The Bumpy Ride Ahead
COVID-19 infection waves are proving hard to predict. Look no further than New Zealand, where after more than 100 days of no community infection an outbreak has occurred, requiring its largest city, Auckland, to be locked down. In Australia, there is hope but no certainty that the large second wave of community infections in Melbourne and Regional Victoria is peaking. Small infection numbers have placed New South Wales on a knife edge and are causing other states and territories to maintain tight border restrictions, shelving earlier plans to re-open.
It is not possible to predict confidently when and where COVID-19 flare ups will occur and what restraints may be imposed to contain them. The uncertainty surrounding COVID-19 shocks is playing havoc with economic forecasting.
Before the Victorian second wave of infections, it looked like Q2 2020 would see the bottom of the recession with the beginnings of economic recovery starting late 2020 and noticeably stronger economic growth occurring in 2021. A typical “V-shaped” recovery was expected as most economic models fed with a singular large downside shock to the economy (COVID-19 and consequent containment restrictions) followed by stimulus, from very low interest rates plus substantial lift in government spending (the biggest lift since mid-World War II) will predict a sharp recovery line in GDP growth.
When the modelling makes assumptions about the main downside shock; when it diminishes; when it might end keep changing, the recovery trajectory line generated by the model is destined to keep changing as well. The ride ahead becomes much less predictable than usual and bumpier. That essentially is the position we are in now. Some economic readings relating to the period just ahead of the latest COVID-19 flare-up in Victoria point to recovery starting. The problem is the Victorian cases have changed the game.
The July labour force report, for example, showed a better-than-expected employment lift, +114,700 (consensus forecast +40,000) and with full-time employment up 43,500. The labour force participation rate rose sharply to 64.7% from 64.0% in June and the unemployment rate rose less-than-expected to 7.5% (consensus forecast 7.8%) from 7.4% in June. Total hours worked increased 1.3% m-o-m.
On the face of it, the July labour force report taken together with the June report, when employment rose by more than 200,000, point to the beginnings of recovery from the low point of the recession in Q2. The problem is that the survey for the July report was taken in the first two weeks of the month just as tighter restrictions were being imposed in Victoria.
The labour force readings for August and September will look nothing like those of June and July and will be much weaker. That much is fairly much certain.
What happens after is back in the realms of a guess and will depend on whether restrictions start to ease in Victoria and hopefully tighter restrictions are not imposed outside Victoria to contain yet unforeseen COVID-19 outbreaks.
It is possible that everything goes well (COVID-19 infections abate to a low, sustainable level and a vaccine is proven late 2020 for widespread use towards mid-2021) and steady reduction of restrictions commences in October.
Equally, it is also possible that COVID-19 outbreaks keep recurring or proving a vaccine is protracted, forcing erratic reimposition of restrictions in October and periodically well beyond.
Which of the two outcomes or variations in between should be factored into economic forecasts? Nobody can say with any confidence. Most likely a succession of different outcomes will play out over at least the remainder of this year and well into 2021.
Current GDP growth forecasts, whether those of Treasury, RBA or private forecasters are subject to greater than usual uncertainty and may change substantially over coming months.
At present, most forecasters are working off a base that real GDP fell by more than 5% q-o-q in Q2 (due to be released in early September) and with the second wave restrictions in Victoria starting in July stymieing earlier hopes of a Q3 improvement to be replaced with another quarterly fall.
As for Q4 2020, it could see a sharp bounce in quarterly GDP if Victoria’s restrictions ease in October with easing restrictions elsewhere on low COVID-19 infection numbers. But it could also see another fall in GDP if infections are slow to contain in Victoria and rise elsewhere, prompting tighter restrictions. Either of these two different growth outcomes is possible.
Heightened uncertainty about Q4 growth prospects could persist in forecasts for quarterly GDP growth in 2021.
The uncertainty is likely to reduce the willingness of businesses and households to spend, weakening whatever economic recovery trajectory develops.
Policymakers can offset the uncertainty in the economic forecasts to some degree by reassuring that the stimulus from higher government spending and very low borrowing interest rates is unstinting and undoubted.
The RBA’s constant reassurance that the cash rate will be no higher than 0.25% for at least the next few years is helpful in this respect and provides some certainty. However, the economic recovery from the COVID-19 health crisis is still likely to be a slow and bumpy affair where economic forecasts will be revised substantially from time-to-time.