CBA: No ‘snap back’ for Aussie economy

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From Gareth Aird, head of Australian economics at CBA:

  • The RBA expects the pace of economic recovery to be slower than previously forecast.
  • The RBA’s central scenario sees GDP falling by 4% in 2020 and rising by 2% in 2021.
  • The unemployment rate is forecast to peak at 10% in Q4 20 and to decline to a still high 7% by end-2022.
  • Underlying inflation is forecast to be below 1½%/yr until H2 22.
  • We expect the cash rate to be left at 0.25% until at least 2023 and for QE to be in play over that period.

The RBA’s updated economic forecasts in the August Statement on Monetary Policy (SMP) reflect the profound negative impact that the COVID-19 pandemic is having on the Australian economy. The pandemic has also created an extraordinary level of uncertainty around the economic outlook which makes forecasting exceptionally challenging. We have made material revisions to our forecasts on several occasions over the past two months as new information on the spread of COVID-19 shifts the economic outlook. We are not alone in doing so.

It is only just over two weeks ago that the Federal Government published updated fiscal and economic projections. And yet those forecasts are already outdated given the imposition of stage 4 restrictions across metropolitan Melbourne. The RBA’s updated profile for GDP and unemployment in the August SMP takes account of the latest developments in Victoria. Recall that earlier this week we revised our forecasts for GDP and the labour market due to the new restrictions (see here).

The RBA’s updated central scenario for GDP to contract by 4% in 2020 and to rise by 2% in 2021 is essentially the same as our profile (we expect GDP to fall by 4¼% in 2020 and to rise by 1¾% in 2021–note that the RBA rounds GDP growth to the nearest whole number).There are two important points to note from the RBA in their revised GDP profile:(i) the contraction over the first half of 2020 was smaller than the RBA anticipated three months ago; and (ii) the pace of recovery is expected to be slower than previously forecast. That marries up with our view. The simple reality is that the news around containment of COVID-19 was better than expected over Q2 20. But since then the spread of COVID-19 in Victoria and resultant stage 4 lockdown has seen the economic outlook deteriorate.

On unemployment, the RBA expects the jobless rate to peak at 10% in Q4 20 (we expect the unemployment rate to peak in Q320 at 9% but to remain around that level until mid-2021 as the participation rate lifts with a gradual recovery in the labour market). The level to which the official unemployment rate rises will be heavily dictated by the participation rate. Wild swings in the participation rate as restrictions remain in play in many ways render the official unemployment rate meaningless.

The trajectory for underlying inflation has been lowered a touch but the message from the RBA remains the same. The economy will have a huge output gap over the forecast horizon as evidenced by an elevated unemployment rate. This means that wages growth and underlying inflation will stay very low –we completely agree.

The RBA has not attempted to put any downward pressure on the AUD by noting that, “the Australian dollar is now in a range that is broadly consistent with its fundamental determinants”. It was also stated that, “there was not a case for intervention in the foreign exchange market. Intervention in such circumstances is likely to have limited effectiveness.” The Board continues to view negative interest rates as being extraordinary unlikely in Australia. So it looks like monetary policy will remain unchanged for the foreseeable future.

The RBA once again provided upside and downside scenarios in addition to their central scenario. See page 2 for a discussion on these additional scenarios. Overall today’s SMP is a stark reminder of the huge challenges that the Australian economy faces over the next few years. COVID-19 has altered the landscape in ways that seemed unimaginable at the beginning of the year. It is easy to focus on only the negatives in such an extraordinary time. But we remind readers that the Government continues to support household income through stimulus payments. According to our internal data the counterintuitive dynamic of a positive shock to household income continues. In addition, more Government support for businesses has been announced today with some easing of eligibility rules around JobKeeper. The changes are expected to result in an additional $A15bn being injected into the economy.

The deficit will now exceed 10% of GDP in 2020/21. But it many ways that is irrelevant right now. The RBA can continue to purchase government bonds in the secondary market. And the borrowing cost is extraordinarily low. The fiscal tap needs to remain turned on to continue to support income in the economy in the face of such a significant contraction in spending and production.

Scenarios

Similar to the May SMP the RBA has included an upside and downside scenario alongside the base case forecasts. The main difference between the scenarios relates to how quickly the virus is controlled in the near term. The base case assumes the current stage 4 restrictions in Victoria are in place for six weeks and are then gradually wound back. Restrictions in place in the rest of the country are also assumed to be wound back slowly.

The upside scenario assumes that there is faster progress in controlling the virus domestically in the near term. Restrictions are assumed to be lifted with the exception of international travel. This would likely see consumer and business confidence recover and a faster recovery in consumption, investment and unemployment. Under this scenario the unemployment rate would peak at a slightly lower level than under the base care scenario and decline faster, reaching 6% at the end of the forecasting horizon (Q4 2022). It’s worth noting that at 6% the unemployment rate would still be well above where it was pre-COVID (~5%).

The downside scenario is based on the assumption that there are further periods of outbreaks in Australia and tighter restrictions in certain areas. It is also assumes that the world experiences a widespread resurgence of infections.

Under this scenario it is likely that the recovery in services exports (i.e. tourism and overseas students) would be delayed further. And consumer spending would continue to fall through H2 2020. Business investment would also decline sharply. It’s expected that domestic activity would take a lot longer to recover with the economy well still short of its pre-COVID-19 size at end 2022. The unemployment rate is expected to peak close to 11% and remain close to that level throughout 2021.

At this stage the downside scenario looks more likely that the upside scenario.

About the author
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.