Glass half full outlook for Australia’s economy
Suncorp's Chief Economist Paul Brennan explains why Australia's COVID-19 economic recovery has been stronger than expected, despite the pandemic still wreaking havoc overseas.
It is often the case in forecasting the impact of adverse shocks to economies that views initially underestimate the likely impact, but ultimately become too pessimistic. The current experience with forecasting the impact of COVID-19 has been no exception. Despite new and deadly waves of COVID-19 that have led to repeated lockdowns, particularly in emerging economies and in Europe and Japan, the recovery in the global economy continues to be stronger than expected.
Pandemics also tend to be catalysts for social and economic changes. The depopulation during the Black Death in the 14th century saw a change in the social order as labour shortages empowered peasants and labourers with rising wages and more evenly distributed incomes. In the case of the Spanish Flu, pent up demand, changes in fashions and the application of new technologies that had been delayed by the war and the pandemic ushered in the roaring 20’s which saw booming asset prices, more opportunities for women to work outside the home, and improved access to jobs and education.
Some positive structural changes in response to COVID-19 are already evident, including the acceleration of online economic activity that is delivering services more cost-effectively and making working arrangements more flexible. Ultimately these changes could boost productivity growth.
There has also been a change in the management of the economy with both central banks and governments being more patient and less forward-looking in considering when they should withdraw stimulus. This change is promoting a faster recovery from the pandemic.
In Australia, this has meant the RBA has maintained its dovish monetary policy guidance despite being in a constant cycle of upgrading its economic growth and labour market forecasts, in common with the Treasury and most private-sector forecasters. It’s worth recalling that the RBA’s initial easing of monetary policy in March last year was based on a forecast of the unemployment rate rising to around 10% and to be still above 7% at the end of 2022.
The RBA’s guidance of not increasing the cash rate “until 2024 at the earliest”, first introduced in November last year, was based on the unemployment rate remaining around 6% at the end of 2022 and average annual wage rises of 1.75%. The February forecasts in the Statement on Monetary Policy (SMP) earlier this year lowered the unemployment rate forecast at the end of 2022 to 5.5% with wage rises unchanged at 1.75%.
With the continued rapid improvement in the labour market since those forecasts were made in early February, the unemployment rate has reached the 5.5% forecast more than 18 months early. Even if the pace of improvement in unemployment now slows with the ending of JobKeeper, the strength of hiring intentions and job vacancies and the broader positive signs on the economy would suggest the unemployment rate could still fall a further 1% point to 4.5% by mid next year.
Indeed, in his post-May Board statement, Governor Lowe indicated that the unemployment rate is now expected to fall to 4.5% by the end of next year. But despite the rapid improvement in unemployment, Lowe again stated that “A pick-up in inflation and wages growth is expected, but it is likely to be only gradual and modest.”
This suggests that the Bank’s wage forecasts, to be released on Friday, will be little changed from its February forecast of wage inflation of 2% in mid-2023. This is well short of its goal of 3% plus that it believes would be consistent with a sustainable return of consumer price inflation to its 2%-3% target. Indeed, Lowe signalled that the RBA had only slightly revised up its forecast for underlying inflation (the trimmed mean of the CPI) at mid-2023 from 1.75% to 2%.
As a result, it’s not surprising that Lowe reiterated that the Board remains fully committed to its ultra stimulatory monetary policy stance and continued to signal it does not expect to increase the cash rate until 2024 at the earliest. Lowe in his statement also signalled that at its July meeting the Board will consider whether to retain the April 2024 bond as the target bond for the 3-year yield target or to shift to the next maturity, the November 2024 bond. But either way, he indicated the target of 10bp will remain.
In our view, the combination of further upgrades to its economic forecasts and the greater support for the economy in next week’s federal budget should give the RBA more confidence that it does not need to keep extending its timeline for the 3-year yield target.
Extending the target to the next maturity implies the RBA would expect to keep the cash rate unchanged for longer than it currently believes is necessary. To do this would be inconsistent with the faster recovery in the economy and labor market.
At the July meeting, the Board will also consider future bond purchases following the completion of the second $100 billion of purchases. The fact that the Board will decide whether to further extend the program well ahead of its current planned end in September suggests that it doesn’t want to make the program contingent on how the economy is unfolding at that time.
Given that, and the signals from other central banks that they are not yet ready to taper their own QE programs, strongly suggests the program will be extended for the third time. However, by September the RBA will own around 30% of Australian government bonds and 15% of state government bonds, making the functioning of the bond market heavily dependent on the Bank’s purchases. It therefore could announce a lower third tranche of purchases, similar to what the Bank of Canada recently announced.