The Reserve Bank Governor has provided the Bank’s first forecasts during this crisis. The official forecasts are very close to the forecasts Westpac released on March 31. Both the speech and the April board minutes confirm the Bank’s commitment to the three year 0.25% bond target rate.
This note draws on the Governor’s speech and the minutes of the Board’s April meeting.
The Governor has provided us with the first glimpse of the Bank’s economic forecasts. Full details will be released in the Statement on Monetary Policy which will print on May 8.
The forecasts accord very closely with the forecasts Westpac released on March 31.
The Governor carefully notes that a number of scenarios for the developments around the Virus are possible but provides forecasts for what seems to his central scenario.” Various restrictions begin to be progressively lessened as we get closer to the middle of the year and mostly removed by late in the year, except perhaps the restrictions on international travel”. This scenario is broadly in line with the scenario on which we based our forecasts which we characterised as the restrictions being gradually eased through the September quarter with nearly all internal restrictions eased by year’s end although international restrictions were expected to remain well into 2021.
On the basis of that scenario the RBA has forecast that the economy will contract by around 10% in the first half of 2020 with most of the contraction centred around the June quarter. Westpac forecast contraction of -0.7% in the March quarter followed by -8.5% in the June quarter.
He forecast that the Australian economy would contract by 6% in 2020 compared to our forecast of minus 5% . We forecast a growth “bounce back” of around 5% in the second half of 2020, centred mainly on the December quarter. The Governor seems to favour a more even distribution of the growth rebound between the two quarters than we expect but the overall magnitude of the recovery pace in the second half of 2020 seems to be broadly in line with our view..
We do differ on the pace of growth in 2021 with the RBA expecting a spectacular 6–7% in 2021 whereas we expect around a 4% recovery with the economy still being smaller by around 1% by the end of 2021 compared to the beginning of 2020. I am surprised that the Bank is so optimistic for 2021 particularly given the Governor’s own admission that “the twin health and economic emergencies… will cast a shadow over our economy for some time to come.”
We forecast that the unemployment rate would reach 9% by end June while the Governor has estimated 10%. He adds some depth to that forecast by noting that hours worked will contract by 20% over the first half of the year and pointed out that “the unemployment rate would have been much higher… without the government’s JobKeeper wage subsidy” Recall that Westpac estimated that the unemployment rate would have lifted to 17% without the subsidy.
We forecast that the unemployment rate was likely to fall to 7% by year’s end but remain above 6% in 2021.The Governor concurs noting “the unemployment rate will remain above 6% for the next couple of years”. We agree but expect that if the RBA achieves it’s 6–7% growth forecast in 2021 then unemployment is likely to fall somewhat below 6%.
We have forecast wages growth at 1.5% in the year ended June 2021 The Governor expects a similar deceleration with “year ended wages growth to decline below 2%”. Not surprisingly we have no issue with his expectation that “in underlying terms inflation is expected to remain below 2% for the next couple of years”.
Monetary Policy
Both the Minutes and the Governor have emphasised the Bank’s commitment to anchoring the three year bond rate “The Bank would continue to do what was necessary to achieve the three year yield target with the target is expected to remain in place until progress was being made towards its goals of for full employment and inflation”.
Based on the forecasts set out above it is not surprising that in the Q and A the Governor speculates that the target will remain in place for a number of years. And, of course, the Bank is committed to not raising the target cash rate before it lifts the three year bond target.
Contrast this approach to the post GFC attitude of the RBA where it was apparent that the Bank was anxious to move away from “emergency” levels of rates as soon as possible. Recall that the first rate increase in the new cycle (October 2009) occurred only six months after the last rate cut (April 2009).
The speech and the Q and A gave us some more insights into the Bank’s “unconventional“ approach to monetary policy. To date it has purchased around $47 billion of government bonds; across the yield curve and issued by both the Australian government and the states. The purpose of the policy has been to target the three year bond rate and to ensure smooth functioning of the bond market. Both objectives have been achieved with bid offer spreads in the market back to “normal” and the three year rate closely centred around 0.25%. The Governor noted that the Bank has restricted its purchases in the shorter than10 year maturity range.
However he pointed out that the end effect of the purchases was to lower the cost of funding for governments and the private sector.
Westpac expects that the bond selling program for the Australian government over 2019/2020 and 2020/2021 will lift by around $310 billion to total supply of nearly $900 billion. It seems reasonable that as long as the bond market is operating smoothly the Bank will concentrate its efforts on targeting the three year part of the curve not only because that maturity is the official policy objective but because the Bank sees that maturity as the most relevant for private sector fixed borrowing rates. The yield curve is likely to steepen significantly once the weight of supply (including the indirect effect of supply on other national bond markets).
Looking forward we also need to be mindful of the Governor’s emphasis that the Government is raising its funds from the market – the separation between the government and the Reserve Bank (fiscal and monetary policy) needs to be observed. As supply builds and the Bank is required to take an increasing volume of bonds that separation may well be tested.
However, given the spectacular expansion of the balance sheet of the Federal Reserve (from below $4 trillion to potentially near $10 trillion), precedents for the dominance of central banks in financial markets are being set on a daily basis
