Australia - In or out of recession: Who's right, the Federal Govt or the RBA?

Chief Economist's View

Download the PDF version including our economic update by region here: Australia - In or out of recession: Who's right, the Federal Govt or the RBA?

This week, the news on the domestic economy has been very promising. The good news centres around the household sector, who the CBA told us led to a drop in loan deferrals to 2.9% from almost 11% at the peak of the COVID crisis.

In addition, consumer confidence climbed yet again in November; a trend that is likely to continue given the developments on the COVID vaccine, the ongoing easing of restrictions in Victoria and of course the related state border openings. While the housing market looks to have turned the corner with house prices rising in October and building approvals surging in September.

What would cause households’ financial stress to abate so quickly? Three factors explain the rapid improvement.

First, the better than expected handling of COVID, notwithstanding the problems in Victoria. Remember that when COVID first broke back in March, the government warned the national economy was going into hibernation for six months, but even in Victoria, that wasn’t the case as many businesses managed to continue trading through working-from-home or at least kept the lights on although operating at reduced capacity.

Second, the JobKeeper payment and JobSeeker supplements. Due largely to these support schemes, household disposable income has actually risen over the months of COVID, despite a fall in employment and wage growth.

Third, the fall in the cost of credit. By dropping the cash rate to 0.1%, supplying low cost credit to banks via its Term Funding Facility and, most recently, announcing quantitative easing, the Reserve Bank of Australia (RBA) has managed to lower interest rates to households and businesses.

The positive data have led the Morrison government to claim that the Australian economy is now out of recession. Of course, a technical definition of a recession is two quarters of negative GDP growth, which happened over the first half of the year.

But with the September quarter looking positive and with the economy poised for a more solid rebound in the December quarter, the government is calling an end to the recession. But while signs of recovery from the bottom of the cycle are promising, does this mean we can claim we’re out of recession; particularly when the fall economic activity in the first half of the year was as large as the one we have just experienced?

We must remember that economic activity was down by over 7% in the first half of the year and even if the economy bounces back over the second half of the year, as most forecasters (including QIC) are expecting, Australian GDP will still be down by over 4% from its pre-COVID level. Notwithstanding the bounce in consumer confidence, with an unemployment rate of around 7% many families will be feeling that this is a recession Christmas.

In contrast to the Federal government, senior officials at the RBA, including Governor Lowe, have been stating that the economy remains in recession. This is because the RBA is interpreting the outlook more in terms of the current state of the economy compared to where the economy should be full employment prevailed and the level of production hitting its potential level.

Clearly, neither of these two conditions (full employment nor full productive capacity) are being met. Indeed, we are a long way from both and are at levels that we only observe in times of recession.

Meanwhile, while Australian policy makers dispute whether Australia is in recession, US and European COVID case rates continue to climb. Each major European country has been forced into some version of a lockdown, and although the US has avoided a lockdown, State legislators of major cities such as New York are toying with the idea and Chicago has issued a 30-day stay-at-home advisory.

The second COVID wave currently engulfing Europe and the US is bad news for the global economy. Will Australia be isolated from the impending shock? A hit to global growth is most directly transmitted to Australia via trade linkages and while we don’t have a large trade exposure to the US and Europe, we do to China.

The US and Europe account for around 30% of China’s exports, so a drop in demand from those two regions is a big negative for the Chinese economy. But paradoxically, that may not turn out to be such a bad thing for Australia, if China responds as it has in the past by ramping up stimulus measures focused on infrastructure build and housing market support. These stimulus measures increase China steel production and demand for our iron ore and met coal exports, both of which are positives for the Australian economy.

Table 1: Financial market movements: 5 - 12 November 2020

Source: Bloomberg