Macro (Re)view (31/7) | Historic impact of COVID-19 confirmed

The historically large impact of the pandemic on economies across the globe was confirmed this week, while an increasingly fragile outlook kept policymakers committed to providing more support. Starting offshore, the US GDP posted its largest contraction on record falling by 9.5% quarter-on-quarter in the June quarter to be down by 9.5% over the year reflecting the shuttering of the economy to limit the spread of the virus. This was driven by a 10.1% plunge in consumption spending the quarter in which spending on services was down by a deeper 13.3%. Notable weakness also came through from business investment (-8.5%q/q) and residential construction activity (-11.5%q/q). Towards the end of the quarter, the reopening of the economy started to occur progressively, though the virus has been an ever-present threat, particularly in the south and also in the west, leading to the reversal of reopenings in various states in those regions and contributing to signs of a stalling in the overall pace of the national recovery. 

This notion of a faltering in the recovery in the US was the key theme highlighted by the Federal Reserve at this week's policy meeting of the FOMC. As expected, policy settings were left unchanged, with the Committee noting that the outlook for the economy would depend heavily on the path of the virus and that "the ongoing health crisis will weigh heavily on economic activity, employment, and inflation in the near term". In the post-meeting press conference, Chair Jerome Powell outlined that the Committee was closely monitoring a range of high-frequency indicators and the recent signs were that as virus cases started to rise strongly through June economic activity looked to have slowed. While there was uncertainty over how long-lasting the slowdown might be, it was emphasised that the path of the virus is the key factor that will shape the Fed's outlook going forward. The other influential aspect in this regard is the actions of policymakers to support the economy. Chair Powell reiterated that the Committee will be maintaining its accommodative monetary policy stance for "an extended period", until such time as progress is being made towards its macroeconomic objectives of full employment and price stability. The Fed will likely move towards a more explicit form of forward guidance later on this year when its monetary policy review is complete. The importance of the role of fiscal policy in the current crisis continued to be highlighted by Chair Powell, though progress from Congress in coming to terms on the details of the next support package continued to be slow and limited this week, despite the end of month deadline on the $600 per week enhancement to unemployment benefits. 

In Europe, June quarter GDP contracted by its most in the bloc's history falling by 12.1% to extend the decline in annual terms to -15.0% from -3.1%. Unsurprisingly, the declines at a country level were more significant where stricter and longer shutdowns were implemented with Spain -18.5%q/q, France -13.8%q/q and Italy -12.4% standing out. Germany — the bloc's largest economy — fared comparatively better but still contracted by 10.1% in Q2. While the onset of the pandemic led to a deeper decline in GDP in Europe than in the US, the continent has seen a much milder rise in unemployment by comparison. Data this week showed the euro area's unemployment rate lifted to its highest level since early 2019 with a 0.1ppt increase in June to 7.8%, while in the US its unemployment rate currently stands at 11.1% in June, down from a peak of 14.7% in April. The spread reflects the difference in policy responses to the crisis with national governments in Europe focusing on measures to maintain links between workers and their employers, such as short-time work schemes and income substitution, whereas in the US workers who were laid off, even temporarily, were classified as unemployed and were then able to access support through enhanced unemployment insurance or were later taken back by their employer once the government's Paycheck Protection Program was activated. In other European data this week, the flash estimate of headline inflation in July was little changed at 0.4%Y/Y from 0.3% in the month prior. The services sector has been hardest hit by the pandemic and as a result inflation in the sector has fallen to a 4-year low (0.9%Y/Y) while weak demand has driven energy prices lower (-8.3%Y/Y).  

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Turning to Australia, there were further signs from the high-frequency data this week that the economic recovery was stalling. Google's mobility indexes indicated that activity levels slowed over July as the Victorian capital city of Melbourne was placed back into shutdown and this appeared to weigh on confidence more broadly. This was reflected in the ABS's latest household survey that highlighted a considerable level of uncertainty in states outside of Victoria over the timing as to when conditions would return to normal (see here). In Victoria itself, the recent escalation in virus cases unsurprisingly has residents there expecting a longer and a more uncertain recovery than in the rest of Australia. The increased level of uncertainty has been reflected in ANZ-Roy Morgan's weekly consumer confidence index that posted its 5th consecutive decline with a 1.9% fall to be down by more than 4% over July. In another sign of a stalling in activity levels, the ABS's weekly payrolls data reported that employment growth in the payrolls index had contracted by around 1% since the start of July to be back at its level from late-May to early-June. While difficult to establish the read-through to the traditional employment data, it was clearly not a constructive signal at this stage of the national reopening. Also raising concerns was the ABS's monthly Business Impacts of COVID-19 survey that reported strains on revenue had continued into July with restrictions limiting the ability of firms to operate at previously normal levels of capacity (see here). While some of this was being mitigated by the current support measures put in place by federal and state governments to provide cash flow assistance, some painful adjustments could lie ahead when these measures are due to expire with 16% of firms indicating they would look to cancel or scale back investment plans, 13% saying they would reduce staffing levels and 10% reporting they would cease operating. All of this highlights the fragile nature of the recovery and the need for ongoing support.

