Patrick Flynn

After successfully navigating our initial response to the COVID-19 (coronavirus) health crisis, backed up with $285 billion in government support to individuals and businesses to keep the economy ticking over, thoughts are turning to how to get the economy back on its feet.

It’s a huge task, but Australia is better placed than most countries. Pre-pandemic, our Federal Budget was close to balanced and on track to be in surplus this financial year. Economic growth was chugging along at around 2 per cent.

In his Statement on the Economy on May 12, Treasurer Josh Frydenberg gave an insight into the extent of the challenge ahead.

On what would have been Budget day (the annual Budget has been postponed until October), he announced that the underlying cash deficit was $22 billion to the end of March, almost $10 billion higher than forecast just six months ago. And that was before the $285 billion in support payments began to flow into the economy.

Global comparison

Economic forecasts are difficult at the best of times, but especially now when so much hinges on how quickly and safely we and the rest of the world can kick start our economies.

The International Monetary Fund (IMF) is forecasting the world economy to shrink by 3 per cent this year. To put this in perspective, even during the GFC the contraction was only 0.1 per cent in 2009.

In Australia, the government forecasts growth will fall by 10 per cent in the June quarter, our biggest fall on record. If we manage a gradual economic reboot, with most activity back to normal by the September quarter, the Reserve Bank forecasts a fall in growth of 6 per cent this year before rebounding by 7 per cent in the year to June 2021.ⁱ

Even if we pull off this relatively fast return to growth, it will take much longer to repair the budget.

Budget repair

Economists have recently reduced their forecasts for the budget deficit after the JobKeeper wage subsidy program came in $60 billion under budget. However, they are still predicting our debt and deficits will reach levels not seen since World War II.

For example, Westpac chief economist, Bill Evans forecasts a budget deficit of $80 billion this year and $170 billion next year. AMP’s Dr Shane Oliver also expects the deficit to peak at $170 billion next financial year.ⁱⁱ

Australian Federal budget deficit

While polling shows most Australians approve of the way the federal and state governments have handled the crisis, many are beginning to wonder how we as a nation are going to pay for it.

The key to recovery will be getting Australians back to work; for those who have had their hours cut to return to full-time work, and those who have lost jobs to find work.

It’s all about jobs

The unemployment rate is forecast to double to 10 per cent, or 1.4 million people, in the June quarter with total hours worked falling 20 per cent After the June 2020 peak, the Reserve Bank expects a gradual fall in the annual unemployment rate to around 6.5 per cent by June 2022. This is still above pre-pandemic levels of around 5.2 per cent.ⁱ

With the government announcing the easing of restrictions on movement in three stages by July, Treasury estimates 850,000 people would be able to return to work. More than half of these workers would be in three sectors – accommodation and food; arts and recreation; and transport, postal and warehousing.

Treasury also estimates that this easing of restrictions will increase economic growth by $9.4 billion a month. However, this outcome depends on us following the health advice. The cost of re-imposing restrictions could come at a loss of more than $4 billion a week to the economy.

The stakes are highest for our two most populous states. The cost of re-imposing restrictions could amount to $1.4 billion a week in NSW and $1 billion a week in Victoria. This provides an insight into why those states have moved more cautiously than others in reopening some sectors of their economies.

The growth strategy

Looking ahead, Treasurer Frydenberg said the government’s focus will be on ‘’practical solutions”, citing existing policies such as reskilling and upskilling the workforce, maintaining our infrastructure pipeline, cutting red tape and tax and industrial relations reform.

The Treasurer also made it clear he expects the private sector to lead job creation, not government. If the past few months are anything to go by, Australians have risen to the challenge.

From working from home and staying connected via Zoom, to restaurants pivoting from dine-in to takeaway and manufacturers switching to production of ventilators and hand sanitiser, individuals and businesses have been quick to adapt and innovate.

This is likely to be one of the positive legacies of the pandemic and should help our economic recovery in the years to come.

If you would like to discuss your finances and how to make the most of the recovery, give us a call. 

i rba.gov.au/publications/smp/2020/may/economic-outlook.html
ii amp.com.au/insights/grow-my-wealth/the-coming-surge-in-australias-budget-deficit-and-public-debt
Unless otherwise stated, figures have been sourced from Treasurer Josh Frydenberg’s “The economic impact of the crisis” statement ministers.treasury.gov.au/ministers/josh-frydenberg-2018/speeches/ministerial-statement-economy-parliament-house-canberra

The Morrison Government’s mind-bogglingly large support packages to get Australians through the COVID-19 shutdown have dominated headlines, and rightly so. Only months ago, the Australian economy was in relatively good shape and headed for a Budget surplus.

