Minutes of the Monetary Policy Meeting of the Reserve Bank Board
Sydney – 4 August 2009
Glenn Stevens (Chairman and Governor), Ric Battellino (Deputy Governor), John Akehurst, Jillian Broadbent AO, Roger Corbett AO, Graham Kraehe AO, Donald McGauchie AO, Warwick McKibbin
David Gruen attended in place of Ken Henry AC (Secretary to the Treasury) in terms of section 22 of the Reserve Bank Act 1959.
Guy Debelle (Assistant Governor, Financial Markets), Philip Lowe (Assistant Governor, Economic), Tony Richards (Head, Economic Analysis Department)
Anthony Dickman (Acting Secretary)
International Economic Conditions
Over the past month there had been additional evidence of an improvement in the global economy, especially in Asia. Global growth forecasts had been revised upwards for the first time in more than a year.
Measures of global industrial production showed some growth in the June quarter after earlier sharp declines. The recovery in industrial production had been strongest in China, where production had more than regained the falls in late 2008 and early 2009. Other east Asian economies (excluding Japan) had regained around two-thirds of earlier falls and production in Japan had also increased. Members noted that the recovery in Asian industrial production was positive for Australia, although industrial production was still very weak in the United States and the euro area.
Chinese GDP growth had surprised on the upside in the June quarter, reflecting the effects of significant monetary and fiscal stimulus. Members noted that there had been a number of measures to boost bank lending, and credit had grown at an annualised rate of 45 per cent in the first half of the year. Housing prices were also increasing again. Members also discussed the very strong growth in investment in China, especially in the central and western provinces, noting that there were some reasons to expect that high levels of investment could continue for some time yet.
There had also been an improvement in conditions in the higher-income economies in Asia. GDP growth in Korea had been strong in the June quarter, partly reflecting growth in household consumption, which had been boosted by temporary fiscal measures such as the incentives for the purchase of cars. June quarter GDP data were not yet available for Japan, but industrial production showed a strong pick-up after very large falls in late 2008 and early 2009. This pick-up was most noticeable in consumer durables, which had earlier seen the largest falls: this partly reflected government incentives to buy cars and energy-efficient appliances.
In the United States, output had again fallen in the June quarter, but by less than in the previous two quarters. Members noted that survey measures of business conditions had now returned to levels that were consistent with output no longer contracting. The outlook for the housing sector had improved, with measures of house prices no longer falling, and house sales and building starts showing small increases recently. In contrast, members noted that conditions in the commercial property market were still looking weak and that the impact of the weaker economy had not yet been fully reflected in banks' asset portfolios.
Conditions in the United Kingdom had been weak, with another significant decline in output in the June quarter, although the decline was smaller than in the December and March quarters. As in the United States, measures of confidence had improved, as had some housing indicators.
Domestic Economic Conditions
The news on the domestic economy had mostly been positive over the past month, with the economy continuing to hold up better than had been expected. Business surveys had continued to strengthen and consumer sentiment had risen sharply over the past two months.
Retail spending had been strong in the first part of the June quarter, which had been reflected in a 2 per cent increase in real spending in the quarter, according to data that became available during the meeting. Members discussed the likely durability of this strength, noting that data for the month of June had showed a reversal of some of the earlier gains, and staff liaison with retailers suggested that spending in July might be weaker than in earlier months. Members also noted, however, that there had been a significant increase in household wealth since March, reversing a considerable share of the earlier decline.
Housing loan approvals had strengthened considerably in the first five months of the year, especially for first-home buyers. Members noted that this increased demand had contributed to an increase in housing prices. Private-sector price measures had strengthened further in June, and the ABS data showed a very strong increase in the June quarter after being relatively weak in the March quarter. The recent strength in housing prices was fairly widespread, including in the higher-priced suburbs, where repeat buyers predominate. Members observed that the strength in housing prices also reflected other factors, including low mortgage rates, strong population growth and inelastic supply. They noted that commencements in recent years had been below estimates of underlying demand. The recent, albeit moderate, growth in building approvals for houses was positive, although approvals for apartments remained weak.
