Minutes of the Monetary Policy Meeting of the Reserve Bank Board
Sydney – 3 March 2009
Glenn Stevens (Chairman and Governor), Ric Battellino (Deputy Governor), Ken Henry AC (Secretary to the Treasury), John Akehurst, Jillian Broadbent AO, Roger Corbett AO, Graham Kraehe AO, Donald McGauchie AO, Warwick McKibbin
Guy Debelle (Assistant Governor, Financial Markets), Malcolm Edey (Assistant Governor, Economic)
David Emanuel (Secretary), Anthony Dickman (Deputy Secretary)
International Economic Conditions
The economic data that had been released over the past month indicated very weak conditions in the December quarter in most regions. GDP data for the December quarter in the major economies had now been released, showing a fall of 1.8 per cent for the G7 as a whole, the biggest quarterly fall since these data were first available in the early 1960s. Looking across the individual countries for which GDP data for the December quarter were available, the bulk of countries had recorded falls in output greater than 1 per cent. A small number of economies in east Asia had recorded very large falls in quarterly output, similar to those seen during the Asian financial crisis in the late 1990s.
In the United States, revised figures showed that GDP in the December quarter fell by more than indicated in the advance estimate. Quarterly output was 1.6 per cent lower, resulting in a decline over the year of almost 1 per cent. Members noted that the effect of the various financial assistance packages that had been announced in recent months had been very significant in budgetary terms, with US official forecasts for the deficit to rise to over 12 per cent of GDP in 2010, the highest in the post-War period. More recent economic data showed further deterioration in the labour market and ongoing weakness in the housing sector, with house prices continuing to fall on some measures.
In the December quarter, Japan recorded its largest fall in quarterly GDP in over three decades. The year-ended decline in output of almost 5 per cent was the largest in the post-War period. Indicators of activity for the March quarter were also weak, with industrial production falling by 10 per cent in January, to be 30 per cent below its peak in mid 2008. This suggested another large fall in GDP in the March quarter was likely. Members noted that the level of industrial production had fallen back to that of 25 years ago.
Elsewhere in east Asia, apart from the Philippines and Indonesia, GDP had fallen in the December quarter, as foreshadowed by the monthly data on industrial production.
The Indian economy was now also slowing significantly, following a period of rapid growth. The slowing had reflected the effects of international trade linkages and a broader moderation in the domestic economy, with industrial production weakening.
In China, there had recently been some positive signs in the monthly manufacturing indicators, but it was too early to assess their significance.
The economy of the euro area was also weak in the December quarter, with a fall in GDP of 1.5 per cent. The economic sentiment indicator, which tracks output growth relatively well, had fallen further in February.
Turning to commodity markets, members noted that there had been some stabilisation in a number of key commodity prices since late last year, notably oil prices and, to a lesser extent, base metals prices. Spot prices for bulk commodities had also stabilised somewhat in the past few months, but had fallen again more recently.
Movements in commodity prices largely determined Australia's terms of trade, which peaked in the September quarter following a large run-up over the preceding decade. Although the terms of trade were now falling sharply, and therefore subtracting from growth in Australian national income, the expected level over the next year or so was still relatively high.
Domestic Economic Conditions
Members were informed that, with the national accounts for the December quarter scheduled for release the day after the meeting, the partial data available to date indicated a small fall in output in the quarter. This was similar to the expectation held a few months earlier. Recent indicators suggested that economic activity had remained subdued in the early part of the March quarter.
Members then considered in detail the information provided by the regular data releases.
In the business sector, the NAB survey indicated that after the sharp fall late last year, confidence had remained at very low levels in recent months. Business conditions, while also having fallen, were fluctuating around levels similar to those seen during the slowdown early in the current decade. Slowing business activity had led to further declines in capacity utilisation, which had fallen noticeably from the peak levels reached a year or so earlier.
Turning to the household sector, retail spending had increased sharply in December, after a run of weak readings in previous months. This produced a rise in spending in inflation-adjusted terms in the December quarter, following three quarters in which sales had been relatively flat. Data released during the meeting showed that the higher level of December sales was maintained in January, with sales rising by a further 0.2 per cent.
Members noted that real household disposable income had been boosted towards the end of 2008 by lower lending interest rates, lower petrol prices and government transfer payments. Members recognised that these effects were not evenly spread across households and that for households which are interest receivers there had been a loss of income from that source. But for the household sector as a whole, the net effect had been a significant addition to disposable income. Liaison conducted by the staff indicated weakness in retail conditions in February. Consumer sentiment had fluctuated around the low level reached in the latter part of 2008, though conditions for purchasing major household items were perceived to have improved in the past few months.