In other developments this week, Australia's Consumer Price Index fell by its most in a single quarter on record contracting by 1.9% in Q2 as the annual pace rolled over into deflation from 2.2% to -0.3% making this a 23-year low (full review here). Much of this can be attributed to the impact of policy, namely the Federal Government's decision to make child care services free for families between early April and mid-July. Furthermore, mandated shutdowns significantly reduced demand for automotive fuel leading to much lower petrol prices, while state government initiatives to allow tenants to negotiate rent reductions where they had been impacted either by a loss of work or income when the pandemic emerged and to provide assistance to households through reduced utilities costs all weighed on inflation, as shown in the chart below.     

Chart of the week

As such, some of these effects will reverse in the September quarter. Most notably out-of-pocket costs have come back for child care and this will also impact pre-school and primary education costs, while petrol prices have lifted off their shutdown lows. However, the RBA's preferred trimmed mean measure of inflation, which posted its weakest outcome on record in the June quarter at -0.15%q/q and 1.22%Y/Y, is unlikely to show much sign of improvement with the domestic economy operating well below potential and spare capacity in the labour market highly elevated. On the RBA, Assistant Governor Christopher Kent this week in a speech outlined that the package of measures implemented by the central bank back in late-March had contributed to improving market sentiment and easing financial conditions, enhancing the availability of credit to the real economy. Also this week, Australian building approvals declined by more than expected in June with a 4.9% fall to come in at an 8-year low at around 12.2k (see here). Approvals contracted by 10% over the June quarter with uncertainty around population growth dynamics and the broader economic outlook likely to be weighing on the residential construction sector. 

Australian business impacts of COVID-19 - July survey

The ABS's monthly Business Impacts of COVID-19 Survey for July reported ongoing strains on the revenue of Australian firms and a strong dependence on support measures implemented by federal and state governments. 

In this survey, around 2,000 firms were surveyed by the ABS between the 15-23 July with a response rate of 50%. The impact of the pandemic on firms' revenue continued to be significant into July with 47% of businesses reporting a decrease over the month. This follows on from the finding in the June survey that 66% of firms had seen revenue fall compared to a year ago. Revenue was reported as being flat through July by 32% of firms, while 16% noted an increase. In looking ahead to August, 49% of firms expected a stabilisation in revenues to emerge, though 27% expected that revenues would be lower again. 

  Source: ABS 

Notably, businesses operating under modified conditions in order to comply with restrictions were around three times more likely to be forecasting revenues to decline next month compared to those firms operating under 'normal' conditions. The previous survey reported that 73% of firms were now operating under modified conditions, with the introduction of hygiene protocols and limitations on the number of people on site the most prevalent changes that have been implemented.
   

Source: ABS 

On support measures, 42% of firms reported that they were currently accessing some of the available schemes including the JobKeeper policy, cash flow assistance, loan deferrals and rent/lease renegotiations. Some 54% of firms were benefitting from the Federal Government's 'Boosting Cash Flow for Employers' policy, which is effectively a refund of tax withheld ranging between $20,000-$100,000. This support was predominantly being used to pay wages (61%) and meet fixed costs such as rent (56%). The ABS compiled the figure (below) to highlight the areas in which industries were making use of this cash flow assistance. 

  Source: ABS 

However, with these support measures being temporary, attention turns to how businesses might respond when those programs are wound up. The table, below, highlights some concerning outcomes with 16% of firms identifying that they would need to either cut or defer capital expenditure plans, while 13% said they would look to reduce the size of their workforce. These outcomes were expected to be more pronounced in medium-size businesses (20-199 employees) than in small (0-19 employees) and large (200 or more employees) firms. In addition, 10% of firms said they would cease operating, with this mainly being a small business story.   

Source: ABS 

An analysis of the specific actions various industries might be expected to take when support measures come to an end is summarised in the figure, below.

Source: ABS

The July survey highlights that business conditions for Australian firms remain extremely challenging with the onset of the pandemic, as well as ongoing measures to comply with restrictions, significantly impacting revenues. Broad-based support measures are reaching many of these impacted firms, but unless more support is forthcoming when those programs expire, some painful adjustments could lie ahead through lower business investment and more layoffs.  

Australian building approvals decline to an 8-year low in June

Australian dwelling approvals weakened to an 8-year low in June after falling for a fourth consecutive month. The COVID-19 pandemic appears to have weighed on both house and unit approvals over the June quarter with uncertainty over the economic outlook and population growth dynamics elevated.   

