The RBA’s August Statement on Monetary Policy presents revised forecasts incorporating both the stronger than expected economic rebound in the first half of 2021 and a Q3 shock from ‘delta lock-downs’. With the latter expected to have few enduring impacts, the net effect has seen the Bank’s end-2022 unemployment rate forecast lowered from 4.5% to 4.25%, explaining the Board’s decision to leave policy settings unchanged at its August meeting.
The RBA’s August Statement on Monetary Policy (SoMP) contains significant changes to the banks near term forecasts but retain a more upbeat view over the medium term horizon that frames the Bank’s policy decisions.
Economic growth
The RBA’s GDP growth forecast for 2021 has been lowered from 4.75% to 4%. Virus disruptions are expected to see the economy contract noticeably in the September quarter – “by at least 1 per cent” – with some of the decline recovered in Q4, assuming limited further lockdowns. That compares to Westpac’s considerably weaker profile of a 2.2% fall in Q3 and 3% rebound in Q4 taking annual growth down to 3.2%yr.
The RBA forecasts have the snap back sustaining growth of 4.25% through 2022, moderating to 2.5% as reopening rebounds are cycled in 2023. That is close to Westpac’s forecasts of 4.2% and 2.7% respectively.
The bank’s ‘baseline’ scenario assumes that the domestic vaccine rollout accelerates in the second half of the year, reducing the frequency and severity of lockdowns and allowing the international border to be reopened gradually from mid 2022. The Sydney lockdown is assumed to run through the September quarter – in line with Westpac’s assumptions. The latest lockdown in southeast Queensland is assumed to end as planned. Forecasts were completed prior to latest 7-day lock-down announced for Victoria.
Labour market
The forecast unemployment rate by end 2021 has been reduced again, from 5% to 4.5%. The improvement beyond that is still expected to be much slower with the unemployment rate at 4.25% by end 2022 (compared to 4.5% forecast in August) and 4% by the end of 2023 (the RBA’s first full year forecast for 2023).
The near term shock is expected to see the unemployment rate rise in coming months although most of the adjustment is expected to come via hours worked and participation rather than job losses. This week’s payrolls data release shows impacts were starting to come through in early July, although as we note, there are some important nuances to this data around both the definition ‘jobs’ compared to the labour force survey and technical issues around seasonality and the tendency for upward revisions (see here for more).
The main takeaway from the SoMP is that the RBA’s ‘baseline’ scenario has no lasting impact from the latest round of COVID disruptions. Specifically: “output and employment are expected to have returned to their previously anticipated paths by early next year” (in fact, the level of output beyond the near term is forecast to be a little higher than expected in the May SoMP). Hence the net effect of a stronger starting point for labour markets is a slightly lower unemployment rate by the end of next year. The net impact on 2022 looks to be the key determining factor for whether policy should respond to the latest COVID shocks.
Wages and prices
The forecast pace of wages growth has been lifted again, consistent with the lower profile for the unemployment rate with a 2.25% gain in 2021 (vs 1.75% in the May SoMP), lifting to 2.5% in 2022 (vs 2.25%) and 2.75% by the end of 2023. Despite the upgrade, the lift is still only gradual and does not have wages growth with a ‘3-handle’ seen as a key prerequisite for a sustained return of inflation in the 2-3% target range. Even if the gradual profile is extended, wages growth only just nudges 3% in 2024. That speaks to a still very significant policy task ahead. Of particular note: “liaison information suggests that wages growth in many firms is returning to around the pre-pandemic norm of 2–2½ per cent this year, but not stronger than this”.
On inflation, the trimmed mean inflation forecasts have seen marginal changes – the RBA’s 2021 forecast lifted from 1.5%yr to 1.75%yr but holding at that pace through 2022 (unchanged from the May forecasts), the mid-2023 forecast also unchanged at 2%yr but the extended forecast to December 2023 showing a move into the target band with read of 2.25%. As the RBA Governor commented in his Parliamentary testimony, simply achieving a one-off return to target is not sufficient with a sustained move into the band required for the bank’s policy goals to be achieved.
Conclusion
The RBA Governor’s Opening Statement to the House of Representatives Standing Committee on Economics emphasised five key themes from the August SoMP: 1) Australia’s economic bounce-back to date has been quicker and stronger than expected; 2) the ‘delta’ lock-down will see a significant interruption to the recovery near term; 3) a quick bounce-back is still expected to be seen once associated restrictions ease; and 4) the upside surprises on wages and prices have been more muted than those seen around the real economy (i.e. GDP and jobs).
The biggest uncertainties are clearly still around the near-term path of the virus.
As noted previously, we felt there was a strong case for the RBA to use its new flexible approach to QE at the July meeting, and provide some additional support to the economy by lifting the weekly purchase pace and deferring the planned taper from September to November. The Bank instead chose to sit pat.
The reasoning is clear – expectations for 2022 have not shifted materially. However, risks remain stacked to the downside particularly while the ‘delta’ variant threatens to seed in other major states. The RBA Governor noted that the Board is still prepared to respond with further policy easing “in response to further bad news on the health front that affects the outlook for the economy over the year ahead”. That may go ahead if we see more states succumb to delta outbreaks. While flexible QE gave the bank the option to respond earlier (and, in turn, to wind back measures quickly if needed) the Bank has instead adopted a more patient ‘watch and wait’ approach.
One last point to note, the Governor’s Parliamentary testimony also raised an important medium term issue that is starting to emerge, namely, what the “endemic phase” of the virus will look like once high vaccination rates are achieved in Australia. Experiences abroad and modelling released by both the Federal Government’s health advisors and the Federal Treasury over the last week highlights that high vaccination rates are very unlikely to eliminate the virus altogether. That in turn means there will likely be ongoing need for some measures to control and monitor the virus will almost certainly be required. Treasury’s estimates suggest that even under a positive scenario the ongoing economic cost of COVID-19 management will be around 0.4-0.5ppts of GDP. That in turn may have some marginal implications for potential growth over the medium term.
