The spreading of the delta strain continues to concern markets and pose major risks to the continuation of economic recoveries. This is becoming increasingly evident in Australia with Sydney's lockdown looking like it will remain in place for a while yet, while Melbourne and Adelaide are also currently under stay-at-home restrictions until at least next week, and internal border controls have tightened further over the past week. While caseloads are low by global standards (7-day average over the past week was around 140*), vaccination coverage is also low at around 12%* for both doses (*Johns Hopkins data), so the authorities have opted for city-wide (and in some cases state-wide) lockdowns. Data to hand this week indicates that there has been a sharp loss of momentum in the economy as a result, turning the attention to policymakers.
In the minutes of the RBA's July meeting, it was revealed that the decision by the Board to signal its intention to start tapering its QE purchases from $5bn to $4bn per week in early September was a close-run thing. There were arguments to maintain the existing pace on the basis that employment and inflation were still short of meeting the RBA's goals but in the end a stronger-than-expected recovery and a positive outlook meant that the decision went the way of announcing the start of tapering. But that was before restrictions had been extended and tightened and before the data started rolling over. The exception to this will be next week's CPI data, which will spike north of 3%Y/Y in headline terms in Q2, but the RBA has repeatedly said it will treat the increase as transitory. At the August meeting, the RBA will revise its economic forecasts and with activity likely to contract in Q3, there will be a sizeable downgrade to GDP for 2021 from 4.75% currently. While unemployment has significantly outpaced expectations: the unemployment rate at 4.9% is around where the RBA thought it would be mid next year, the risk of some reversal here is clear, while the pandemic situation means the path forward has become very uncertain. In the circumstances, it could be difficult for the RBA to maintain its taper guidance and the outperformance in the Australian 10-year bond this week (see table below) speaks to this. The increased flexibility the RBA has allowed for its QE purchases post September means there is potentially some chance that the pace of purchases could be dialed up from $5bn/week depending on how the data comes in. The chart below illustrates these various QE scenarios. The situation could also result in additional fiscal support, providing offset to the impact to incomes from lockdowns and restrictions and then serving to spur spending when reopenings come.
Chart of the week
The extent to which the data has been hit by the setback with the pandemic was highlighted in the flash PMI reading for July, which fell to its weakest reading in 14 months at 45.2 from 56.7 in June (readings > 50 signal activity is expanding). The impact of restrictions has been heavy on services, with activity in the sector flipping from rising strongly (56.8) to now be going backwards (44.2) at pace. In keeping with one of the major themes of the pandemic, manufacturing stood resilient, albeit with activity rising at a slightly slower speed (58.6 from 56.8), and could be supported by a rotation in spending back towards goods-related areas as lockdowns and restrictions persist. The reintroduction of restrictions led to a sharper-than-expected fall in retail sales for June, with the ABS's preliminary estimate falling by 1.8%m/m (vs -0.7% expected). Declines came through in all the major states: New South Wales -3.5%, Victoria -2.0% and Queensland -1.5% as capital cities entered periods of lockdown. Signs of strain were also showing in the ABS's high-frequency labour market data, with the national payroll jobs index falling by 1.0% over the fortnight to 3 July. Over the period, payrolls fell in all states and capital cities, with the sharpest falls occurring in New South Wales (-1.4%) and greater Sydney (-1.9%). Softness in job vacancies in June (-0.5%m/m) portends further disruption from lockdowns. But using previous lockdowns as a rule and considering the elevated level of vacancies (around 1.8% of the labour force), underlying labour demand seems likely to ride out the restrictions with hiring to return as reopenings take place. There was good news on the trade front in June as preliminary estimates from the ABS showed goods exports rising through $41bn for the month to record highs, driven by the tailwinds from elevated iron ore prices.
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Offshore, the European Central Bank's keenly awaited meeting this week saw all policy settings left unchanged, though the main story related to the recalibration of the Governing Council's forward guidance on interest rates in response to its newly-minted symmetric 2% inflation target. This change hinted at a more dovish approach to policy and that was confirmed in the Governing Council's decision statement where forward guidance for the timing of rate hikes was linked strongly to its inflation forecasts. Specifically, the Governing Council now needs to see 2% inflation as being on the radar, but coming "well ahead of the end of its projection horizon" and then seeing enough signs from underlying measures of inflation to believe that it will stay at that level over the remainder of the period. Currently, the ECB's forecasts stretch out to 2023 but inflation is only seen running at 1.4%Y/Y by then, indicating that rate hikes are now an even more distant proposition. In the post-meeting press conference, ECB President Christine Lagarde said that its tweaked forward guidance was aimed at ensuring that it avoids tightening policy prematurely, noting that the new inflation mandate now gives the Governing Council the scope to tolerate periods of overshoot on its 2% target. While the need to alter forward guidance was seen as unanimous, media reports quoting ECB sources outlined that there had been at least two Governing Council members that had objected to the changes ultimately made. Nothing has changed with regard to the ECB's asset purchases, with the pace of purchases in its pandemic line (PEPP) continuing to be accumulated at a "significantly higher" run rate than earlier in the year and with no hint as yet as to what will occur when the PEPP is due to be wound up in March next year (though it can be extended beyond this date).
On the economy, the ECB anticipates a robust second half of the year, supported by a wider reopening over the summer leading to GDP returning to pre-pandemic levels by Q1 next year. Though it acknowledges the delta strain as a key uncertainty, its overall assessment is that risks to its outlook for the economy are broadly balanced. Certainly, the ECB will have liked what they saw from July's flash PMI reading where euro area activity on the composite index accelerated to its strongest since 2000 at 60.6 from 59.5 in June. Activity in services sectors was rising at its fastest pace in 15 years, with businesses in tourism and hospitality benefitting from loosened restrictions and increased vaccinations. But there were reasons to be cautious, with business confidence sliding to a 5-month low pointing to the potential delta impact. Meanwhile, in the manufacturing sector activity had come off its recent highs but was still elevated at a 62.6 reading. Supply-side bottlenecks remain significant, with backlogs rising to record highs and prices pushing higher as a result. In the UK, capacity constraints appear to be material concerns at a time when the economy is looking to move up in gear following the removal of pandemic restrictions. July's flash PMI reading slowed from 62.2 to 57.7, with both the services and manufacturing indexes easing back to 4-month lows but still well in the expansionary range. Concerns around rising virus caseloads have added to ongoing issues businesses are reporting with regard to staffing shortages and supply chain disruptions. This was keeping upward pressure on prices, but as discussed in a speech this week by the Bank of England's Deputy Governor Ben Broadbent many of the contributing influences were expected to be transitory and not something for the monetary authority to respond to through tighter policy. Next week, the attention turns back to the US for the Federal Reserve's policy meeting where markets will continue to assess prospects for the tapering timeline amid a range of top-tier data releases including GDP (Q2) and personal consumption (June).
