Central banks optimistic despite coronavirus

On Wednesday the MSCI World Index of developed economy equities hit a record high. For those fixated on equity markets, it is understandable that upbeat narratives are swirling, citing the limited spread of the newly renamed COVID-19 outside China and pledges by the Chinese government to take stimulatory steps to support the economy.

The RBNZ this week joined the RBA in playing down the ultimate economic impact of the virus. Both braced for a hit to at least first quarter GDP but as RBNZ Governor Adrian Orr said, their base case is for the impact to be “of a short duration.” The RBNZ has wrong-footed markets several times under Governor Orr and this week was no exception, the kiwi bouncing 1% and yields jumping as the chances of a rate cut were reduced.

RBA Governor Lowe welcomed the prospect of Chinese fiscal stimulus and in last week’s quarterly statement, the RBA stressed that previous virus outbreaks had had a “short-lived” economic impact on the countries most affected. The SARS virus of 2003 is the obvious reference point. Commodities, trade-sensitive currencies and government bonds have shown a mixed but mostly negative response to COVID-19 so far, in contrast to the resilience in share markets.

So for now, most central banks are treating the virus as something to monitor but not reason to change their growth forecasts or policy stances. Equities may like this optimism but many other markets are a long way from sounding the all clear.

In terms of domestic economic developments, the RBA probably took some heart from the 2.3% rise in Australian consumer sentiment in February and the roughly stable January business confidence reading.

But the starting point for both consumer and business confidence ahead of COVID-19 was quite weak, so it is hard to be confident in the RBA’s “gentle turning point” narrative on economic growth. Westpac expects Australia’s economy to grow only about 2% this year, compared to the RBA’s 2.75% forecast.

The slow growth we expect will mean higher unemployment, which is the key factor in our forecast of 2 further RBA rate cuts. But the monthly labour force survey is always something of a lottery and the strong seasonal factors in January add to the risk of a surprise in either direction in Thursday’s release. We look for unemployment to tick up from 5.1% to 5.2%.

The other key release is Q4 wages. We expect Australian wages growth will remain sluggish, around 2.2% over the year. This compares to 3.2% in the UK and 3.1% in the US, with unemployment below 4% in both nations.

But the RBA has made clear its preference for a steady hand near term, providing some yield support to the Australian dollar as it bumps around 67 cents. Market pricing for a rate cut by May has dropped below 40%. A single rate cut is still fully priced but not until October.

Along with these important data releases, the Aussie dollar in the week ahead will have to negotiate the daily coronavirus updates from China. We will update you on whether it can avoid fresh 11 year lows when we speak to you next week.