In the housing sector, building approvals fell sharply in the second half of 2008, which implied that residential construction activity would fall during the early part of this year. Declines in house prices in the past few months had mainly been in the more expensive suburbs, with prices in other suburbs appearing to level out. In a sign of increased demand for housing, patterns of housing finance indicated an increase in housing loan approvals of about 10 per cent over the past few months, partly spurred by the increased incentives for first home buyers to enter the market. However, credit growth had remained low as borrowers had evidently taken advantage of the extra cash flows created by lower lending interest rates to increase debt repayments. Further signs of an increased level of activity in the secondary housing market were significant rises in auction clearance rates in both Sydney and Melbourne in February, and a component of the Westpac-Melbourne Institute consumer sentiment survey indicated that current conditions were conducive to buying a dwelling.
Members were informed that business investment was still growing during the latter months of 2008, and had now recorded seven years of double-digit growth on average. However, it was clear that investment spending plans for the year ahead were now being scaled back. For instance, non-residential building approvals had fallen by more than half over the past year or so, and this weakness would flow into construction activity over the period ahead. Commercial loan approvals had declined through 2008. Usage of credit facilities had declined less than credit limits, suggesting some tightening in credit conditions. Nonetheless, a survey of small and medium businesses indicated that finance was of less concern than other issues such as lack of demand and concerns about the general economic climate.
Looking at government finances, the Australian Government's fiscal package announced in February would provide significant stimulus to the economy over the next two years. The easing in the consolidated state fiscal position was expected to be smaller than for the Commonwealth. The state governments were in relatively good financial health and the net debt of the state public sector in aggregate was low, measured in relation to state economic output.
Conditions in the labour market had continued to soften, with no growth in monthly trend employment in January. The unemployment rate to date had risen relatively gradually from its low of 4 per cent, though members noted that significant deterioration was forecast. They observed that several other countries had also had quite modest rises in unemployment thus far, with the sharpest rises in the United States and United Kingdom, which had both been at the centre of the financial turmoil over the past year.
The main news in relation to inflation over the past month was the release of the wage price index for the December quarter, which indicated an increase of 1.2 per cent in the quarter and 4.3 per cent over the year. The slightly stronger rise in the quarter mainly reflected a bunching of some major public-sector agreements; the private-sector component rose more slowly and around the same rates recorded in previous quarters. The Bank's liaison information and recent business surveys suggested that growth in labour costs would moderate in 2009.
Although consumers' inflation expectations were not particularly well measured in Australia, they had declined over the past six months or so, following a rise over the preceding year, and now lay within the target band.
Members were briefed that the inflation forecasts remained unchanged from those published in the February Statement on Monetary Policy, namely for inflation in underlying terms to decline to around 2 per cent by mid 2011. They would be reviewed following receipt of the national accounts data for the December quarter.
Members noted that sentiment in global financial markets had deteriorated again in February after having stabilised somewhat over the preceding two months. The deterioration had been prompted by the combination of weak economic data in many countries and concerns about how countries, particularly the United States and the United Kingdom, would resolve their financial difficulties. As a consequence, major equity markets had fallen back to or below the low points reached last November, with financial stocks particularly weak. Equity markets in emerging market economies had not been as weak. Notwithstanding the general deterioration in financial market sentiment, conditions in global money markets were considerably better than late last year.
Policy interest rates in a number of countries had been reduced further towards zero. Several central banks, including the European Central Bank and the Bank of England, were expected to cut rates by around 50 basis points later in the week. In countries where policy rates were at or near zero, policies of ‘credit easing’ had been implemented. The Fed had introduced a long-term repo facility and was buying agency paper, though mortgage rates had not declined any further in the past month or so. The Bank of Japan was buying commercial paper and shares. The Bank of England had begun buying commercial debt.
There had also been a substantial easing in monetary policy over the past month in emerging market economies.
Government bond yields in the major markets had risen over the past month. In Australia, bond yields had generally moved in line with global developments, and initial auctions of Commonwealth Government securities (CGS) had been oversubscribed several times.
Members were briefed on financial market developments in Eastern Europe and their implications. Credit growth in most countries in this region had been high over the past few years and the domestic banking sectors were largely foreign owned. Members noted that while some Western European banks had relatively high exposures, lending to emerging Europe, as a share of their total lending, was not particularly large. Eastern European currencies had depreciated significantly recently and the economies were slowing rapidly. This had exacerbated the difficulties faced by borrowers in meeting their foreign currency loan repayment obligations. Despite these developments, emerging market spreads overall had not risen significantly over the past month.
