No surprises in the November SOMP – policy now focussed on Balance Sheet as Excess Spare Capacity Expected for Years.
Relative to the August Statement on Monetary Policy the Reserve Bank’s November Statement contains a more optimistic outlook for growth (near term) and unemployment but no change with respect to the outlook for underlying inflation.
The growth forecast for 2020 has been lifted from –6% to –4%; while the forecasts for 2021 (5%) and 2022 (4%) are unchanged from August.
On the other hand the unemployment forecasts have been improved across the board to reflect the lower expected starting point.
The forecast unemployment rate in December has been reduced from 10% to 8%; in December 2021 from 8.5% to 6.5%; and in December 2022 from 7% to 6%.
Underlying inflation (trimmed mean) is still expected to hold at 1% in 2020 and 2021; lifting to 1.5% in 2022.
Essentially these forecast changes reflect the improved outlook in the final two quarters of 2020, and early 2021, with little further improvement from the previous outlook in subsequent years.
In comparison Westpac’s growth forecasts are : –3.5% in 2020; 2.8% in 2021; and 3.5% in 2022.
Part of the explanation behind our lower growth forecast in 2021 is due to our stronger expected recovery in the second half of 2020 (recall that until recently most forecasters were expecting a small negative in the September quarter) along with our expectation of a “soft patch” in 2021 in the June and September quarters (annualised growth of only 2%) as the economy adjusts to the scaling back of the various stimuli – including JobKeeper; deferred loans; and insolvency laws.
The RBA explains the rise in the unemployment rate from the current 6.9% to 8% by year’s end largely by an increase in the participation rate as some workers who have withdrawn from the labour force return due to improved job prospects and the tightening of eligibility conditions to qualify for unemployment benefits. While that 8% is only slightly higher than our own forecast an expected lift in jobs growth implies downside risks to that number.
Despite the lower expected trajectory for the unemployment rate (therefore less spare capacity in the labour market) there has been no change in the outlook for underlying inflation.
This may be due to a more cautious approach to wages growth. Liaison reports indicate that 25% of employers plan to introduce a wage freeze; 30% already have a wage freeze; and employers who cut wages in the June quarter have no plans to restore them to pre Covid levels. Consequently, prospects for wage inflation are discouraging with 1% growth (the low point) forecast to mid-2021 and only 1.75% by end 2022.
That outlook certainly seems reasonable given that pre Covid the economy was struggling with a modest 2.5% wages growth despite the unemployment rate being down at around 5%.
The RBA provides two other scenarios – upside and downside.
Even under the optimistic upside scenario (better health outcomes; especially progress in treatment and control of the virus near term) where the unemployment rate falls to 5.5% by end 2021 the underlying inflation rate is still only forecast to reach around 1.75% by end 2022.
These observations are important from a policy perspective. The conditions for raising the cash rate have changed from “progress towards full employment” to “a period of strong employment growth and a return to a tight labour market”.
With the unemployment and wages growth forecasts out to end 2022 in this Statement it is clear why the Governor is comfortable indicating he does not expect to be raising the cash rate any time over the next three years.
On the other hand the Statement is at pains to state “the Board is not contemplating a further reduction in interest rates” – “interest rates have been lowered as far as it makes sense to do in the current environment” – “there is little to be gained from moving short term interest rates into negative territory – a negative policy rate is extraordinarily unlikely”. We have noted recently that the zero ESA rate is likely to result in some private wholesale rates going negative on days of particularly high liquidity, while the implied cost of borrowing in the foreign exchange swap market has already declined to around -6 basis points.
There is certainly no hint of concern about inflating a housing bubble in the Statement, with prices in both Sydney and Melbourne being below the highs of 2017 and rents falling along with rising vacancy rates.
The policy focus has shifted to the government bond purchase program “ the Board is prepared to do more and undertake additional purchases”.
The benefits of the recently announced package of measures are described as – lower rates for borrowers; lower exchange rate (than otherwise);higher asset prices; and boosting liquidity.
Overall there were no real surprises in this very thorough report. Policy has now pivoted to the use of the RBA’s balance sheet and specifically bond purchases. The recent policy package which was announced on November 3 commits a fixed purchase program and TFF facilities out to June next year.
Markets will now be scrutinising signs of the post June policies with respect to the balance sheet and whether, in the wake of negative private wholesale rates and more flexible offshore central banks, the RBA is reconsidering its approach to a negative policy rate.
