Minutes of the Monetary Policy Meeting of the Reserve Bank Board
Sydney – 3 November 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), Philip Lowe (Assistant Governor, Economic), Tony Richards (Head, Economic Analysis Department), Anthony Dickman (Acting Secretary)
International Economic Conditions
Members were briefed that developments in the past month had provided further evidence that the global economy was expanding, with GDP rising in the September quarter in all major countries to have reported data, apart from the United Kingdom.
In the case of the United States, this growth came after four quarters of contraction. Private demand was growing, with the car scrappage scheme boosting consumption spending, and the inventory cycle was also contributing to growth. Dwelling investment had grown for the first time in about four years, helped by incentives for first-home buyers. More generally, the housing market appeared to have bottomed, with most price measures now showing stabilisation or growth. However, the labour market remained weak, with the decline in payrolls in this recession much larger than in earlier episodes.
China had continued to grow strongly, with GDP growth estimated at around 2¼ per cent in the September quarter, following growth of around 4 per cent in the previous quarter. Domestic demand growth remained firm. Import volumes also expanded strongly in the September quarter, and were now above earlier peaks. Members noted that the growth in Chinese imports was significant both in the boost it was providing to activity in other countries and as evidence of some shift towards more domestic-led growth. Credit had continued to grow strongly, albeit more slowly than the extraordinary pace seen in the first half of the year. There had been a shift recently towards lending to households, partly reflecting a range of policies that had encouraged borrowing by households.
Industrial production and exports in India were also growing strongly. In South Korea, GDP had grown by around 3 per cent in the September quarter, including a large contribution from inventories. More broadly, data for the east Asian economies had been positive, with industrial production and exports both growing strongly in September after a pause in August. Both series were now not too far below their earlier peaks. Monetary conditions in these economies were quite stimulatory, with policy rates in many countries at or below 2 per cent. Inflation in most countries in the region remained low, but a number were now experiencing solid growth in housing prices.
Domestic Economic Conditions
Members noted that there had been further evidence that conditions in the Australian labour market were turning out to be better than had been expected earlier in the year. The estimates for September showed an increase in employment and a small fall in the unemployment rate. The improvement in the labour market was also apparent in advertised job vacancies and hiring intentions in business surveys.
Staff liaison had pointed to retailers experiencing mixed conditions in September and October, although the broader perspective was that spending appeared to have held up reasonably well given that the earlier boost from the payments to households was fading. Consumer sentiment had risen further in early October to be close to the highest levels in the history of the series. Responses to forward-looking survey questions had been particularly strong.
Recent business surveys had been broadly positive. It was noteworthy that survey measures of capacity utilisation had showed a modest pick-up over recent months, and the levels of these series suggested that there was now less spare capacity in the economy than had been expected earlier in the year.
Business credit had fallen by 1.3 per cent in September, a larger fall than in earlier months, and by around 6 per cent since late 2008. The weakness was in credit to incorporated firms, with credit to smaller unincorporated entities having risen modestly in 2009. Many larger firms appeared to have replaced bank credit with debt and equity financing in the capital markets. As a result, the overall external funding to the business sector was still growing.
Members discussed developments in the housing market. Monthly measures of housing prices had been broadly flat in September, after strong increases in August. Members noted the weak outlook for construction of apartments, in contrast to the current strong population growth. Among the possible causes discussed were the roles played by tighter lending standards on the part of banks and the costs of new development from the zoning and approvals processes.
With both the population and the capital stock growing at rates that were high by both historical and international standards, the medium-term production capacity of the economy was expanding, though measured growth in productivity had been weak in recent years.
Members were briefed on the most recent inflation data. CPI inflation had been 1 per cent in the September quarter and 1.3 per cent over the year, with the low annual outcome reflecting earlier falls in petrol prices and in the ABS estimate of the prices of deposit and loan facilities. There had been strong growth in prices in the housing component of the CPI, especially in electricity, water and gas prices. Food prices had fallen for the second consecutive quarter, after earlier strong increases. The staff's assessment was that underlying inflation had been around 0.8 per cent in the quarter and 3½ per cent over the year, down from a peak of a little over 4½ per cent a year earlier. This was broadly in line with expectations that price pressures would gradually decline, reflecting the earlier slowing in the economy, the slowing in wage growth and the higher exchange rate.
The staff forecasts were broadly similar to those discussed at the previous meeting. The outlook for commodity prices and the terms of trade had strengthened over recent months, and market expectations were for increases in the contract prices of coal and iron ore in 2010. GDP growth was expected to be close to trend over 2010, rising to around 3½ per cent by the end of the forecast period. Growth in the resources sector was expected to be strong, especially in the LNG industry. Underlying inflation was expected to fall gradually to around 2¼ per cent in 2010 before picking up to around 2½ per cent by the forecast horizon. The profiles of the growth and inflation forecasts had both been revised upwards relative to the time of the August Statement on Monetary Policy.
In the major economies, policy rates were steady but several of the major central banks had continued to expand their balance sheets. Markets were expecting policy rates in these economies to remain at current levels for some time yet. Members noted that the Norwegian central bank had raised its policy rate by 25 basis points during the month. Members also noted that the increase in the cash rate in Australia following the previous Board meeting had been passed through to most housing mortgage rates and to some business lending rates.
