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The RBA, out of moves, has left interest rates on hold at 0.25% — but says the economy could be faring better than first thought

Jack Derwin

As the Reserve Bank of Australia (RBA) met again on Tuesday, its decision-making looks to have become a lot simpler.

Insisting negative interest rates are "extraordinarily unlikely", and with no economic improvement forthcoming, the RBA board was widely expected to remain on hold, and it did, keeping the official interest at 0.25%.

"The substantial, coordinated and unprecedented easing of fiscal and monetary policy in Australia is helping the economy through this difficult period. It is likely that this fiscal and monetary support will be required for some time," RBA Governor Philip Lowe said in a statement.

Noting the global economy was experiencing a "severe downturn" and had produced a "sharp rise" in unemployment, Lowe said the situation was fragile but had continued to improve.

"The Australian economy is going through a very difficult period and is experiencing the biggest economic contraction since the 1930s. In April, total hours worked declined by an unprecedented 9% and more than 600,000 people lost their jobs, with many more people working zero hours," Lowe said.

"Household spending weakened very considerably and investment plans are being deferred or cancelled."

However, despite that Lowe remains upbeat, maintaining the economy is performing above the RBA's base case for it.

"Notwithstanding these developments, it is possible that the depth of the downturn will be less than earlier expected. The rate of new infections has declined significantly and some restrictions have been eased earlier than was previously thought likely," he said.

"There are signs that hours worked stabilised in early May, after the earlier very sharp decline. There has also been a pick-up in some forms of consumer spending."

In response, the RBA only performed one tranche of bond-buying over the last month, with all purchases totalling some $50 billion.

When it comes to further easing, the RBA is stuck

The Reserve Bank – having cut rates and begun effective quantitative easing – has little left to do but make sure the government is pulling its weight.

"Right through to next year the economy is going to need support, from both monetary and fiscal policy… my main concern is that we don’t withdraw fiscal support too early," Lowe told the Senate last week.

It's made the powerful central bank little more than a specator, according to Indeed Asia-Pacific economist Callam Pickering.

"With Australia facing its greatest economic challenge since the Great Depression, it is strange that the Reserve Bank of Australia is effectively a bystander. With Reserve Bank governor Phil Lowe arguing against negative rates, Australia’s central bank has been left to do little more than provide liquidity to the financial system," he said in a note issued to Business Insider Australia.

The bank's refusal to go negative with rates and entertain further easing, while an assurance to the public, is "a mistake" according to Pickering.

"Negative rates may not be an appealing course of action but it may be necessary. Other forms of quantitative easing, whether that be further yield control or the purchase of other financial assets, may also be warranted," he said.

"Right now the only commitment the Reserve Bank has made is that they won’t ‘increase the cash rate target until progress is being made towards full employment’ but that promise isn’t particularly useful if policy is also far too tight to achieve those goals."

Despite these criticisms, the RBA's course for the foreseeable future is likely a predictable one, keeping rates on hold, continuing its bond-buying program, and urging the Australian government to do more to get the economy moving.

The economy will get worse before it gets better

While the outlook remains uncertain, the economy is broadly expected to languish for some time before a recovery can be made.

"Given such an outlook and the damage that lock-downs are doing to the economy’s potential growth rate, we look for a low rate regime to persist for many years," Janus Henderson investment strategist Frank Ulenbruch said ahead of the decision

Ulenbruh's view is largely the consensus view of economists, many of whom expect it'll be some time before the economy begins truly growing again, and two or three years before the central bank will even consider raising rates, with the worst not yet behind us.

"We expect a large fall in output in quarter two of around 8.5% followed by a return to growth in quarter three and a more substantial rebound in activity in quarter four. We think it is unlikely that the level of activity will fully recover to pre-COVID levels before mid-2022," NAB economists wrote on Monday.

"With GDP data relatively lagged, more timely indicators already suggest Australia has entered a downturn of unprecedented speed and magnitude, seen most clearly in the labour market. We expect that the unemployment rate will rise to over 10% by year’s end and then partially recover in 2021, remaining above 7% reflecting the delayed recovery in the level of activity."

According to a Finder survey of 34 economists, 85% said a global recovery would not occur until at least 2022. In a separate finding, nearly half of those asked said the hospitality sector wouldn't be at full operation – without social distancing restrictions – until next year at the earliest.

While the RBA wants to put on a brave face, Governor Philip Lowe will remain cautious in the face of a rising dollar.

"No change in monetary policy is expected but the Australian dollar faces upside risk if the RBA reiterates that the Australian economy is faring slightly better than the Bank’s central scenario," CBA senior currency strategist Elias Haddad said in a research note issued before the decision.

Rising to a four-month high this week, a stronger Australian dollar could only hurt the eventual recovery effort.