Building Approvals — June | By the numbers

• Dwelling approvals (including the private and public sectors) declined by more than expected with a 4.9% fall in June (vs the median forecast of -2.8%) to 12,213 — its lowest monthly total since July 2012. In May, approvals fell by 15.8% (revised from -16.4%). Weakness on approvals through the year extended to -15.8% from -10.9%. 
• Unit approvals weakened by 3.1% to 4,010 — their lowest since June 2012 — to be down by 30.2% year-on-year. 
• House approvals pulled back sharply by 5.8% in June to 8,204 to their lowest monthly total going back to March 2013, with the annual pace sliding to -6.4% from 1.0%.

Building Approvals — June | The details 

Total dwelling approvals posted a sharper-than-expected 4.9% fall in June after declines of 15.8% and 2.4% in May and April respectively. As a result, approvals over the June quarter came in at 40,310, which is the lowest quarterly total since Q1 2013, representing a fall of 10.0% from the March quarter of 2020. As the chart (below) shows, this was the steepest quarterly contraction on approvals in 3½ years. 

The rollover that came through in the June quarter was led by units (-21.6%qtr), though house approvals also weakened (-2.1%qtr). Unit approvals in Q2 came in at 14,351 — their lowest since Q1 2012 — while house approvals totaled 25,961. 

   

While dwelling approvals weakened in the month, the value of alteration work approved to residential properties lifted noticeably in June rising by 11.4% to $0.708bn, though it was down over Q2 (-9.0%) and through the year (-2.0%). This may be a sign of the impact of the Federal Government's HomeBuilder policy, which offers grants of $25k to eligible owner-occupiers to substantially renovate their home. The value of non-residential work approved also lifted in the month (17.8%) but was down significantly in the quarter (-18.1%) and over the past year (-9.0%).

   

The chart, below, summarises the state detail with New South Wales recording the sharpest declines of all the states in June (-14.8%), Q2 (-24.5%) and through the year (-31.7%). This is predominantly due to weakness in unit approvals, though house approvals in that state are now starting to rollover.   

Building Approvals — June | Insights 

Today's data reported a weaker than expected result on dwelling approvals in June following on from weaknesses in recent months. With approvals now down at an 8-year low, this seems to point to some COVID-19-related impacts with the outlook for the broader economy and net overseas migration highly uncertain. The strong uptick in residential alteration could be a sign of rising demand following the Federal Government's announcement of its HomeBuilder policy. 

Australian Q2 CPI -1.9%; -0.3%yr

The COVID-19 pandemic led to the largest quarterly fall on Australian consumer prices on record (-1.9%) driven by the Federal Government's decision to make childcare services free during the national shutdown and by plunging petrol prices reflecting weak global demand for oil. On these effects, the annual pace on the CPI swung from a 5½-year high (2.2%) in the March quarter to a 23-year low (-0.3%).   

Consumer Price Index — Q2 | By the numbers 

• Headline CPI fell by 1.9% in the June quarter — slightly ahead of the expected -2.0% outcome — after rising by 0.3% in Q1. In annual terms, CPI rolled over into deflation at -0.3% (exp -0.5%) from a 2.2% pace in Q1.
• Details for the underlying measures;
• Trimmed mean fell -0.15% (expected: 0.1%, prior rev: 0.48%) as the annual pace slowed from 1.79% to 1.22% (expected: 1.4%). 
• Weighted median was near-flat at 0.07% (expected: 0.1%, prior 0.52%) with the annual pace pulling back to 1.29% from 1.6%. 

Consumer Price Index — Q2 | The details 

As expected, the headline Consumer Price Index recorded its sharpest quarterly fall on record of -1.9% with the pandemic leading to a deflationary shock to the Australian economy. However, some reversal will come through in Q3 with the provision of free childcare services ending on July 12, and petrol prices having since lifted off their shutdowns lows.

To the details and the chart below shows the price changes recorded across each of the groups for the quarter and through the year. The largest fall came from furnishings, household equipment and services (-11.2%qtr) as out-of-pocket child care costs fell by 95.0% following the Federal Government's announcement in early April to make those services available for free to families. This obscures some noticeable price rises within the category from cleaning products (6.2%), non-durable products (3.8%), furniture (3.3%) and appliances (3.0%) reflecting strong increases in demand ahead of the shutdown. The transport category saw a 6.8% decline in Q2 as automotive fuel prices fell by 15.9%. Education costs were also down sharply (-3.7%qtr) because this group includes outside school hours care services, which were also covered by the Federal Government's childcare announcement. Prices across the recreation and culture group were down by 1.0%, with domestic (-2.0%) and international travel costs (-2.0%) imputed by the ABS to have weakened in Q2. The housing group recorded a 0.6% decline, with rents down by a record 1.3% after state governments implemented mechanisms allowing tenants impacted by the pandemic through a loss of work or income to negotiate rent reductions with their landlord. 

