By Gareth Aird, head of Australian economics at CBA
Key Points:
- The July Board Minutes note that the decision to taper bond purchases from mid‑September was underpinned by the assessment that, “economic outcomes had been materially better than earlier expected and the outlook had improved.”
- The near term economic outlook has since deteriorated due to extended lockdowns in large parts of the country.
- We now expect the RBA Board to reverse the decision to taper the bond buying program from mid‑September if Greater Sydney and/or Victoria are still in lockdown at the time of the August Board meeting (3 August).
- We retain our call for the RBA to begin normalising the cash rate from November 2022, but acknowledge the risks are firmly centred on pushing the start date out.
The near term economic outlook has changed since the July Board meeting
When the RBA Board met on Tuesday 6 July Greater Sydney was in the midst of what was assumed to be a ‘snap’ two week lockdown. There was no sense that a larger and lengthier lockdown loomed. ‘Snap’ lockdowns had to date proved effective in stopping the spread of COVID‑19 and the working assumption was that would be the case again. As such, the economic data was the focus for the Board’s policy decisions.
Recall that at the July meeting the RBA Board decided to: (i) keep the April 24 bond as the target bond for yield curve control rather than roll it over to the November 24 bond, and (ii) taper bond purchases from September when the current bond purchase program expires. The conditional forward guidance on the cash rate was also amended from “2024 at the earliest” to simply “2024”.
Put more generally, the Board acknowledged that the recent run of domestic economic data had been stronger than they expected and the appropriate policy response was to adjust the rate of support to the Australian economy, as we expected.
Last week’s labour force figures continued that impressive run of stronger than expected data economic data as compared with the RBA’s expectations. The unemployment rate hit a decade low of 4.9% in June and employment grew by a strong 29k (RBA unemployment rate forecast 5.0% end‑2021).
But things of course have since taken a dramatic turn for the worse as the lockdown in Greater Sydney will now be a lot longer than initially expected and restrictions have been further tightened. Victoria and South Australia are now also in lockdown. The near term economic implications are still highly uncertain. But it is a fait accompli that GDP will contract significantly in the September 2021 quarter. This is likely to have implications for the RBA’s bond buying program.
The RBA’s decision at the July Board meeting to taper its bond purchases from $A5bn per week to $A4bn per week from mid‑September came down to an assessment of the strength of the economy.
More specifically, it was noted in July Board Minutes that, “members acknowledged that an argument could be made to retain the pace of bond purchases at $5 billion per week, given that economic outcomes were still well short of the Bank’s goals for inflation and employment. However, the economic outcomes had been materially better than earlier expected and the outlook had improved.”
But the near term economic outlook has deteriorated since the July Board meeting, as noted above. The medium term outlook is still very good, but the RBA will likely downgrade their near term forecasts for GDP and the labour market in the August Statement on Monetary Policy. This is an uncomfortable place to be for a central bank that has already committed to taper; central banks don’t usually ease their foot off the monetary policy accelerator when making near term downward revisions to the economic outlook.
Giving the unforeseen nature of events with regards to the spread of COVID‑19 and the lockdowns we now expect the RBA to reverse the decision to taper the bond buying program from mid‑September if Greater Sydney and/or Victoria are still in lockdown at the time of the August Board meeting (3 August). We would expect that announcement to be made at the August Board meeting. An upside surprise on the Q2 21 CPI next week may complicate any decision to reverse the decision to taper. But on balance we think the hit to the economy from the lockdowns will trump the inflation data with regards to near term monetary policy decisions.
Here it is worth noting that the July Board Minutes emphasised the flexibility around the bond buying program: “given the high degree of uncertainty about the economic outlook, members agreed that there should be flexibility to increase or reduce weekly bond purchases in the future, as warranted by the state of the economy at the time, rather than a commitment to a specific rate of purchases over an extended period.”
The economic data will guide further decisions around the bond buying program. If the RBA reverses the decision to taper at the August Board meeting the next major signpost will be the November Board meeting. What happens over the period ahead with regards to COVID‑19, lockdowns and the speed at which the economy bounces back will influence the timing of any taper. There is not a lot of point in speculating at this juncture which way things will go given the length of the lockdowns is unknown.
Our wholesale clients can access here the views from our interest rate strategists on what current developments mean bond yields.
The uncertainty around the duration of lockdowns also casts some doubt over our call for the RBA to begin normalising the cash rate from November 2022. Indeed that doubt is growing with each further extension of the lockdown. But for now we are sticking with the call whilst acknowledging the risks are firmly centred on pushing the call out.
For now we want our readers to focus on the picture beyond this lockdown. It may turn out to be the case that economic momentum is once again very strong by Q4 21 if restrictions have been fully eased. And the economic outlook for 2022 looks very good. The vaccine rollout should mean that lockdowns are a thing of the past next year and the domestic economy will have clear air. Exceptionally loose monetary policy coupled with expansionary fiscal settings will provide a tailwind on the economy. In addition, households with be armed with an unprecedented war‑chest of savings that will continue to accumulate over H2 21. In summary the Australian economy will perform very strongly in 2022 and wages and inflation pressures will build.
We will publish a full set of updated economic forecasts once there is a little more clarity on how long the current lockdowns are likely to last.
