ANZ says QE could be coming to Australia

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Australia released another stonkingly strong jobs report in May, continuing the form of the previous two months.

If once is an anomaly and twice is a trend, the astonishing May report seems to be rolled-gold proof that Australia’s labour market is strengthening, and fast.

Unemployment tumbled to a more than four-year low and full-time employment surged by over 50,000, encouraging more people to look for work.

That roll call has a few people excited.

If the labour market is strengthening, it could mean that wage growth and household spending could be next, helping to propel economic growth and inflation in the years ahead.

On the early evidence it’s just what the doctor ordered, particularly when we’ve just learnt that the Australian economy grew at the slowest annual pace since the global financial crisis in the March quarter this year.

For a central bank forecasting that both growth and inflation will pickup in the next couple of years, it’s sure that the Reserve Bank of Australia is hoping so.

But what if the recent strength in the labour market isn’t the start of a long-lasting recovery, but rather a false dawn?

It’s happened before, and not all that long ago.

Think late 2015 when Australia’s labour market was booming, at least according to the ABS data. Just when things were looking peachy the data turned ice cold over the next year and a bit, coinciding with the slowdown in the economy over the same period.

It’s got some asking whether the same thing could happen again, and goes along way to explaining why many economists remain reluctant to get too excited about the recent data, at least so far.

If what happened in late 2015 reoccurred, perhaps the most pertinent question would be what, if anything, policymakers could do to help boost economic activity.

The RBA doesn’t have much ammunition left with the cash rate at just 1.5%, having already delivered 50 basis points of easing in response to the growth slowdown seen in 2016.

And the federal government doesn’t have all that much firepower left either at least if its priority remains getting Australia’s budget position back to surplus in the coming years.

It’s a slightly precarious position to be in given the current set of circumstances.

Just how could policymakers respond to help an already weak household sector grappling high levels of indebtedness and soft incomes growth?

That’s a scenario that David Plank and Felicity Emmett, senior members of ANZ’s economic team, have obviously been studying, releasing an excellent note this week as to what steps policymakers may take should the household sector weaken further.

Given the current set of circumstances they don’t think any solution will be easy, particularly with the economy spluttering along just above “stalling speed” with “an accumulation of evidence that households are under pressure”.

“This continued low growth/low inflation environment presents a significant policy challenge for the RBA and government given the starting point of a low cash rate, fiscal deficits and high household debt,” they wrote.

While ANZ says the economy is likely to “muddle through” the next 18 months, forecasting that growth will average 1.8% this year before accelerating to an around-trend level of 2.7% in 2018, it does not think that it will be enough to make a meaningful dent in the unemployment rate over this period, “raising doubts about the return of inflation into the RBA’s target band over the next few years”.

And while that’s unlikely to see the RBA deliver additional rate cuts in its opinion, should the economy underperform its expectations, it says that the RBA will feel it has little choice but to resume easing.

And not just additional rate cuts, put potentially quantitative easing, or QE.

Money printing.

“In the first instance we think this will take the form of additional rate cuts, with the cash rate falling to 1%,” says Plank and Emmett.

“We think there is a good chance the RBA will match these rate cuts with a discussion of possible QE measures — to prepare the way should these be needed and also to signal the policy stance, namely that this is more than just a tweak in the policy setting.

If such a scenario should eventuate, Plank and Emmett say QE would involve the purchase of Australian Commonwealth government bonds (ACGBs) in the secondary market, something they say will be aimed on weakening the exchange rate rather than driving bond yields sharply lower.

They also say that there’s also a small possibility the RBA could start quantitative easing without cutting the cash rate further.

While QE would be something new in Australia, it would follow the path of other major central banks such as the US Federal Reserve, European Central Bank and the Bank of Japan in the past.

Based on ANZ’s assessment, there’s currently a one-in-four chance that the RBA will have to ease policy further in the period ahead, either through rate cuts, the introduction of QE or a combination of both.

Plank and Emmett also say the federal government will have a role to play should economic conditions weaken further, although they admit that’s likely to face obstacles given the government’s push to bring the budget back to surplus and the current political stalemate in Canberra.

“If the downside risks eventuate we think the government should allow the fiscal deficit to expand in line with automatic macroeconomic stabilisers and not look for offsetting savings, even if this threatens the credit rating,” they wrote.

“Consideration should be given to pulling infrastructure spending forward, though continued attention needs to be paid toward the quality of such spending”, along with a focus on “medium-term growth enhancing reforms”.

However, as many Australians would agree, Plank and Emmett say that they “hold little hope that these would have much success in passing through the current Parliament”.

That suggests that if any heavy lifting is required to the boost the economy, it’s likely that it will come from the RBA rather than the government.

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