          

There were some groups that saw price levels increase overall in Q2 in alcohol and tobacco (1.5%) and food and non-alcoholic beverages (0.5%), with the latter seeing sharp rises from other cereal products (include pasta) (6.1%) on the stockpiling effect. Declines in fruit and vegetable prices (-0.7%) and in some meats suggest that the supply-side disruptions from the drought were moderating.    

The next chart shows the contributions from each group to the headline inflation outcome in Q2. Furnishings, household equipment and services subtracted 1.1ppt, with childcare alone taking 1.3ppts away. Transport subtracted 0.8ppt from headline CPI on the back of the decline in fuel prices (-0.8ppt).

Consumer Price Index — Q2 | Insights 

Today's report contained few surprises with most of the price decline dynamics known well in advance. There will be some reversal in Q3 as out-of-pocket childcare costs return and from higher petrol prices. However, there may not be much improvement in the underlying inflation pulse, which was weaker than forecast, with the domestic economy operating a long way below its pre-pandemic level and is likely to do so for some time yet.  

Preview: CPI Q2

Australia's Consumer Price Index (Q2) report for the June quarter is due out at 11:30am (AEST) today. The data are expected to confirm the largest fall in quarterly prices on record with the onset of the COVID-19 pandemic and the measures implemented to contain the spread of the virus leading to an overall deflationary shock to the economy. 

As it stands | CPI 

Australia's inflationary pulse was a little stronger than expected in the March quarter with the headline CPI rising by 0.3% (forecast 0.2%) lifting the annual pace from 1.8% to 2.2% — its fastest in 5½ years. This was driven by higher food prices with vegetable (9.1%qtr) and fruit prices (2.4%qtr) up strongly due to supply-side disruptions associated with the earlier drought and summer bushfires and by stockpiling of essential items such as non-durable household products (2.8%qtr) and pharmaceuticals (5.1%qtr) ahead of COVID-19 shutdowns. The RBA's preferred trimmed mean measure also outperformed consensus advancing by 0.5% in Q1 to be up by 1.8% through the year but was still well below the lower band of its 2-3% target. For a full review of Q1's data see here.  

Market Expectations | CPI 

The consensus expectation is that headline CPI will post its largest quarterly contraction on record of -2.0% in Q2 between a range of estimates from -2.4% to 0.1%. The annual pace is forecast to swing from 2.2% to -0.5%. A negative outcome is also anticipated on the trimmed mean of -0.1%q/q, slowing the year-on-year pace from 1.7% to 1.4%.    

What to watch | CPI

Today's report will provide an overview of how the COVID-19 pandemic affected price levels in the Australian economy. There are several key dynamics we know already. Firstly, the Australian Government's decision to make childcare services free between early April and mid-July will have a significant deflationary impact with the ABS advising this will subtract in the order of 1.1ppts from headline CPI in the June quarter (see chart, below). Secondly, petrol prices were down sharply in the quarter as the shutdown in Australia and those occurring across other countries saw global demand for oil greatly reduce, which will also take around 1ppt off the headline inflation number. Thirdly, state government initiatives were implemented to assist tenants in the rental market, including mechanisms to negotiate rent reductions with their landlord in the event they had lost work or income, and this will be reflected as a price fall in the CPI. Travel restrictions also prompted some landlords to convert their premises from holiday accommodation to longer-term accommodation, adding to the supply of stock on the rental market. Lastly, assistance was provided to households through various state government initiatives to either freeze prices or enhance rebates on certain charges such as utilities, while many private health insurers in April deferred scheduled premium increases for at least 6 months. There may be some price rises that come through, particularly in food and other essentials that were in strong demand in the lead up to and in the early stages of the shutdown as inventories were run down quickly and supply chains were stretched in trying to keep up, but the impact of the pandemic was net deflationary in Q2.

Source: ABS

There are also some technical details worth highlighting. Given that the pandemic resulted in a range of goods and services being unavailable due to restrictions or closures (international and domestic travel, urban transport services and sporting events etc), the ABS has had to impute price changes for these items as it outlines in this explanatory note. The other point to highlight is that the CPI is based on a 'fixed basket' methodology and thus it will not be representative of the significant shifts in purchasing patterns that we already know have occurred, such as increased demand for essential items (including basic food) and household goods (home office furniture etc) and discretionary expenditure falling away sharply in areas such as travel and dining out.

