- Aus economy to shrink in 1st half 2020

- AUD underperformance could persist

- Quantitative easing at RBA possible

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The Australian economy is being forecast to enter its first recession 20 years by local lender Westpac Bank, a prediction that if correct would likely entrench an ongoing spell of Australian Dollar weakness.

Westpac says the Australian economy will contract by 0.3% in the March quarter and the June quarter in 2020.

"Growth in the second half is forecast to lift by 2.2%. This constitutes a technical recession although with the expected recovery the unemployment rate is unlikely to lift much above 6%," says Westpac Economist Bill Evans.

The predictions come amidst a global economic slowdown linked to the outbreak of the coronavirus which has seen countries like China and Italy initiate quarantine measures to contain the spread of the virus, but a side effect of these measures have a sizeable negative impact on economic activity.

"The economy will be dealing with the impact of the virus when it is in a relatively fragile state with growth in 2019 at 2.2% compared to potential of 2.75%," says Evans.

However, Westpac expect growth to recover in the second half of 2020 as the global economy finds its footing once more.

"Given the expected recovery in the second half of the year it is much more realistic to characterise the situation as a 'major disruption' to growth rather than the style of recession that Australia has experienced in the past. Indeed, recall that in Australia’s last two recessions the unemployment rate lifted from 6% to around 11%," says Evans.

Westpac expects the unemployment rate to hold below 6% through this period.

The UN estimates the cost to the global supply chain of the global response to the coronavirus outbreak is at $50BN, as the typical modern manufacturing process is stretched across many countries owing to years of unrelenting globalisation.

Australia remains particularly exposed to China's decision to quarantine its population in January and February, with the economic slump impacting demand for Australian foreign exchange earners such as iron ore, coal and natural gas. However, Australian industry also relies heavily on the import of parts from China while the Chinese tourist is a major source of business for the domestic services sector.

"Whereas exports (tourism; foreign students; agriculture; resources) and inventories (disrupted supply chains) will explain the major shocks in the March quarter given their exposure to the Chinese economy, the June quarter contraction will be dominated by Australia’s and the rest of the world’s exposure to the virus and the lagged effect of China’s recession in the March quarter. In particular the impact on the rest of the world has already been affecting financial markets which is likely to puncture confidence more widely," says Evens.

The Australian Dollar is particularly exposed to current developments and is one of the worst performing major currencies as a result. The Euro-Australian Dollar is now 8.0% lower in 2020, the Pound-Australian Dollar is down 5.0% and the U.S. Dollar-Australian Dollar is down 6.5%.

"The Australian Dollar, as a proxy for global risk sentiment, and also for China’s growth outlook, will continue to be buffeted by COVID-19 concerns. Record short real money positions should mean two-way price action, but we prefer to sell into any rallies above 0.66. Fragile industrial commodities and the China travel ban threaten each of Australia’s top 5 exports (coal, iron ore, LNG, education, tourism), pointing to a collapse in the trade surplus starting in the Feb data," says Tim Riddell, Macro Strategist at Westpac.

The Australian Dollar fell sharply at the start of the new week, with the Pound-to-Australian Dollar exchange rate breaching 2.0, as coronavirus concerns increased and amidst an eye-watering slump in the value of oil.

The fall in crude prices were as great at 33% at one point, understandably this weakness had a knock-on effect on the price of natural gas, which we have already pointed out is a top 5 Australian export.

The mix of coronavirus fears, recession fears and heavily discounted energy sector therefore create the fundamental backdrop for ongoing underperformance by the Australian Dollar.

However for the Australian Dollar, much will depend on the Reserve Bank of Australia responds to the slowdown, Governor Lowe and his team still have at their disposal one or two further interest rate cuts before unconventional quantitative easing is considered.

An aggressive response that includes quantitative easing - the printing of money to buy government and corporate bonds - would present a scenario that sees losses in the Aussie Dollar.

"The RBA seems set to use its remaining conventional policy ammunition in April if it cuts the cash rate to 0.25% (assuming it doesn’t decide negative rates are an option)," says David Plank, Head of Australian Economics at ANZ. "We expect the RBA to retain an explicit easing bias after an April rate cut. With conventional policy exhausted, this bias must encompass the possible implementation of quantitative easing (QE) in some form."