NAB Monetary Policy Update – August 2021

While Sydney and Melbourne remain a key risk to the outlook, NAB re-affirms its 2024 rate call.

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Overview

NAB re-affirms its 2024 rate call, which we have held since February 2021. The protracted lockdowns in Sydney and Melbourne remain a key risk to the outlook with a significant hit to activity and a reversal of some of the recent gains in the labour market in the near term. We remain confident that activity will rebound strongly once restrictions are eased. With key vaccination thresholds to start the transition to living with the virus within sight, the RBA should remain confident (despite the near-term hit to activity) that its goals of full employment and inflation being sustainably within the target can be reached by early 2024. As for tapering bond purchases, the RBA Minutes downplayed the near-term impact of any additional purchases, noting that they would have only a “marginal effect at the present” with a “maximum effect [in 2022]”. Accordingly NAB expects the RBA to continue with its plans to taper QE purchases in September, but the optics of tapering amid prolonged lockdowns means it is likely to be a close decision.

Prolonged lockdowns in Sydney and Melbourne are likely to continue to disrupt Australia’s COVID-19 recovery in the near-term. Sydney has been in a protracted lockdown since June 26 with lockdown restrictions set to continue at least until the end of September. Melbourne has also been in and out of lockdown with a 12-day lockdown in July (July 15-27) followed by its current four-week lockdown since August 5, which is likely to be extended again given ongoing high case numbers. A significant hit to activity is guaranteed and NAB has pencilled in a Q3 GDP contraction of around 3.0% q/q and expects the unemployment rate to rise to 5.6% from 4.6%, though there are clear risks of even higher unemployment outside of measurement issues. Note July’s unemployment rate fall to 4.6% from 4.9% was flattered by a 0.2 point fall in the participation rate and an increase in people working zero hours. Incorporating these effects suggests the effective unemployment rate is already hovering around 5.4-5.6%.

Importantly though, with key vaccination hurdles likely to be achieved by year end, we expect activity to rebound strongly in 2022 and we project the unemployment rate to be back below 5% by mid-2022 to end the year at 4.4%. Our assumption of a strong rebound means the unemployment rate will be close to the RBA’s central scenario of 4¼% by the end of 2022, despite the current deterioration relative to those forecasts. A strong rebound in activity after restrictions have been eased is very likely based on prior experience. Activity rebounded strongly when Melbourne came out of its prolonged lockdown in October 2020, while substantial fiscal support along with loan and rent deferrals for those in lockdown is again likely to insulate household balance sheets.
As for inflation, the myriad of government support payments and the potential for lockdowns to further postpone wage acceleration, means a clearer picture of underlying inflation pressures will likely not emerge until mid-2022. The interpretation from the July and August Board Meetings was that the RBA’s upside scenarios meant there was a probability that the RBA would see the conditions for a rate hike in 2023, which we saw as a risk to our 2024 view. That risk is now less, and we remain confident in our early 2024 view for the first rate rise.

As for tapering, we noted last month that we saw little difference between $5bn per week and $4bn per week considering that a taper is not a tightening, and even at a pace of $4bn per week the RBA would continue to add substantial stimulus to the economy. While we eventually did call for the RBA to postpone its asset tapering, we also did not see the case for increasing purchases beyond $5bn a week (as some other banks were calling for). The latest RBA Minutes note that while the RBA discussed delaying the scheduled taper of asset purchases, they noted “any additional bond purchases would have their maximum effect at that time [in 2022 as the rebound was underway], with only a marginal effect at present, which is when the extra support might be required”. The Bank also suggested that fiscal policy was better placed to deal with such a shock. With expectations of a strong rebound in 2022, we think this logic will continue in September, but the optics of tapering amid prolonged lockdowns means it is likely to be a close decision.

Our core views are:
• QE tapering to continue as scheduled to $4bn a week in early September from its $5bn a week. We pencil in the next QE taper in February 2022 by which time the strong rebound in the economy will be evident. We expect the total QE program from September to total around $130bn with tapering to occur progressively before ending in mid-to-late 2022.
• First rate hike to occur in early 2024. We see the first move as lifting the cash rate target by 40bps to 0.50%; this is to allow normalisation of the ES rate corridor and would see the actual cash rate trade close to 25bp (i.e. it would effectively be a 25bp rate hike).

Following this, we see increases of around 25 points per quarter – a fairly rapid normalisation as the RBA again becomes forward looking. By mid-to-late 2025 we expect the cash rate to trade around 1.75-2.00% depending on the degree of excess liquidity in the cash market.