Households uncertain over the outlook

The ABS's 8th Household Impacts of COVID-19 Survey highlighted the range of uncertainty of Australians have around expectations for a return to 'normal' conditions. Given the unfortunate surge in virus cases in Victoria, expectations for the timing of the recovery are longer and more uncertain in that state than is the case across the rest of Australia. While that may not be surprising, it will certainly constrain the nation's pace of recovery as a whole while adding more uncertainty into the outlook that could have spillover effects on confidence in the other states.    

This latest survey was for the period between 6-10 July measuring responses from 1,000 Australians. The key finding in today's survey was the spread in expectations over the timing of the recovery in Victoria compared to the other states. This divergence between a deteriorating picture in Victoria and a still weak but much less pessimistic dynamic across the rest of the nation is consistent with what has recently been shown in other high-frequency indicators such as Google's mobility indexes and consumer sentiment data. Overall, it would appear to add weight to the thesis that the key factor in achieving sustainable reopenings is keeping the virus under control. 

Looking at the findings, around 73% of Victorians anticipated the return to normal would take between 3 months to more than a year, which compares to 62% for residents across the rest of Australia. It would be reasonable to think that level of divergence might have widened further since the survey was taken given that virus cases have continued to rise through the first two weeks of the Melbourne shutdown. A considerably higher proportion of Victorians were also unsure over the timing of the recovery (16.4%) than across the other states combined (7.8%). In Victoria, almost 23% saw the return to normal taking between 4-6 months, 18.1% forecast a quicker recovery of 3 months, 17.5% though it would take more than a year and 14.7% placed a timeframe of 7-12 months on that outcome. For the rest of Australia, opinions are really divided with 15.9% anticipating a return to normal within 3 months, 16.5% between 4 and 6 months, 11.5% within 7 to 12 months and 18.4% taking longer than a year. Additionally, there was 13.2% of Australians outside of Victoria who already felt that life had returned to normal. The ABS's chart (below) shows these outcomes.  

  Source: ABS 

In looking out to the future, the survey also asked respondents what aspects of life under the COVID-19 restrictions would they like to continue in a post-pandemic economy. The top 5 responses were; spending more time with family and friends (29%), reducing environmental impacts (27%), spending less/saving more (25%), working or studying from home (25%) and embracing a slower pace of life (23%). Perhaps, one positive that can come out of the pandemic is the chance people have had to reassess what is important to their lives and adjust their behaviour accordingly. The responses to this question are summarised in the chart produced by the ABS (below).

Source: ABS 

Macro (Re)view (24/7) | Fiscal takes up the running

The main theme over the past week was fiscal authorities the world over moving towards providing additional support to their pandemic-hit economies. The onset of the crisis resulted in quick and aggressive policy easing from central banks, but the sustainability of the recovery coming out of shutdowns will require progress firstly on the health front and secondly through ongoing fiscal support. In Australia, extensions to key income support measures were announced, while offshore European leaders agreed to terms for the €750bn recovery fund and in the US negotiations continued towards the phase 4 stimulus package. 

Starting domestically, the Federal Treasury handed down its Economic and Fiscal Update (reviewed here) this week ahead of the budget to be delivered in early October. Treasury estimates that on budget night the deficit for 2019/20 will be $85.8bn (4.3% of GDP) before widening out to $184.5bn (9.7% of GDP) in 2020/21. In pre-pandemic times last December, small budget surpluses of $5.0bn and $6.1bn were anticipated in 2019/20 and 2020/21 respectively. The seismic shock caused by the pandemic has plunged the nation into recession for the first time since the early 1990s with significant repercussions for public finances. The deterioration in the budget position for 2019/20 comes from $58.4bn in policy support measures and a weak economy that dents the coffers by $32.4bn, while in 2020/21 policy measures ramp up to $118.4bn and the impact of the recession escalates to a $72.2bn hit to the budget.

These latest estimates incorporate the announcements from this week regarding the extension to the JobKeeper policy and enhanced JobSeeker payment, though further changes could be delivered before October and that would alter the budget projections. On these measures, a 6-month extension was announced to the JobKeeper (wage subsidy) policy to cover the December quarter of 2020 and then the March quarter of 2021, with firms needing to satisfy the existing revenue test each quarter to retain the support. For the December quarter, the flat payment of $1,500 per fortnight is lowered and then tiered to $1,200 for those working more than 20 hours per week and to $750 for workers that come in below that threshold, while in the March quarter a further reduction is penciled in at $1,000 and $650 respectively. This extension increases the size of the policy from around $70bn to $85.7bn over the two years from 2019/20 to 2020/21, though it is still significantly below Treasury's initial estimate of $130bn so there is potentially scope for further support beyond this. Meanwhile, the coronavirus supplement for JobSeeker recipients has been extended by a further three months through to the end of 2020, though the size of the enhancement lowers from $550 to $250 per fortnight from September 25 onwards, in effect lowering the maximum payment available from $1,116 to $816 per fortnight. The extension to the coronavirus supplement costs $3.8bn, with the overall package advancing to $16.8bn. The extensions to JobKeeper and the JobSeeker enhancement together with other initiatives recently announced adds in the order of $22bn in direct support and will help to reduce the gradient of the 'fiscal cliff' that would have otherwise loomed at the end of September. This has lifted total direct support from the Commonwealth to $164.1bn, or to around 8.2% of annual GDP, with $111.8bn of this coming through in the current financial year (see chart of the week, below). 

