Reserve Bank Governor outlines sombre forecasts
Reserve Bank Governor speech

The Reserve Bank Governor delivered a speech: “An Economic and Financial Update”.

The speech provides information that will enable businesses to plan for periods ahead.

What did the Governor say?

Overall Outlook

• “The result of both the restrictions and the uncertainty is that over the first half of 2020 we are likely to experience the biggest contraction in national output and income that we have witnessed since the 1930s.”

Economic forecasts

• “National output is likely to fall by around 10 per cent over the first half of 2020, with most of this decline taking place in the June quarter.

• Total hours worked in Australia are likely to decline by around 20 per cent over the first half of this year.

• The unemployment rate is likely to be around 10 per cent by June, although I am hopeful that it might be lower than this if businesses are able to retain their employees on lower hours. The unemployment rate would have been much higher than this without the government’s JobKeeper wage subsidy.

• In terms of inflation, we are also expecting a significant decline in the June quarter. The large fall in oil prices, combined with the introduction of free childcare and the deferral or reduction in some price increases mean that it is quite likely that year-ended headline inflation will turn negative in June. If so, this would be the first time since the early 1960s that the price level has fallen over a full year. In underlying terms, however, inflation is expected to remain positive.”

Recovery

• “We can be confident that our economy will bounce back and that we will see it recover. We need to remember that once the virus is satisfactorily contained, all those factors that have made Australia such a successful and prosperous country will still be there.”

• “Whatever the timing of the recovery, when it does come, we should not be expecting that we will return quickly to business as usual. Rather, the twin health and economic emergencies that we are experiencing now will cast a shadow over our economy for some time to come.”

• “It is likely that the unemployment rate will remain above 6 per cent over the next couple of years. With many firms delaying or cancelling wage increases, year-ended wage growth is expected to decline to below 2 per cent, before gradually picking up again. In underlying terms, inflation is expected to remain below 2 per cent over the next couple of years.”

• “It is difficult to be precise and it makes sense to think in terms of scenarios. Consistent with this, the Bank will discuss some possible scenarios in the Statement on Monetary Policy in a few weeks’ time.”

Fiscal measures & Banks

• “Australia’s long record of responsible fiscal policy has allowed the government to use its balance sheet to help smooth out the income shock and to offer protection to those most affected. In doing so, it is making a major difference. The strong balance sheets of our banks are also helping. By offering payment deferrals and concessional terms, our banks are rightly acting as shock absorbers and helping the country through this difficult period.”

Recovery scenarios

• “One plausible scenario is that the various restrictions begin to be progressively lessened as we get closer to the middle of the year, and are mostly removed by late in the year, except perhaps the restrictions on international travel.”

• “Under this scenario we could expect the economy to begin its bounce-back in the September quarter and for that bounce-back to strengthen from there. If this is how things play out, the economy could be expected to grow very strongly next year, with GDP growth of perhaps 6–7 per cent, after a fall of around 6 per cent this year.”

Productivity

• “The best way of dealing with these reverberations is to reinvigorate the country’s growth and productivity agenda. As we look forward to the recovery, there is an opportunity to build on the cooperative spirit that is now serving us so well to push forward with reforms that would move us out of the shadows cast by the crisis. A strong focus on making Australia a great place for businesses to expand, invest, innovate and hire people is the best way of extending the recovery into a new period of strong and sustainable growth and rising living standards for all Australians.”

Exchange Settlement Accounts

• “At the beginning of March these balance stood at around $2½ billion. Today, they stand at $83 billion.”

• “The very large increase in the balances in Exchange Settlement Accounts has affected the operation of the cash market. The number of transactions in this market has declined as fewer institutions need to borrow settlement balances each day. The cash rate has also drifted below 25 basis points and today is at 15 basis points. Both of these changes are consistent with experience in other countries and have not come as a surprise to us.”

What are the implications for investors?

• The Reserve Bank Governor has laid it on the table. The economy is set to record a significant contraction in the June quarter. And while the economy will bounce back, the nature of the recovery is uncertain.

• The Governor has indicated that interest rates will be low for years, meaning that investors will need to think more closely about the type of investments that are embraced and the returns generated on those investments.

• The Governor remains keen on tax reform and infrastructure spending. Governments are more focussed on flattening the curve at present but the Governor is expected to remain persistent with his views.

• At some point the Government will revisit the trade-off between the GST rate and personal tax rates in the time of an ageing population.

Published by Craig James, Chief Economist, CommSec