Outcome: March 2020

Covid-19, Weak Wages Growth, and Persistently Low Inflation: Cash Rate Should Remain Steady, Just

Fear about a global coronavirus pandemic are already taking their toll on world financial markets and are likely to impose significant economic costs on the Australian economy, should the crisis worsen. Tepid wage growth, a slight increase in the unemployment rate and an inflation rate that remains below the Reserve Bank of Australia’s official target range of 2-3% all point to economic weakness. The RBA Shadow Board’s conviction that the cash rate should remain at the historically low rate of 0.75% equals 49%, while the confidence in a required rate cut equals 46% and the confidence in a required rate hike 6%.

Based on ABS figures for January, the seasonally adjusted unemployment rate in Australia ticked up, from 5.1% in December to 5.3%. This is due to the labour force participation rate rising 0.1 percentage points, to 66.1%, as total employment increased by 13,500. According to the latest quarterly data, a key variable for gauging inflationary pressures as well as the outlook for consumption expenditure, real wage growth remains worryingly low, at 0.4% year-on-year.

The Aussie dollar, after repeatedly testing support levels, has posted new lows. It is currently trading just above 65 US¢. Yields on Australian 10-year government bonds have also extended their recent declines, to a historic low of 0.86%. As in the previous month, the slight inversion of the yield curve in short-term maturities (2-year versus 1-year) remains in place, the spread having actually narrowed to -6.6 basis points. In mid-term vs short-term maturities the yield curve remains effectively flat. Like other stock markets across the globe, the Australian share market took a recent hit, retracing from its recent historical all-time high. The S&P/ASX 200 stock index fell more than 700 points, to below 6,450.

The most visible concern about the outlook for the global economy, adding to the already weak outlook (as stated in recent reports by the International Monetary Fund, the OECD, and other organisations), relates to the Covid-19 crisis. The World Health Organisation says the coronavirus outbreak has reached a decisive point and it may yet declare a pandemic. The Australian government in turn announced it was preparing for a major outbreak and putting in place appropriate measures. The fear surrounding this crisis has clearly battered financial markets worldwide although the likely cost to the Australian economy from it remains highly uncertain.

The government has repeatedly stepped back from its earlier commitment to deliver a budget surplus this year. However, even with fiscal policy less restrictive than planned, it may not be sufficiently expansionary to prevent the Australian economy from slowing down.

Consumer confidence, as measured by the Melbourne Institute and Westpac Consumer Sentiment Index, came in slightly higher in February, compared to a month earlier, at 95.5. According to the most recent data available (December) retail sales contracted by 0.5% (month-on-month). Year-on-year retail sales increases by 2.8%, which is still weak. Business confidence (NAB) remains virtually unchanged in January while the manufacturing and services PMIs feel further, to 45.4 (48.3 in previous month) and 46.6 (48.7), respectively. The capacity utilisation rate increased slightly in January, from 80.9% to 81.3%.

The Shadow Board now attaches a 49% probability that the overnight interest rate should remain at the historically low rate of 0.75%, down from 70% in February. It attaches a 46% probability that a rate cut, to 0.5%, is appropriate (up from 20% in February) and only a 6% probability (down from 10% in February) that a rate rise, to 1% or higher, is appropriate.

The probabilities at longer horizons are as follows: 6 months out, the estimated probability that the cash rate should remain at 0.75% fell from 46% in February to 35% in the current round. The probability attached to the appropriateness for an interest rate decrease increased markedly, from 34% to 56%, while the probability attached to a required increase equals 9% (21% in the previous round). One year out, the Shadow Board members’ confidence that the cash rate should be held steady equals 29% (35% in February) while the confidence in a required cash rate decrease equals 51% (33% in February) and in a required cash rate increase 19% (32% in February). The range of the probability distributions over the 6 month and 12 month horizons has narrowed slightly, extending from 0% to 1.75%.