Sovereign spreads of some smaller euro area countries had risen in response to concerns over exposures to Eastern Europe as well as rating downgrades.
In Australia, the market for semi-government securities had been disrupted by the recent rating downgrade of Queensland. As a result, spreads to CGS had widened by over 25 basis points, more so for Queensland. Semis were now trading at the same spread as government-guaranteed bank paper and supras that carried AAA-government guarantees. Members noted that actual yields nonetheless remained low by historical standards.
Bond issuance by highly rated corporates had been quite significant in recent weeks, primarily in the United States. Issuance of government-guaranteed debt by banks in the United States and Australia had continued to be very strong. After falling initially, spreads on this type of debt, relative to government bonds, had stabilised in both markets.
The Australian banks had raised further large amounts of guaranteed debt in February, including two large raisings in yen in the Japanese market. Nearly all of the issuance had been guaranteed, with there being negligible investor interest in non-guaranteed bank debt. The issuance meant the banks were well ahead on their funding programs for 2009. There had also been an increase in the average maturity of their outstanding debt.
Turning to foreign currency markets, members noted that the major exchange rates had been more stable over the past month, apart from the yen, which had depreciated noticeably. The US dollar was now around 20 per cent above its trough early in 2008. During most of the past month, the Australian dollar had shown little net change, but had fluctuated in a relatively large range; it had fallen in the days preceding the meeting. On a trade-weighted basis, the Australian dollar had depreciated by more than 20 per cent over the past year, with a significant fall against the yen, though some of the fall against the yen had been reversed in recent weeks.
The domestic share market had declined by about 8 per cent over the past month and, overall, was back below the trough in November 2008. Resources stocks had fallen more modestly over the month.
The December half-year corporate profit reporting season had revealed that headline profits were significantly lower owing to higher provisioning and write-downs, but underlying profits had been relatively stable. In terms of market capitalisation, the bulk of companies reporting had recorded reasonable increases in underlying profits. Non-financial companies had been issuing a large amount of equity in the past few months, to replace debt that had been difficult to roll over.
Members were briefed on the pass-through of the monetary policy change in February to lending rates in Australia. The reduction in the cash rate in February had been passed on in full to housing and small business loan rates, but there had been less pass-through to other business rates, as risk margins were widening. Members noted that housing lending rates were now at multi-decade lows and business lending rates were well below average.
Market expectations for the outcome of this meeting were mixed; pricing indicated a 50 per cent chance of a 50 basis points cut in the cash rate.
Considerations for Monetary Policy
Members noted the rapid deterioration in the world economy in the December quarter and the likelihood that many countries would experience further sizeable falls in output in the current quarter. Although there had been an improvement in conditions in global credit markets over recent months, a lack of clarity about how overseas authorities would resolve problems in their financial sectors had significantly weakened equity markets, particularly for financial stocks. These ongoing strains had continued to affect adversely the confidence of businesses and consumers across the world. Although significant macroeconomic policy stimulus had been put in place in many countries, it was too soon to see the effects of those measures; in some cases fiscal stimulus had been announced but not yet implemented. The near-term outlook for the global economy therefore remained very weak and official forecasts of world economic growth in 2009 were likely to be revised down further.
Members noted that the domestic financial system remained strong and the monetary policy transmission process was working to deliver large reductions in interest rates to end borrowers, particularly households. Early indications were that credit demand by households was responding to these changes. Nonetheless, while the Australian economy had so far remained stronger than many other economies, the speed and scale of the global economic deterioration and its effect on confidence meant that in the near term domestic activity would unavoidably be weak, and indicators for the most recent period would show that weakness as they were released. The latest available information suggested that the national accounts to be released the following day would probably show a small fall in GDP in the December quarter, a weaker outcome than had appeared likely a few days earlier, though not significantly different from forecasts made for the previous meeting.
Members further noted that the easing implemented over recent months was large by historical standards. These measures, together with very substantial fiscal policy measures, had been taken before official data were available to gauge the extent of economic weakness. Early indications were that the monetary and fiscal stimulus that had been applied to the economy was having an expansionary effect, but the size of this remained unclear and it would take some time for the full impact to come through.
The question for policy was whether further stimulus should be added at this meeting, or whether, having reduced rates at each meeting since September, the Board should pause for a further evaluation of the situation. Members could see reasonable cases for both courses of action. On balance, they judged that, having made a major change to monetary policy over the preceding several meetings in anticipation of weak economic conditions, the best course for this meeting was to leave the cash rate unchanged. Members believed this would leave adequate flexibility for policy at future meetings.
The Board decided to leave the cash rate unchanged at 3.25 per cent.