There had been little change in government bond yields around the world. Spreads on corporate and emerging market sovereign debt were continuing to narrow. Government-guaranteed bond issuance was well below levels earlier this year and some guarantee programs were near their termination dates.
Global equity markets had shown some volatility but were broadly unchanged over the month. Earnings reports in the United States market had overall been a little stronger than expected.
The Australian bond market was normalising. Issuance by Australian banks had been reasonably strong in October, and for the major banks it was now mostly cheaper to issue unguaranteed debt. Members noted a sizeable offshore unguaranteed issue by a lower-rated bank during the month. Conditions in mortgage-backed securities markets had also continued to improve; there had been two small issues of residential mortgage-backed securities in October. The Australian Office of Financial Management had taken up around 40 per cent of the issues, a considerably smaller proportion than earlier in the year; this indicated further improvement in the securitisation market.
In the banking sector, there remained a divergence between the relatively weak performance of many of the large international banks and the Australian banks that had recently reported half-year earnings. Among international banks, there had been a continuation of the pattern of stronger earnings from banks with larger investment banking operations. Commercial banking operations continued to record losses or reduced income, with credit quality remaining poor and write-downs remaining large. In contrast, the Australian banks had reported solid underlying profits and indicated that their loan books were performing better than expected. While measures of asset quality had weakened and expenses for bad and doubtful debts had risen, overall asset quality remained strong by international standards.
Members discussed the change in the structure of Australian banks' balance sheets as banks responded to the challenges of the financial market turmoil of the past two years and as the regulatory response became clearer. Strong competition for deposits, partly reflecting a desire by banks to reduce their reliance on short-term capital market funding, had pushed up interest rates on deposits relative to other funding sources. Members considered the possible implications for Australian banks of global proposals for changes to liquidity and capital standards.
In foreign exchange markets, the US dollar had continued to depreciate, unwinding the appreciation seen in the second half of 2008 and early 2009, and in effective terms was only moderately above the lows seen in the first half of 2008. The Chinese renminbi had remained broadly stable against the US dollar over this period, so in effective terms it had appreciated during the worst period of the crisis but had depreciated since early this year. The Australian dollar had tended to strengthen modestly since the previous meeting, and movements in the currency had been highly correlated with movements in global equity markets and investors' risk appetite.
Members discussed the results of the March 2009 hedging survey recently published by the Australian Bureau of Statistics. It confirmed the results of the 2001 and 2005 surveys, showing that the vast majority of the nation's foreign debt was either issued in Australian dollars or hedged into Australian dollars. The survey confirmed that Australian banks' foreign liabilities were almost fully hedged, the exception being some foreign currency borrowing for foreign operations. In aggregate, Australia had a significant net foreign currency asset position, with foreign currency assets exceeding foreign currency liabilities.
Considerations for Monetary Policy
Information becoming available over the past month continued to suggest that a recovery in the global economy was under way. Asian economies were generally growing at quite solid rates, after having had sharp contractions in some cases. In the advanced economies conditions remained weak, but activity in most of these had now also begun to grow again. While the recovery in these latter economies was expected to be subdued, the important consideration for the Board was that, for the group of economies that comprise Australia's major trading partners, a broad range of forecasters were expecting growth to be around trend in 2010.
Financial markets had seen increased volatility over the past month, but conditions remained much better than had been the case six months earlier. Both debt and equity markets were providing easier, and less costly, access to funds.
In the domestic economy, the recent inflation data had been broadly as expected, showing a gradual easing in underlying inflation. Given the earlier period of lower demand growth and the moderation in labour costs, this trend decline in inflation was expected to continue over the coming year, with underlying and CPI inflation expected to be consistent with the target in 2010. Members noted that this represented some further upward revision to forecasts of some months earlier, which had suggested inflation might fall below the target for some time.
There had been a relatively limited amount of new data on real activity in the economy; the September labour force data had provided further evidence that the downturn in the labour market had been more moderate than expected earlier in the year. Looking ahead, the outlook was for the growth rate of output to rise gradually to a pace close to trend in 2010.
Overall, members considered that the recent information was consistent with the conclusions reached by the Board a month earlier: namely, conditions in the global and Australian economies were significantly better than had been expected earlier in the year when the Board had lowered the cash rate to 3 per cent; the Australian economy was operating with less spare capacity than earlier thought likely; and the growth outlook for the next few years had improved. The Board therefore concluded that it remained prudent, over time, gradually to reduce the degree of monetary accommodation.
In considering the pace of that adjustment, members were conscious of balancing risks. On the one hand, business and consumer confidence could prove fragile, and economic activity at home and abroad might slow more than expected as the effects of stimulus measures faded. Also, the rise in the exchange rate would constrain output and dampen inflationary pressure, and credit conditions for some borrowers remained quite difficult. On the other hand, a lengthy period with interest rates at a very low level carried its own risks, particularly once the threat of serious economic weakness had passed.
After giving careful consideration to these issues, members judged that it was prudent to take a further step to lessen the degree of monetary stimulus. Looking ahead, members expected that if economic conditions evolved as expected, further gradual adjustment in the cash rate would most likely be appropriate over time, though the pace of the adjustment remained an open question.
The Board decided to raise the cash rate by 0.25 percentage points to 3.5 per cent, effective 4 November.