Chart of the week

Public net debt is now forecast to hit $488.2bn (24.6% of GDP) in 2019/20 and then rise to $677.1bn (35.7% of GDP) in 2020/21. This is, however, comparatively low by global standards and as RBA Governor Philip Lowe highlighted in a speech this week, it is entirely appropriate for the government to be using its balance sheet to smooth out the substantial hit to incomes the pandemic has brought on and to limit the potential for it to inflict longer-term scarring on the economy by permanently reducing its productive capacity. Furthermore, Governor Lowe noted that the government is able to fund deficit spending on very favourable terms with bond yields down at historically low levels, while there continues to be very strong demand for those securities in global markets. In Governor Lowe's speech and in the July meeting minutes, it was highlighted that the Board had reviewed its monetary policy stance and considered alternative options. Overall, the Board concluded that its current stance was appropriate, though it would be prepared to make adjustments if the circumstances were to warrant that course of action. This would most likely be a further reduction in the cash rate (to as low as 0.1%) or more bond purchases, but negative interest rates, foreign exchange intervention and direct monetary financing are not seen as options that it needs to keep on the table. In a light week for data releases, retail sales advanced by 2.4% on a preliminary basis in June driven by the reopening of cafes, restaurants and discretionary stores, while exports were estimated to have risen by 8% in June on strong Chinese demand for iron ore as imports posted a smaller increase of 6%.  

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Developments offshore this week highlighted the spread that is starting to widen in the economic recovery in Europe compared to the US. This was not reflected in the price action in equity markets but it was in foreign exchange with the US dollar index down in the order of 1.6% over the week, which lifted the Euro, Sterling, Yen and Australian dollar (see table, below). A less constructive relative view on the US saw real yields drifting further negative to their weakest levels since 2012 with markets speculating that more support will be required from the Federal Reserve. 

On policy this week, European leaders reached agreement on the terms of the €750bn recovery fund after almost five days of negotiations. This will allow the European Commission to use its triple-A rating to issue common bonds and provide a mechanism for fiscal transfer to its member nations that have been hit hardest by the pandemic but are constrained by the state of their public finances. The terms were not as favourable as they might have been with €390bn to be disbursed in grants and €360bn in low-interest loans, whereas the initial proposal put forward by Germany and France was for as much as €500bn in grants and €250bn in loans. In the end, the north, led by the Netherlands, was successful in its push for a greater share of the funds to be disbursed as loans and greater conditionality on how it is to be used, but it was still clear progress in moving towards a fiscal union and it will encourage nations in the bloc to implement structural changes identified in the European Commission's Country Specific Recommendations to lift the growth potential and resilience of those economies.

Over in the US, Congress is struggling to agree to the details of its next stimulus package at a time when the enhancement of $600 per week to unemployment insurance is due to expire at the end of the month. The Democrats want to see this extended through to the end of the year, while the Republicans are divided with some wanting it to be extended but at lower levels, while others are reluctant to moves for more support to be injected. Notwithstanding this, markets still expect some extension of the enhancement as well as another round of stimulus cheques of $1,200 for individuals, though it may take some time to reach that agreement. 

Together with divergence on progress towards fiscal support is vast differences in health outcomes as virus cases have surged in the US since June as it spread down to the south and to the west while Europe has been able to avoid further outbreaks. The relative differences in the reopenings of the two regions can be seen in July's flash PMI readings that were released this week. On a composite basis, activity in the euro area advanced from 48.5 to 54.8 (readings > 50 indicate expansion) signalling that growth was starting to return early in Q3 with output and demand picking up coming out of the shutdown, whereas in the US conditions were only able to stabilise in rising from 47.9 to 50.0 held back by reversals of reopenings. In particular, the impact of the pandemic has mainly been a services story and here the contrast is sharp with Europe now starting to expand (55.1 from 48.3) just as the sector in the US is still in contraction (49.6 from 47.9). 