It’s not just the Government that has swung into action. Behind the scenes, the Reserve Bank of Australia (RBA) has also pulled out all stops to keep the economy moving.

RBA monetary policy is the yin to the Government’s fiscal policy yang. During the current crisis it’s designed to complement, and to some degree pay for Government spending which already exceeds $320 billion.

On March 19, RBA Governor Philip Lowe announced a package of monetary support policies to “support jobs, incomes and businesses”. These policies included maintaining the cash rate at 0.25 per cent, the creation of a $90 billion funding facility to support business lending, and the purchasing of government bonds.

Rates as low as they will go

Australia began 2020 with the official cash rate at what was an historic low of 0.75 per cent. This left little wiggle room for the RBA to provide further economic stimulus the traditional way, by pulling the interest rate lever.

After two rate cuts in March, the cash rate is currently at a new all-time low of 0.25 per cent. The RBA has promised to keep it there until “progress has been made towards full employment and it is confident that inflation will be sustainably within the 2-3 per cent target range”. With unemployment expected to hit double digits we could be waiting for some time, although inflation jumped to 2.2 per cent in March. ⁱ

Source: RBA

Increased funding for SMEs

While low interest rates traditionally encourage individuals and businesses to borrow and spend, there’s less inclination to do either while the Coronavirus shutdown continues.

The prospect of some business failures and loan defaults is also a disincentive for the banks to lend. So the RBA has provided a three-year funding facility for the banks at a low fixed rate of 0.25 per cent to reduce their funding costs and encourage borrowers.

The banks will be able to access this funding if they increase lending to business, especially small and medium-sized businesses which have been especially hard hit by the shutdowns.

Bond buying bonanza

The cash rate is not the only interest rate the RBA monitors. In its March statement it also set a target for the yield on 3-year Australian Government bonds of around 0.25 per cent, in line with the cash rate.

This was a signal to the market that the central bank is serious about keeping rates lower for longer. At the time 3-year Government bond yields were around 0.85 per cent.

The RBA set out to achieve this target by buying Government bonds in the secondary market. This is a monetary policy lever it has never used before, known as quantitative easing.

If you haven’t heard of quantitative easing – QE for short – or you have but you can’t get your head around it, you’re not alone.

How does quantitative easing work?

QE is where central banks print money to buy government bonds. A government bond is a low risk investment product whereby investors lend money to the government for a set period at a predetermined rate of return which is referred to as the yield or interest rate.

When the RBA enters the secondary market to buy billions of dollars of government bonds, it effectively gives the Government a lot more cash to spend and this money flows through the economy.

The RBA’s bond buying also raises the price of bonds and lowers their yields, which in turn lowers funding costs for borrowers and allows them to cut interest rates on home loans and business loans. Coupled with low interest rates, banks are better off lending money than holding onto it.

To date, the RBA has spent more than $36 billion in bond purchases and 3-year Government bond yields have dropped to around 0.25 per cent.ⁱⁱ So, by spending huge quantities of cash the RBA eased monetary policy, which is a roundabout way of saying it used quantitative easing.

What does it mean for me?

The prospect of low interest rates for the next few years creates opportunities and dilemmas for borrowers and investors.

As banks pass on some or all the cuts in official interest rates to their home loan customers, first home buyers are well-placed to secure a good deal. Existing homeowners might also take the opportunity to refinance.

According to Canstar, by shifting from the average variable interest rate of 3.52 per cent to the lowest rate on offer of 2.39 per cent, a borrower on a 30-year, $400,000 loan could save more than $240 a month or more than $87,400 over the life of the loan.ⁱⁱⁱ

Retirees and others seeking income from their investments are not so lucky, but there are some good rates on offer if you are prepared to shop around. The best 12-month term deposit rates and bonus savings account rates are as high as 2 per cent.^{iv, v}

These are undoubtedly difficult times, but the decisions you make now could put you in a good position when markets recover. So give us a call to discuss your financial situation.

i https://www.rba.gov.au/
ii https://www.afr.com/markets/debt-markets/rba-the-new-major-bond-market-player-20200414-p54jjz
iii https://www.canstar.com.au/home-loans/coronavirus-refinance/
iv https://www.finder.com.au/term-deposits
v https://www.canstar.com.au/savings-accounts/anz-nab-86400-savings-rate-changes-april-2020/