Australia's central bank was the focus of proceedings domestically this week as the RBA outlined its thinking for 2021 and beyond. At Tuesday's policy meeting, Governor Philip Lowe's decision statement reported that the Board elected to expand its bond purchase program by $100bn, taking effect from April once the initial $100bn tranche of purchases is complete with the $5bn weekly run rate to be maintained (see chart), while its benchmark interest rates were left unchanged at 0.1% (reviewed here). The expansion announcement arrived earlier than markets had been anticipating, though it appears a prudent move in hindsight ending speculation over the path forward before it ever really got going, and with the outlook indicating the macro conditions are likely to remain well adrift from the Board's objectives "until 2024 at the earliest", providing more accommodation sooner rather than later is understandable. The following day, in his "Year Ahead" speech at the National Press Club, Governor Lowe provided further insight into this decision by noting that the bond purchases had resulted in lower rates and a weaker currency than otherwise, while it was also in keeping with the actions of central banks offshore that had recently committed to further bond-buying. Also of note was that the 0.1% targets for the cash rate and 3-year yield were expected to remain in place for some time yet, though on the latter a decision would need to be made later on in the year if the focus for the policy would shift from the April 2024 bond to the November 2024 bond.
Chart of the week
While the RBA's quarterly Statement on Monetary Policy pointed to an improved outlook for the Australian economy, the key theme here and in Friday's parliamentary testimony was that very accommodative policy continues to remain necessary. In the Bank's set of updated forecasts, the path for GDP has lifted with the contraction in 2020 now expected to be much smaller at 2%, compared to 4.5% previously. Forecast growth of 3.5% in 2021 sees GDP return to its pre-pandemic level by the middle of this year, before advancing by a further 3.5% in 2022. One the key uncertainties to this outlook is the period of adjustment households and businesses face as fiscal support, most notably from the JobKeeper policy, is tapered back. While the withdrawal of stimulus is potentially a headwind, balance sheets were strengthened tremendously by these measures over the course of last year so there is plenty of ammunition available to help smooth this transition. Despite this upbeat outlook for activity, spare capacity is expected to remain substantial over the next few years. The unemployment rate is forecast to decline fairly moderately this year from 6.6% to 6.0%, then lower by 0.5ppt to 5.5% by the end of 2022. Consequently, underlying inflation is seen to remain low and steady, coming in short of the Bank's 2% lower target over the forecast period out to mid-2023. Overall, while the RBA's forecasts convey a sense of optimism around the outlook, the effects of the pandemic crisis are expected to persist well into the future.
The week also saw a sweep of domestic macro data releases. The housing market continues to reflect the tailwind of policy support with the value of borrower-accepted housing finance commitments surging by 8.6% in December (31.2%yr) driven by very strong demand from the owner-occupier segment (see here), while the HomeBuilder policy boosted dwelling approvals by 10.9% in December (22.8%yr) ahead of the reduction in grants from the start of the new year as detached approvals hit a record high (see here). After surging in the month prior, retail sales softened in December falling by 4.1%, though the elevated annual growth rate (9.6%) speaks to the strength of household spending, while volumes came in stronger than expected at 2.5% in Q4 as demand in Victoria surged (12.8%) on the state's reopening (see here). Meanwhile, the nation's trade surplus widened to $6.8bn in December as exports advanced (2.8%mth) on higher commodity prices supported by improving economic activity offshore (see here).
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Moving offshore where again it was the theme of reflation that came to the fore driving steeper yield curves, while the US dollar found strength on the back of the move higher. It was also a strong week for equities, with the cyclical sectors (led by banks) working well. This week's highlight in the US was January's nonfarm payrolls report in which employment lifted by 49k, coming in well short of the median estimate for a lift of 105k. Further, more jobs were lost in December than initially reported, with the contraction in that month deepening to -227k from -140k. While the unemployment rate outperformed consensus falling to 6.3% where it was expected to hold steady at 6.7%, this was accompanied by a tick down (-0.1ppt) in the participation rate to 61.4%. Perhaps the best news out of the report was another sharp decline in the underemployment rate, which fell 0.6ppt to 11.1%, and while the level is still much higher than it was before the onset of the pandemic (8.7%) the downward trend from last April's peak (22.8%) remains intact. The overall soft performance from the labour market in January was something of a surprise given the resilience that has been evident in the recent data flow. Emphasising the point was this week's ISM activity indicators. The services index lifted to a 23-month high in January at a reading of 58.7 driven by notable strength in the new orders component, while the manufacturing index also came in at 58.7—slightly slower than in the month prior at 60.5 but still strong. Gaining most of the focus in the manufacturing index was a sharp 4.5ppt rise in prices to 82.1, this component's highest reading since April 2011 on rising input costs.
Over in Europe, the scale of the setback to the economy from the resurgence in the virus is shaping up to be much less severe than occurred at the onset of the pandemic, though it will now clearly mean that it will be a more protracted recovery while the outlook still remains highly uncertain with the vaccine roll-out there much slower to get going than in the UK and US. After surging by 12.5% on reopening in Q3, real GDP contracted by 0.7% in the December quarter widening the decline through the year back out to -5.1% from -4.3%. With the social distancing restrictions intensifying early in the new year, the slowdown in the economy may yet be sharper in Q1. Reflecting this, the eurozone composite PMI slid further into contraction at a reading of 47.8 in January from 49.1 in the month prior. With the service sector hit hardest by the restrictions the slowdown is becoming more acute (45.4 from 46.4), though attenuating this is strength in manufacturing with the sector posting its seventh consecutive expansionary reading at 54.8 in the month. Also of significance in the continent this week was a stronger-than-expected rebound in inflation, with the headline CPI in annual terms rising to 0.9% (vs 0.6% expected) from -0.3%, while the core CPI lifted to a 5-year high at 1.4% (vs 0.9% expected) from 0.2%. These rebounds largely reflect transitory factors such as the rise in the German VAT tax after a temporary 6-month period of reduction that was introduced as a pandemic stimulus measure and the delaying of usual discounting for winter sales with the retail sector largely shuttered, effectively creating a low-base effect. While there may be more temporary effects on inflation going forward, weakness in the underlying economy will be a restraining force.
In the UK this week, the Bank of England kept its monetary policy settings (bank rate 0.1%, asset purchases £895bn) unchanged, with the MPC maintaining its forward guidance that "significant progress" towards eliminating spare capacity in the economy and inflation returning to the 2% target sustainably was required before tightening would be in prospect. Notably, the meeting minutes clarified that preparatory work by the banking regulator around the implementation of negative rates "had not been intended to send any signal about the likelihood or imminence of such a policy" and the rates markets have since priced out the chance of the bank rate going negative in response, with the UK 10-year yield rising sharply by 16 basis points this week. The updated forecasts in the BoE's Monetary Policy Report were conditioned on the basis of the effects of the pandemic dissipating over the course of this year in response to the roll-out of the vaccine leading to a strong rebound. While the impact of the shutdown and the new Brexit arrangement is expected to result in a 4% contraction in GDP in Q1, activity is forecast to start rising from Q2 and gather pace thereafter to expand by 14.2% through the year to Q1 2022, upgraded from 10% expected previously. As this occurs, the outlook for inflation is forecast to improve towards the target, though progress in lowering the unemployment rate is seen to be a more gradual process.
