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Economic Update: Is it the end of the world as we know it?

Updated: Feb 21, 2022

The title of the REM song ‘The end of the world as we know it’ came to mind as I was thinking about the world we are now living in: the headline is always about the latest virus news, the restrictions on movement, worries about crowds. In economics, we will likely find out that the economy in Q2 slowed at its sharpest rate since the Great Depression (as it has done in most other countries). In the same quarter, Australia suffered deflation (the two are linked). And in financial markets interest rates are not only at historic lows but expected to remain there for some years.

Interest rate update

Right now the expectations are that the next move in the cash rate in Australia (and most other developed countries) will be up. There has been increasing hope that a vaccine/treatment will be found (albeit unlikely to be widely available until at least the second half of next year). And while the Australian economy (and that of many other countries) have taken a step back because of the appearance of a ‘second wave’, the economy will still end the third quarter in a better place than it entered the second quarter.

What else can they do?

So what else could the RBA do? Through a combination of ‘yield curve control’ (ie, RBA setting the level of interest rates for more than just the cash rate) and forward guidance on the outlook for the cash rate, the RBA could reduce interest rates for longer maturities (it already is doing that out to three years). This would be helpful for long-term borrowers (such as infrastructure providers and governments). But its wider impact on the economy would be limited given that the majority of borrowing is relatively short term.

Foreign exchange market update

The AUD has had a good past few weeks (only the major European currencies have done better) reflecting the bounce-back in the global economy (particularly China). This benefited our main exports (commodities such as iron ore). It also enabled a reduction in financial market volatility that provided global investors with more comfort to invest in smaller markets such as Australia (and New Zealand). Relatively high-interest rates also provide investors with a reason to invest in Australia. And running a current account surplus means that even modest inflows of money can boost the $A.

At the time of writing the AUD was getting close to 72c (at the time of writing my ‘simple’ AUD model was 73c). From here the $A journey gets tougher. After a (brief) period of being too low, the AUD has moved back to be close to its fundamentals and around its long-term average.

For R.E.M. it may have been the end of the world as they knew it. Right now the world is not as we knew it. Better days will return. How long and bumpy our journey to that day is the unknown.

Original post by Bank of Queensland



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