The week's events domestically were highlighted by a significant speech from the Reserve Bank of Australia Governor Philip Lowe that has outlined a shift in the central bank's policy regime. Following a similar shift from the US Federal Reserve in late August, there is to be a change in the RBA's reaction function, with the labour market to be its main focus as the economy recovers from the pandemic crisis. Governor Lowe provided clarity on how the Bank's forward guidance will evolve to match this shift. The current forward guidance emphasises that rates will not start to rise until "progress is being made towards full employment" and that it has confidence that inflation "will be sustainably within the 2-3 per cent target band". Going forward, Governor Lowe outlined that greater prominence will be given to its full employment objective, just as this week's labour market data for September showed a stalling in the recovery through the loss of 29.5k jobs and an uptick in the unemployment rate to 6.9% (see our full review here).
Previously, the thinking was that as the labour market improved over the next few years, the forecast path for inflation would rise and this would ultimately lead to rates needing to be hiked preemptively to prevent the economy from overheating. However, over the period ahead, the sensitivity to inflation forecasts will be turned down, with the RBA to focus on speeding up the labour market recovery by actively using their policy tools to lower unemployment. Inflation pressures will need to actually materialise before this focus changes. This shift in thinking around forward guidance is in effect a de facto easing in the RBA's monetary policy stance and the foreign exchange and bond markets have responded accordingly. While it was already widely expected, given that there is still scope for the RBA to lower its rates structure, the shift almost certainly demands that the targets for the cash rate, 3-year Australian Government bond yield and Term Funding Facility rate all be lowered from 0.25% to 0.1% at the November Board meeting. Whereas financial stability considerations previously may have been a barrier, potential risks are seen to be mitigated by higher employment supporting balance sheets and reducing troubled loans.
Governor Lowe also provided insights into the importance of relativity in terms of the RBA's monetary policy stance compared to other central banks offshore. In an environment where rates across the globe are either at or close to their effective lower bounds, balance sheet expansion has been key. The RBA's balance sheet has expanded by around 7% of GDP this year, but as the governor noted this is smaller than what has occurred in other economies and the RBA is now working through what the impacts of this might be, such as on the level of the exchange rate and longer-term bond yields. In comparison to the actions of other central banks that are more focused on the longer-end of their yield curves through asset purchases, the RBA's actions have been directed at keeping short-end rates anchored via its yield target. It, therefore, appears likely that the RBA will move towards a quantitative easing program where it would purchase a certain amount of government bonds within 5-10 year maturities. Speculation of this saw the 10-year Commonwealth Government bond fall to its lowest level since April (see chart below). It is possible that expanded bond-buying could be announced at the November meeting, though there are a few details the RBA is working through here so it could take a bit more time.
Chart of the week
The likelihood of further RBA easing coming soon after the Federal Budget, together with the nation's progress in managing the pandemic, appeared to be the key factors in a surge in consumer sentiment according to the Westpac-Melbourne Institute's index in October. The monthly reading advanced by 11.9% to 105.0, its highest level since mid-2018. The earlier stimulus measures from the Government and RBA continue to be reflected in the family finances sub-indexes 'vs a year ago' +6.2% (+15.7%yr) and 'next 12 months' +9.4% (+18.7%yr) and this is also consistent with the strengthing evident in household balances sheets in the latest ABS Household Impacts of COVID-19 Survey for September (see here). The contribution that strengthened household balance sheets can play in Australia's recovery was an aspect covered by Governor Lowe in his speech this week, with the key to deploying this being the public maintaining confidence in the authorities to manage the pandemic and support the economy.
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Switching the focus offshore, the IMF this week published its latest World Economic Outlook for October with the group now forecasting a smaller contraction in global GDP this year of -4.4% compared to -5.2% in its June update, which reflects the earlier than anticipated lifting of shutdowns, though a slightly slower rebound of 5.2% is expected to ensue in 2021 from 5.4% previously. Outside of China, the projected recovery in 2021 is still likely to leave GDP below pre-pandemic levels in both advanced and emerging economies due to the extent of scarring that has occurred in labour markets and elevated uncertainty that has reduced investment spending. As outlined by the IMF, the most prominent risk to its outlook remains the path of the virus, as seen in Europe and the UK this week where rising virus cases have necessitated the tightening of containment measures. After negotiating a successful initial phase in the reopening over the northern summer, the outlook in the continent has quickly deteriorated with the PMI data indicating that economic activity was already slowing ahead of the resurgence in the virus. The situation in the UK is also looking increasingly complex with the government establishing a 3-tiered alert system that mandates different sets of restrictions to apply in local areas depending on the severity of the virus. Meanwhile, on the Brexit front, UK PM Boris Johnson elevated the rhetoric surrounding current negotiations with the EU expressing a preparedness for a no-deal scenario come January 1 next year.
In the US, conflicting headlines around prospects for a new round of fiscal stimulus ahead of the upcoming election continued over the past week. Though it is still possible a pre-election package could be agreed upon, Treasury Secretary Steven Mnuchin conceded this would be "difficult". The data from the US was mainly positive this week, highlighted by a stronger-than-expected retail sales report for September with turnover advancing by 1.9%m/m against the median estimate for a 0.7% lift. More positively, control group sales (more closely aligned with consumer spending within GDP calculations) surprised to the upside by a higher magnitude coming in at 1.4%m/m compared to just 0.2% expected. Clearly, there are risks in terms of the sustainability of this momentum in the absence of more stimulus, though notwithstanding this, consumer sentiment firmed a little in October from a reading of 80.5 to 81.2 driven by a 4.2% rise in the expectations component for future economic conditions. Meanwhile, headline CPI matched expectations in printing at 0.2%m/m and 1.4% through the year to September, while the core measure was also in line with consensus rising by 0.2% in the month as the annual pace held steady at 1.7%.
