The RBA believes this is what will happen to our economy

The RBA has updated its economic outlook in its May Statement on Monetary Policy.

The RBA provided three economic scenarios, namely a baseline, upside and downside.

The baseline is broadly similar to market expectations, with a steep drop in near-term activity, double-digit unemployment, and recovery starting as health restrictions are rolled back.

Even with an unprecedented easing of monetary and fiscal policy, uncertainty is extreme because economic recovery depends on both the path of the virus and restoring household and business confidence.

The RBA has attempted to capture this uncertainty in its upside and downside scenarios, but in any of these cases unemployment remains uncomfortably high and inflation remains below the inflation target, pointing to very low interest rates for an extended period.

• The economy will contract very sharply in the near term. As flagged in Governor Lowe’s speech, the RBA forecasts a very large fall in activity of 10% over the first half of 2020 with unemployment peaking at 10% in Q2. This forecast of a sharp contraction and double-digit unemployment was widely expected and broadly matches NAB’s estimate of a 7% fall in activity and a peak in unemployment of around 12% by mid year. Coronavirus containment measures have seen consumer spending and business investment fall sharply as people have lost their job, restrictions have limited spending and firms sought to conserve cashflow amid the steep fall in demand. In addition, travel bans have seen a collapse in tourism and education exports.
  • The RBA notes that while it expects employment to fall 8%, or by 1 million workers, there will be a sharper 20% fall in total hours worked. This means there will be an extremely large hit to household income even with extensive government handouts and its wage subsidy scheme, which will weigh on consumer spending during the recovery. The bank also warns that while it expects unemployment to rise to 10% it is uncertain about how many people will drop out of the labour force in this unusual period.
• The path of the recovery is extremely uncertain. Economic recovery begins when restrictions are eased, with an automatic increase in activity as businesses re-open and people leave their homes more often. After this initial rebound in spending, the RBA expects business investment decisions will be the stronger force shaping the recovery.  As such, the RBA emphasises that the outlook is highly uncertain, where much depends on the rollback of containment measures and household and business confidence. Prolonged containment and uncertainty could see spending, hiring and investment plans delayed further, increasing the economic pain from the pandemic.
• The RBA outlines three scenarios: baseline, upside and downside. In the baseline scenario, most restrictions are lifted by the end of Q3, aside from limits on very large gatherings. The international border is also assumed to remain closed until the end of the year. In the upside scenario, the restrictions are lifted earlier in late Q2/early Q3. In the downside scenario, recovery is delayed by either restrictions remaining in place for longer or a second wave of infections.
  • The RBA’s baseline scenario is similar to the market consensus. This scenario sees growth recover in H2 2020, turning around from -10% in Q2 2020 to 7% in Q2 2021. Growth then remains strong, slowing to 5% by mid 2020. Under this outlook, unemployment recovers steadily from 10% in Q2 2020 to 6.5% in Q2 2022. These forecasts are broadly similar to market conseneus and NAB’s forecasts, although our outlook for inflation is much weaker. Where the RBA expects core inflation to slow to 1% by Q1 2021, then recover to 1.5% in mid 2022, NAB expects inflation to slow to just 0.4% by the end of 2021.
  • The upside scenario sees unemployment back to pre-virus levels in 2022. In the upside scenario, activity begins to rebound late in Q2, such that the downturn is smaller and shorter. Growth over the entire forecast horizon is stronger as confidence quickly recovers, with a resumption of consumer spending, business investment and hiring. Unemployment falls quickly to 5% and inflation recovers to just below 2% in Q2 2022.
  • The downside scenario forecasts a steady but slower recovery. In the downside scenario, activity only begins to recover in Q4 2020, although that marks the start of a steady recovery. Annual GDP growth turns from a fall of 10% at end-2020 to a strong 7% by end-2021. This sees unemployment fall steadily from 10¼% at the end of 2020 to just under 8% by mid-2022. The recovery in inflation is more gradual, but still clear as core inflation rises from 0.9% in early 2021 to 1.2% in mid-2022.

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About Michael Yardney Michael is a director of Metropole Property Strategists who help their clients grow, protect and pass on their wealth through independent, unbiased property advice and advocacy. He's once again been voted Australia's leading property investment adviser and one of Australia's 50 most influential Thought Leaders. His opinions are regularly featured in the media.