bloomberg Economics, ANZ and others are also forecasting Australia’s to tip into its first recession -- defined as two straight quarters of contraction -- since 1991.

(Updates with comment from Lowe’s speech in eighth paragraph.)

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