Reserve Bank Board seems set for a long period of steady policy despite AUD already being five cents above forecast base with a lot more to come!

As expected, the Reserve Bank board kept its policy settings unchanged at the Board meeting in July.

The assessment in July confirms the theme in the June Board meeting (“it is possible that the depth of the downturn will be less than earlier expected”) with, “Conditions have stabilised recently and the downturn has been less severe than earlier expected”.

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However, as with June, the outlook is described as “highly uncertain”.

On August 7, the Bank will release its revised forecasts out to December 2022 (extended from June 2022 in May).

We will be interested in how this more positive assessment channels into the forecasts.

From a policy perspective the most interest will be in the assessment of the medium term outlook.

We assess that the Bank expects it is extraordinarily unlikely to see the need to adjust policy settings in 2021.

But recall that in its “upside scenario” in the May Statement on Monetary Policy the Bank assessed an unemployment rate of 5% by June 2022. Such an improvement in the unemployment rate would probably see it considering a move in its three year bond target at that time since it confirmed today ”the yield target will remain in place until progress is being made towards the goals of full employment and inflation”.

The unemployment rate in the base case is forecast to be six and a half per cent by June 2022 – down from nine per cent in December 2020.

That nine per cent is likely to be reduced (Westpac is currently at eight per cent) reflecting the “less severe” near term conditions but I would be surprised if the Bank has seen enough evidence around the growth risks to lower the base unemployment forecast in June 2022, particularly given the Governor’s understandable caution around the virus both domestically and internationally.

Growth through to December 2020 is also likely to be revised up from minus six per cent to nearer Westpac’s forecast of around minus four per cent.

But that will be largely offset by a considerable reduction in the 2021 growth forecast of six per cent (Westpac’s forecast is three per cent).

Evidence that the Bank may adjust its 2021 forecasts downwards comes through the Governor’s observation that “As some businesses rehire workers as demand returns, others are restructuring their operations”.

Of considerable interest will be the Bank’s assessment of the level of activity in the economy by end 2021 relative to the end of 2019. Current forecasts are for activity to be only around 0.4 percentage points below that level.

Westpac is more cautious at around 1.2 percentage points but both estimates will have activity more than five percentage points below trend over those two years.

And, of course, bear in mind that those forecasts in May assumed an AUD at USD 0.64 over the forecast period. Readers will be aware that Westpac expects the AUD to lift to USD 0.72 by December 2020 and to USD0.76 by end 2021.

Markets have been expecting that the Governor might comment on the AUD’s current level which is above USD 0.695.

However, while I am sure that he would like a lower AUD there is not much point in criticising its level if he has no intention of addressing the issue through policy. Policies such as negative interest rates and/or unsterilized intervention have been variously described as extraordinarily unlikely.

The Statement today clearly signalled steady policy except with respect to targeting the three year bond rate “will do whatever is necessary to ensure bond markets remain functional and to achieve the yield target for three year AGS”.

That statement implies that the Bank has adequate commitment to add to the AUD 40 billion it has already purchased, although only around a quarter was purchased in the two – three year maturity range.

Those purchases were in a year when the Budget deficit lifted from “balance” to a deficit of (we forecast) AUD 95 billion. This year (2020/2021) we expect the deficit to balloon to AUD 240 billion, making for a more active RBA, specifically if domestic and global growth surprise to the upside or market stability falters.

The Deputy Governor Guy Debelle seemed more flexible by ending his speech to the Economic Society last week with, “the Reserve Bank will maintain the current policies to keep borrowing costs low and credit available, and stands ready to do more as the circumstances warrant”.

Candidates for those “circumstances” range from a rampant AUD to another global crisis.

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