CBA: RBA too optimisitc on COVID impacts, more printing ahead

CBA’s Gareth Aird with the note. I agree:

The RBA has modestly downgraded their assessment of the Australian economic outlook in the near term whilst simultaneously upgrading their view on the Australian economy over the medium term.

The RBA’s central scenario sees GDP growth at +4.0%/yr at end-2021 (from +4.75% previously) and the unemployment rate at 5.0% at end-2021(unchanged).

The unemployment rate is forecast to be 4.25% at end-2022(from 4.5% previously)and 4.0%at end-2023.

Underlying inflation forecasts are little changed and the RBA expects the trimmed mean to be 1.75%/yr at end-2022 (unchanged) and 2.25% at end-2023.

We think the RBA’s updated forecasts are too optimistic on the economy in the near term.

The RBA’s August Statement on Monetary (SMP) makes for interesting reading. The RBA has doubled down on their upbeat assessment for the medium term by downwardly revising their end‑2022 forecast for the unemployment rate from 4.5% to 4.25% at a time when the economy is going through a big (and potentially prolonged) negative economic shock.

This forecast revision is consistent with the RBA’s announcement at the August Board meeting that it will stick its decision to reduce bond purchases from $A5bn to $A4bn from early September. But the timing of the revision is a little bit unusual given lockdowns across the country to contain the COVID‑19 delta variant are having a big negative impact on the economy.

We broadly share the RBA’s optimism about the economy over the medium term. But we are more concerned about the economy over the near term and think that it will take a while to regain economic momentum again once lockdowns are over. Indeed the RBA’s central scenario for the economy over the near term looks incredibly rosy compared to our forecasts (see here).

The RBA’s implied profile indicates they expect the economy to expand by 1.4% over H2 21. Reconciling the text in the SMP with the forecast table means the implied quarterly profile for GDP looks to be ‑1.0% in Q3 21 and +2.4% in Q4 21.

Those outcomes look vastly different when compared with our forecasts (CBA profile is ‑2.7% in Q3 and +1.9% in Q4 21). This means we expect the level of GDP in Q4 21 to be below Q2 21. We assume that restrictions in Greater Sydney are not eased in any material sense until the middle of Q4 21. The RBA’s central scenario assumes only “brief and less severe” restrictions occur over the December quarter.

We think that the risks to our forecasts are skewed to the downside given lockdowns across the country have become more frequent which has a damaging impact on confidence, hiring and investment. As a result, we think that the RBA is significantly underestimating the impact that COVID‑19 will have on the economy until the vaccine has been rolled out sufficiently for lockdowns to be a thing of the past.

The RBA is also more optimistic than us on the unemployment rate in the near term. The RBA has forecast the unemployment rate to end the year at 5.0% while we expect it to be 5.2% (with a peak of 5.6% in October).

Given the updated forecasts in today’s SMP we think that the RBA is likely to be surprised at how significantly the economic data deteriorates over coming months. On Tuesday the RBA Governor noted that, “the Board will maintain its flexible approach to the rate of bond purchases. The program will continue to be reviewed in light of economic conditions and the health situation, and their implications for the expected progress towards full employment and the inflation target”. The emphasis on economic conditions and the health situation means that there is a clear risk that the RBA still reverses its decision to taper its bond purchases even though the impact on the economy of buying bonds at a rate of $A4bn per week as opposed to $A5bn a week is negligible.

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