Recession or Bounce Back – Cautious Optimism From The Reserve Bank

Posted on: 19/10/2020

Raffi Pailagian
MBA, BSc, DipFP
Financial Planner / Managing Partner

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Reserve Bank Update – The Uneven Recession We Had To Have

The Australian economy may seem precariously balanced. But if we look at the words of Philip Lowe, Governor of the Reserve Bank, perhaps things aren’t as bad as they may seem.

On Thursday Philip Lowe gave a speech at Citi’s 12^th Annual Australia and New Zealand Investment Conference, in which he not only appeared cautiously optimistic, but signalled a change of focus for Reserve Bank Monetary Policy.

So let’s take a look at what monetary policy is, and how this change from the Reserve Bank might play out.

Monetary Policy Fiscal Policy and Deficits

Before we get too deep into what Philip Lowe had to say, it’s worth providing a couple of definitions.

Monetary Policy

The Reserve Bank sets monetary policy, which uses interest rates to manage the speed of the economy. The official interest rate, or ‘cash rate’, is set based on whether the economy needs to be slowed down or accelerated, the stability of the Australian Dollar, and levels of unemployment.

Fiscal Policy

Fiscal Policy is determined by the Government and is the collection and spending of Government revenue to influence the economy. In our current situation the key fiscal policy decisions have included JobKeeper ($30b) and JobSeeker (increased by $15b), along with a range of other initiatives implemented by the Government to support workers and businesses through the pandemic.

Deficit

The deficit is the difference between the income and expenditure of the government.

Where Are We Now

Lowe described the current recession as ‘uneven’, with the nature of the recovery still ‘highly uncertain’[i].

The fact is, the speed and success of economic recovery is still very much dependent upon the trajectory of the virus. Currently Australia is well placed, thanks in part to the quick action of our governments and to the willingness of the Australian public to co-operate. However, the magnitude of the second wave now sweeping Europe could be cause for concern.[ii]

This uncertainty will undoubtedly have an effect on the economy because both businesses and individuals are becoming more cautious and risk averse. According to Lowe there has been a big increase in household saving. This is likely due to a combination of the limited opportunity to spend during lockdowns, and the availability of government support programmes.

For the Australian economy to begin working its way out of recession we need to increase spending and investing. The question is, how do we achieve this in the understandably cautious health and financial environment?

Winners & Losers

There have certainly been winners and losers in the economic effects of the pandemic.

Certain business sectors, like hospitality, have been hit hard, while others, including mining and the public sector have fared much better.

Younger workers have been disproportionately disadvantaged, as have certain states.

Small businesses have been harder hit than larger ones and Lowe expects to see an increase in the number of business failures and households under financial stress.

What Is Changing?

In an earlier article How Experts Read an Economy we talked about three of the key factors affected by Monetary Policy – interest rates, inflation and the labour market

In the recent past the Reserve Bank has generally focussed on the setting of the official interest rate based on managing inflation, aiming to keep it within the range of 2-3%. In his speech on Thursday Philip Lowe signalled a change in focus:

“The Board views addressing the high rate of unemployment as an important national priority.”

While the inflation and the job market are inextricably linked, this slight shift in focus does highlight the position of the Board that inflation is unlikely to fall into the target range without a return to a tighter labour market.

A Word About The Deficit

Historically, Australia as a nation likes to operate with a low deficit. When the deficit increases the media tend to go into a feeding frenzy. Following the budget last week there was a great deal of talk in the media about the size of the current and projected future deficit. The numbers are pretty eye watering.

What we need to consider is how and why this deficit has come about. Without the fiscal policy put in place by the government, protecting jobs, businesses and those left unemployed, the Australian economy would most certainly be in a perilous position.

What hasn’t been as widely reported is the fact that, compared to many other countries, Australia still has a relatively low deficit. Countries like the UK, USA, France and Germany all have much higher government debt than Australia[i]. Yes, two wrongs don’t make a right. But if there was ever a time when a deficit was excusable, it is certainly now.

Indeed, Lowe seems to think there is little cause for concern:

“For a country that became used to low budget deficits and low levels of public debt, this is quite a change. But it is a change that is entirely manageable, affordable and it is the right thing to do in the national interest.”

Good News Or Bad News

Uncertainty around the progress of the virus is inevitable. However, Lowe has attempted to put some certainty into monetary policy by stating clearly that the Board does “…not expect to be increasing the cash rate for at least three years.”

This is great news for mortgage holders and those wishing to invest in their business. If your job or business is relatively secure, now could be a good time to consider expansion with borrowing so affordable.

However, it’s not such great news for self-funded retirees and those planning to retire in the short term. So, it is more important than ever to have a well designed financial plan.

Whatever your position, expert advice on your own particular circumstances is a must in these volatile times.

One Last Word…

How all this eventually plays out is, to a great extent, dependent upon the progress of the virus. Should we find ourselves with a ‘second wave’ comparable to the second wave in Europe, or a vaccine not be developed in the short term, the current unevenness will likely continue. The good news is, we are in steady hands and Australia is well placed, both physically and economically, to survive the current recession.

If you would like to read the entire speech, click on this link.

Interested in finding out how the current economic environment might impact you and your financial plans? Give us a call on 02 9976 3388 or click below and we’ll be in touch: