Australia to Resume Bond Buying as Victoria Slows Recovery

(Bloomberg) -- Australia's central bank kept its interest rate and yield target unchanged, while announcing it will end a three-month hiatus in bond buying, as Victoria state's tighter and longer lockdown adds to headwinds.

Reserve Bank of Australia Governor Philip Lowe and his board left the cash rate and three-year bond yield target at 0.25% on Tuesday, as expected by most economists. The bank will purchase Australian government securities on Wednesday, to keep yields consistent with the target, Lowe said.

Australian government bonds rallied after the governor's statement. Three-year yields dropped 1.4 basis points to 0.255%, the biggest decline since June 11. The Australian dollar advanced after the release, before easing back to trade little changed at 71.20 U.S. cents at 3:31 p.m. in Sydney.

Strategists were surprised by the decision to resume buying securities and the timing of the move.

“We counted the three-year bond as having been above 25 basis points for the last 18 consecutive days, and given the governor had said it needs to be sustainably above that, then 2-3 weeks might be the line in the sand,” said Su-Lin Ong, head of Australian economic and fixed-income strategy at the Royal Bank of Canada. She wondered if it was due to the situation in Victoria, but questioned today's announcement: “Why not just come in and do it tomorrow given surprise is their biggest weapon?”

The RBA is trying to navigate the hit to the economy from the effective isolation of Victoria, which accounts for almost a quarter of gross domestic product, and the broader impact on sentiment with rising uncertainty.

“As Australians deal with the coronavirus, the economy is being supported by the substantial, coordinated and unprecedented easing of fiscal and monetary policy,” Lowe said in a statement after the decision. “This accommodative approach will be maintained as long as it is required.”

Victoria has ordered a shuttering of large parts of Melbourne's economy for six weeks as the virus outbreak shows no signs of abating, three weeks after Melbourne's 5 million residents were ordered back into lockdown. The renewed restrictions risk derailing an economic recovery that was underway. Hiring intentions have slowed and consumer confidence is becoming more pessimistic.

Construction firms in Melbourne must radically reduce worker numbers on sites, while production at meatworks statewide will be cut by a third. Premier Daniel Andrews on Monday said essential services such as banks, supermarkets, pharmacies and petrol stations will remain open, but that the new restrictions would see an additional 250,000 workers forced to stay home.

Credit Suisse Group AG analysts said in a note that they expect greater disruptions to the labor market as around 600,000 people are employed in highly impacted sectors. So far the market has not reflected the severity of the restrictions in Victoria, they wrote, noting that retail, wholesale, services and construction sectors will be hit hard.

The RBA, while acknowledging the major impact of the shutdown on Victoria's economy, was more optimistic about the overall outlook. It said “the downturn is not as severe as earlier expected and a recovery is now underway in most of Australia.”

The bank provided updated baseline scenarios for Australia's outlook, predicting output will fall 6% over 2020 and grow by 5% in 2021.

“In this scenario, the unemployment rate rises to around 10% later in 2020 due to further job losses in Victoria and more people elsewhere in Australia looking for jobs,” Lowe said. “Over the following couple of years, the unemployment rate is expected to decline gradually to around 7%.”

What Bloomberg's Economists Say

“The RBA's latest assessment of the economy highlights the dominance of virus developments over the outlook for policy. Whether Australia's post-lockdown recovery is merely dampened, or instead derailed, depends on containment success within the country's second-largest economy and any spillovers -- from both the virus, and confidence.”

James McIntyre, economist

Amid the growing gloom, commodities are providing a welcome tailwind for the economy. The price of iron ore -- Australia's largest export -- remains north of $100, reflecting demand from China as it churns out steel under a stimulus program to revive its own economy.

Australia recorded its fourth consecutive trade surplus of A$7 billion or more, coming in at A$8.2 billion ($5.8 billion) in June. That commodity demand, coupled with attractive relative rates, has driven about a 25% rebound in the local currency from a March low. While the RBA would prefer a lower Australian dollar to aid the recovery, it sees the level as broadly in line with fundamentals.

Lowe said the RBA also considered other scenarios for the economy:

• “A stronger recovery is possible if progress is made in containing the virus in the near future. This progress would support an improvement in confidence and a less cautious approach by households and businesses to their spending;
• On the other hand, if Australia and other countries were to experience further widespread lockdowns, the recovery in both output and the labor market would be delayed”

Details will be provided in Friday's Statement on Monetary Policy, he said.

©2020 Bloomberg L.P.