The shutdown in Melbourne has altered our growth profile for the Australian economy. We have slightly lowered our annual forecast for 2020 from a contraction of 4% to 4.2%. We retain our forecast for growth in 2021 of 3.0% recognising that this shutdown will represent a permanent loss of activity out to end 2021.
We are forecasting that the Australian economy contracted by 7% in the June quarter. Hours worked contracted by 9.5% in April and 0.7% in May so, although we have not yet seen hours worked data, any recovery in June is likely to be very mild compared to the collapse in April. Accordingly, for Melbourne (and regions including the NSW border, accounting for an estimated 25% of the economy), the base from which we calculate the impact of the latest shutdown is still going to be quite weak compared to full capacity prior to the previous shutdown.
Say the recovery through June was 1.5% (proxied by hours worked) then with the economy relapsing to ‘shutdown’ pace again we can argue for a 1.5% contraction over the next 4–6 weeks.
So, if we look at the September quarter for Melbourne (and regions) – a contraction of 1.5% over the next six weeks is forecast to be followed by an expansion of 1.5% (equivalent to the reopening effect we assess for June) over the second half of the quarter.
This means that while about 75% of the economy will still grow by 1.5% in the September quarter, 25% will stall, reducing our growth forecast for Australia to 1.1% in the September quarter from 1.5%.
The unknown variable is the impact on national confidence of this unexpected development. In that regard the release of the Westpac-MI Consumer Sentiment Index next week will be of particular interest in gauging the initial impact of the shutdown.
However, the subsequent impact on confidence will depend on whether there is a relatively quick outbreak in the virus elsewhere. Given that the original source of Victoria’s outbreak has been attributed to the management of overseas returnees, scrutiny across the country around international borders and visitors will be intense. We have been surprised to see media reports from the Prime Minister’s office that around 72,000 people have arrived from overseas in the last month. That includes around 40,000 for NSW; 15,000 for Victoria; 10,000 for Queensland; 5,000 for WA; and 680 for SA.
Victoria has already announced a suspension of international arrivals for two weeks; NSW is announcing a cap on arrivals and the Prime Minister is also indicating restrictions. The large numbers of international arrivals clearly represent risks to containing any further outbreaks in Australia. This ongoing source of new infections is amplified by an increasingly relaxed attitude locally (with the exception now of Victoria). As such, these steps by governments to address the risks from offshore are welcome.
For the December quarter our base growth forecast is 2.0% contingent on no further significant shutdowns and the sustained reopening of Melbourne.
In a note earlier this week we discussed the fiscal outlook, factoring in a more constructive policy response. Recall that both the JobKeeper and JobSeeker payments are scheduled to terminate at the end of September. For the December quarter we are forecasting a partial extension to JobKeeper (for around a third of the current 3.3 million recipients) and a reduction in JobSeeker payments of around $300 – not the currently budgeted full $500 reduction. That limits what would otherwise have been a substantial fiscal shock in the December quarter.
With Melbourne showing a degree of ‘pent up demand’ we expect that Melbourne and regions will grow by 3% in the December quarter compared to 2% for the rest of the country. That implies overall GDP growth of 2.2% for the December quarter.
Overall, our original forecast of a 4% contraction in the Australian economy in 2020 has been reduced to 4.2% with a somewhat weaker September quarter to be followed by a stronger December quarter
Australia’s recent setback with the virus has not impacted the Australian dollar. On the day of the announcement of the Victorian shutdown the AUD faltered by around US0.4¢ but quickly recovered to be around USD0.695 at the time of writing.
Readers will be aware that Westpac is forecasting an AUD at USD0.72 by end 2020 and USD0.76 by end 2021. Global issues are important for these forecasts. We have recently reviewed our outlook for the US economy, revising down the likely growth profile in the second half of 2020 to a mere 2% lift off following the 10% decline in the first half (see here for more). Even that cautious approach remains threatened by the US issues in dealing with the virus. On the other hand we anticipate China’s growth at around 15% in the final three quarters of 2020 following its 10% contraction in the first quarter of 2020. Such a contrast in 2020 followed by an expected 5% lift in global growth in 2021 supports our AUD view.
Markets were surprised that in his Statement this week the RBA Governor did not comment on the strength of AUD given that the Bank’s current forecasts are based on an AUD of USD0.64. My view is that the RBA understands that unless it is prepared to use its policy tools to address the issue there is little point in passive observations. Certainly the Governor’s Statement points to stable policy: “The accommodative approach will be maintained as long as it is required”.
That contrasts with a somewhat more flexible stance from Deputy Governor Debelle who recently remarked that the Bank “stands ready to do more as the circumstances warrant”.Arguably, he was referring to more than just purchasing more government bonds to achieve the twin targets of holding the three year bond rate at 0.25% and maintaining stability in the bond market.
Candidates for ‘more’ could include: purchasing commercial debt (only buying on repo at the moment); more extensive yield curve control by targeting other parts of the bond curve; pushing the cash rate into negative territory; or engaging in unsterilised currency intervention.
Commercial debt and the longer term bond rate do not have a high intensity around the accepted channels of monetary policy – asset prices; the exchange rate; spare cash flows of the household sector.
On the other hand a negative cash rate would have a highly positive impact on asset prices and via the AUD while intervention would also weigh on the AUD.
For now, and given our base case growth outlook as described above, the Bank is ‘extraordinarily’ likely to keep policy on hold but, significantly, risks around this virus both domestically and internationally loom large and it is reassuring that the Bank is prepared for further action if necessary.