In review: Australia July Economic and Fiscal Update

The Federal Treasury has today provided its Economic and Fiscal Update ahead of the budget due to be handed down on October 6. Back in December last year, Treasury's Mid-Year Economic and Fiscal Outlook forecast the budget to be on track for surpluses of $5.0bn in 2019/20 and $6.1bn in 2020/21. With the onset of the pandemic driving the nation into recession for the first time since the early 1990s and to its sharpest downturn in the post-war period, the budget outlook has changed drastically with fiscal support being ramped up at full throttle, while the Reserve Bank of Australia also announced a significant package of measures to ease its monetary policy stance in March.    

Today's update forecasts budget deficits of $85.8bn in 2019/20 (4.3% of GDP) widening to $184.5bn in 2020/21 (9.7% of GDP). In the 2019/20 financial year, the budget position is impacted by $58.4bn provided in policy support measures and a $32.4bn hit from the economic downturn resulting in tax revenues falling (-$32.6bn). For 2020/21, the broadening in the deficit reflects policy support ramping up by $118.4bn, while the recession costs the budget $72.2bn with revenues down by $56.4bn and payments rising by $15.8bn. As a result, government net debt is projected to rise to $488.2bn (24.6% of GDP) compared to the $392.3bn figure forecast in the 2019/20 MYEFO and then to $677.1bn (35.7% of GDP by June 2021. However, with yields on 10-year Commonwealth government bonds at around 0.9% and well below the nation's economic growth potential, the increase should be manageable.    

On the economic outlook, Treasury forecasts domestic real GDP to contract by 0.25% through the 2019/20 financial year, this after the 0.3% decline in the March quarter and a forecast fall of 7% in the June quarter. Over the year to 2020/21, real GDP contracts by 2.5% on weakness across household consumption (-1.25%), dwelling investment (-16%) and business investment (-12.5%). Under this baseline scenario, Treasury assumes that, outside of Victoria, the reopening of the economy progresses in line with the government's three-stage plan, with localised virus outbreaks contained. In Victoria, the current shutdown of Melbourne is projected to remain in place for 6 weeks leading to a mid-September reopening. Meanwhile, the overseas travel ban is assumed to be lifted in the first half of 2021, but with a two-week period of quarantine on arrival into Australia.

A drawn-out recovery is expected in the labour market. The national unemployment rate currently stands at 7.4% as of June and is forecast by Treasury to reach a peak of around 9.25% by the end of this year before easing back to 8.75% at the conclusion of the 2020/21 financial year. While the participation rate is forecast to gradually improve from 64.0% to 64.75% by mid-2021, this would still be well below its pre-pandemic level of around 66%. Meanwhile, employment growth is only seen to improve to a 1% pace through to 2020/21 after contracting by 4.4% in 2019/20.

In terms of policy measures, the key announcements around the extensions of the JobKeeper and enhanced JobSeeker benefits were already made public in the days leading up to today's update. The JobKeeper (wage subsidy) policy has been extended by 6 months through to March 28, 2021. Between September 28 and January 3 (2021), the current flat payment of $1,500 per fortnight reduces to $1,200 for employees working more than 20 hours per week and to $750 for employees working fewer than 20 hours per week. A further reduction then occurs between January 4 and March 28 (2021) to $1,000 and $650 respectively. This extends the estimated cost of the JobKeeper policy from $70bn to $85.7bn over the two years to 2020/21. Meanwhile, the $550 per fortnight enhancement to the JobSeeker support payment has been lowered to $250 from September 25 through to the end of 2020 at a cost of $3.8bn, taking the total to $16.8bn over the 5 years from 2019/20.

Direct Commonwealth fiscal support is now estimated at $164.11bn out to 2023/24, representing around 8.2% of annual GDP, with $111.82bn of this front-loaded into the current financial year.  

Link to July 2020 Economic and Fiscal Update here

Macro (Re)view (17/7) | Reopening not synonymous with recovery

Australia's update on the labour market for the month of June was the highlight of events domestically this week. In line with the Federal government's three-stage reopening plan, shutdowns across most states started to be gradually wound back from early May leading to a modest rebound in labour demand. In June, 210.8k jobs were added back to the domestic economy in an upside result on the consensus forecast of 100k (full review here). This was comfortably the highest increase on a single month on record, but the key point is that this represents jobs restored, not newly created as is usually the focus. More pertinently, June's rebound needs to be assessed against the quantum of the 871.5k jobs that were lost through April and May as the emergence of the pandemic prompted the authorities to mandate shutdowns to limit the spread of the virus. The part-time segment of the labour force had taken the brunt of this but led the rebound in June as 249.0k jobs came back while full-time employment contracted by a further 38.1k. Overall, the initial stage of the reopening was able to restore 24% of the jobs that were lost through the shutdown (see chart, below). 

