Morning Commentary: The Reserve Bank of Australia: Back to Work

A daily summary and commentary of events and factors that affect the global markets, with a particular emphasis on the foreign exchange markets.

The Reserve Bank of Australia: Back to Work Share this story: Andrew Kositkun Senior FX Advisor

The Reserve Bank of Australia (RBA) will hold its first board meeting of 2021 later tonight when it is expected to release updates to its quarterly economic forecasts.  Since the bank’s last update in November, economic data has surprised to the upside. The expectation is for the bank to see these developments as a positive but to emphasize the underlying issues facing the economy as fiscal support winds down and the global economic recovery remains uneven.  Regarding economic indicators, the bank should focus on the labor market, financial conditions and inflation. While the risk to growth forecasts remains skewed to the upside, expect the bank’s new projections to include a small downgrade to the labor market outlook. As for policy parameters, the bank should leave its current rate settings unchanged, with an extension to its QE program likely for the following reasons:  To extend the economic recovery: Unemployment is falling and below the RBA’s forecasts, but the current 6.6% is still well above estimates of full employment. Further progress will be difficult as labor force participation picks up due to the withdrawal of federal income support measures.  Inflation is still well below target: The RBA has shifted focus to actual rather than expected inflation. Core measures remain well below the 2%–3% target band that the central bank has, with the bank making it clear that its rate stance will not change until actual inflation is well within the target range.  The desire to avoid further currency appreciation: The failure to extend QE will result in tightening financial conditions. As the central bank has noted, the reason for adopting QE was because longer-term Australian yields were higher than those in other advanced countries. As such, a normalization in global yields from stronger global growth would be welcome by the RBA, but it’s difficult to see the RBA delivering a hawkish surprise with Australian-US 10-year yield differentials positive again.  Of course there are risks from keeping rates too low for too long, such as a surge in housing prices and a rise in household debt, so normalization will have to happen at some point. When economic conditions eventually justify an unwinding of unconventional policies, expect to see QE tapering before a relaxation of the bank’s yield curve control (YCC) policy, as YCC reinforces the bank’s forward guidance on its cash rate. HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT: Ten GOP senators have drawn up a $600 billion fiscal stimulus alternative to President Biden’s $1.9 trillion plan. In the same way that Biden’s $1.9 trillion proposal is the opening move in negotiations, the GOP’s $600 billion proposal is also likely the opening offer. Assuming that negotiations lead to both sides splitting the difference, you have a package just north of $1 trillion. It should be noted that 10 Republican senators are needed to hit the magic number of 60 votes. Elsewhere, House leaders are expected to start progress on a Democrat-only stimulus bill.  U.S. ISM manufacturing PMI came in at 58.7 versus expectations for a 50.0 print.   The disparity in vaccination doses administered per 100 people among European countries continues, with the U.K. significantly ahead of countries such as Italy, Germany and France. German Chancellor Merkel will hold crisis talks with pharma executives today in the hope of speeding up delivery. The U.S., based on doses administered per 100 people, is well ahead of Italy, Germany and France but significantly behind the U.K.  Markets are pricing in an end to Italian political drama, as the spread between Italian bonds and their German equivalent has narrowed to the lowest point since Jan. 19.  China’s manufacturing PMI number came in at 51.5, missing expectations for a 52.6 print. Even though the number came in softer than expected, it still came in above 50, meaning that the economy is continuing to expand.  Myanmar’s military arrested Aung San Suu Kyi and seized control of the country for a year after claiming election fraud and declaring a state of emergency.

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