Chart of the week

The dislocation is still significant with hours worked some 6.8% below their pre-pandemic level, even after rebounding by 4.0% in June. With workforce force participation lifting by 1.3ppt to 64.0% as more Australians returned to work and some unwinding of the relaxation of the mutual obligation requirement linked to the JobSeeker payment, the unemployment rate increased from 7.1% to 7.4% — its highest since late 1998. However, this understates the true scale given the number of workers that have left the labour force since the pandemic, while the ABS noted there were some 1.15 million Australians that worked either no hours or fewer hours than usual due to 'economic reasons'. The underemployment rate is a more accurate reflection of the situation standing at 11.7%, though it did at least improve slightly from 13.1% in the month prior.

Looking ahead, the labour market faces very significant challenges. As covered last week, the reopening of the domestic economy has run into trouble through the reintroduction of shutdown orders in Melbourne. Clearly, this is of particular concern in Victoria but there were signs this week this was affecting the other states through weakening confidence and high-frequency mobility data suggesting activity was starting to level out. The Westpac-Melbourne Institute Consumer Sentiment Index rolled over by 6.1% in July to 87.9 from 93.7, indicating a notable increase in outright pessimism. Sentiment in Victoria declined by 10.4% on the back of the surge in virus cases leading to the Melbourne shutdown, though the 4.5% fall in confidence across the other states points to a broader degree of nervousness. Renewed virus concerns also appear to have led to a rerating of consumers' economic outlook. After rising by 8.4% last month, the economic conditions next 12mths index plunged by 14% in July, while the next 5yrs outlook more than reversed June's 6.4% advance with a 10.3% decline. Accordingly, unemployment expectations, which had shown notable improvement coming out of the shutdown, deteriorated by 12.1% in July.

On top of renewed virus concerns, the other headwind facing the labour market is from an economy likely to be operating well below capacity for the foreseeable future. This was highlighted in this week's NAB Business Survey for June with capacity utilisation in all measured industries excluding retail falling well below long-run average levels. Certainly, the persistence of the virus and ongoing precautions will continue to weigh on output. The June survey reported a moderation in the weakness of business conditions from -24 to -7 and confidence improved from -20 to +1, though it pre-dated the Melbourne shutdown so some reversal, particularly for confidence measure, appears likely for July. Meanwhile, ongoing weakness in forward orders continues to point to firms being reticent to invest and hire in the months ahead.    

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Switching the focus offshore, China reported a rebound on Q2 GDP growth of 11.5% after the pandemic saw output contract by 9.8% in the March quarter. As a result, growth in annual terms improved from -6.8% to 3.2%. The key theme was not that the rebound occurred but more so its uneven nature. The supply side of the economy has been able to come out of the shutdown with vigour as seen by industrial production rising by 4.8% through the year to June, though there is a divergence with the consumer pointing to ongoing caution due to the virus with retail sales having contracted by 1.8%Y/Y. Over in the US, high frequency indicators have indicated that the reopening of the economy has been losing momentum of late on the back of surging infection rates. Case in point this week was California where the authorities announced the reinstatement of a wide range of containment measures. The latest Beige Book that provides a snapshot of economic conditions across each of the 12 Federal Reserve districts noted that while the reopening had seen activity and labour demand pick up, they remained a long way short of pre-pandemic levels. With more support needed and with the scheduled end to enhanced unemployment benefits nearing, attention now turns to the next fiscal package from Washington, with President Trump appearing to be in favour of payroll tax cuts. Whether there will be more support coming from the Federal Reserve is a live issue, with FOMC member Lael Brainard noting that the pandemic called for "a sustained commitment to accommodation, along with additional fiscal support". On the data front, consumer sentiment according to the University of Michigan index weakened notably from 78.1 to 73.2 in July, consistent with the increased concern over the virus. Retail sales posted a stronger-than-expected rise of 7.5% in June, but that is at risk of slowing from next month as the reversal of reopenings plays through.

Both monetary and fiscal authorities were the focus of developments in Europe this week. There were few surprises from the European Central Bank (ECB) at its latest meeting of the Governing Council as policy settings were left unchanged. Its most recent policy change was the announcement of the expansion of its Pandemic Emergency Purchase Programme from €750bn to €1,350bn. Cumulative purchases through to 10 July stand at around €383bn and the main takeaway from ECB President Christine Lagarde's post-meeting press conference was that its baseline was for the full €600bn expansion in the purchase envelope to be used on the basis that it was required to address the dual purpose for its inception being to reduce the risk of market fragmentation through a widening in sovereign yield spreads and to ease the broader monetary policy stance. Meanwhile, European leaders gathered in Brussels for weekend talks over the details of its recovery fund. The proposal up for discussion is a €750bn fund comprising €500bn in grants and €250bn in loans to support the recovery from the pandemic amid a bleak economic outlook across the bloc. Northern European nations, led by the Netherlands, are pushing for a different composition with a greater share going to loans and more control over how the funding will be disbursed.