Members discussed some of the factors influencing the business sector. There had been some recent strength in spending on some forms of equipment, including motor vehicles. This had reflected the temporary tax allowances on such assets, and members expected that this boost would fade. Approvals for private non-residential construction had remained weak in the first half of the year, after falling significantly during the second half of 2008. This weakness was in part due to the sharp turnaround in conditions in the office property sector, where capital values had fallen significantly and vacancy rates were rising. Overall, business investment was expected to fall significantly as a share of GDP over 2009 and 2010, but it would still remain quite high by historical standards. Partly offsetting this weakness, there was likely to be a pick-up in public investment spending, with the public building approvals data for June showing a very large increase, as the Australian Government initiatives on education spending began to take effect.
Members discussed trends in business financing. They noted that while business credit had fallen over the first half of this year, businesses had raised significant funds from capital and equity markets. Within bank credit, the decline in the first half of this year had been in lending to corporates. Credit to unincorporated enterprises had declined in the second half of 2008, but had grown in 2009 to date. Members noted, however, that the terms and conditions of lending had typically been tightened significantly relative to pre-crisis levels.
Labour market data for June showed a fall in employment and a modest increase in the unemployment rate. The fall in aggregate employment in this downturn had been quite small, though the data for hours worked had showed a larger decline. Overall, the deterioration in the labour market had recently been less than expected earlier in the year.
CPI inflation had slowed to 1.5 per cent over the year to the June quarter. The decline in measures of underlying inflation had been more gradual, to around 0.8 per cent in the quarter and 3¾ per cent over the year. The unusually large gap between the CPI and underlying inflation was mostly accounted for by the large fall in petrol prices around the turn of the year, and the estimated fall in the price of deposit and loan facilities used by households.
Members discussed the revised staff forecasts prepared for the meeting. The central forecast for GDP through 2009 had been revised from a decline of 1 per cent to a rise of ½ per cent. About half of this revision reflected the stronger-than-expected GDP data for the March quarter. It was noted that the wide discrepancy in the various estimates of GDP suggested that this figure was subject to greater-than-usual uncertainty. More generally, the upward revision to the forecast reflected a view that exports, business investment, household consumption and dwelling investment would all be stronger than earlier expected. The outlook for 2010 was also slightly stronger. Members noted that it was still unclear how much of the greater-than-expected recent buoyancy in the economy might have been due to the temporary effects of earlier fiscal stimulus. Overall, however, they concurred that the economic outlook had improved.
The central forecast for underlying inflation was broadly unchanged in the near term, but the upward revision to the growth outlook meant that the trough in inflation was unlikely to be as low as had been previously expected. The staff forecasts now suggested that underlying inflation would fall to about 2 per cent around late 2010 and early 2011.
There had been a material improvement in conditions in financial markets over the past month, especially in the two weeks leading up to the meeting.
Internationally, spreads in money markets had continued to fall and were now clearly below the levels that had prevailed shortly before the collapse of Lehman Brothers last September. In the case of Australia, the bank bills to OIS spread was at its lowest level since the onset of the crisis in mid 2007.
Spreads on government-guaranteed issuance had also tended to narrow. The amount of government-guaranteed issuance globally was also falling. Australian banks were increasing their issuance of unguaranteed debt, including in offshore markets, though they had continued to issue sizeable amounts of guaranteed debt.
Members noted developments in the Federal Reserve's balance sheet. Usage of the shorter-term emergency liquidity facilities had fallen, but the Fed had continued to buy Treasury and mortgage-backed securities. These purchases had helped to reduce mortgage yields. Overall, the size of the Fed's balance sheet had not changed much since the start of the year.
In the case of the Reserve Bank, however, all of last year's expansion in the balance sheet had now been reversed, which was another sign of the normalisation of Australian markets. Exchange settlement balances had been reduced to a little over $1 billion, which was only marginally higher than their pre-crisis levels.
Members noted that the general improvement in financial markets had also been reflected in increases of around 10 per cent in global equity prices over the past month. Equity prices had now risen by around 40 per cent from the lows earlier this year. The market had been bolstered by earnings reports from a number of the large global banks, which had benefited from strong earnings from investment banking activities; profits from commercial banking activities were more restrained. There had been larger recoveries in emerging equity markets, notably in China, where prices had doubled from earlier lows.
The Australian share market had increased broadly in line with markets in other developed economies. Resource shares had risen especially strongly since the previous Board meeting, consistent with the rise in commodity prices. Members noted that equity raisings had been particularly strong recently, amounting to 7 per cent of market capitalisation over the past year.
In currency markets, the US dollar had tended to depreciate over the past month, while the Australian dollar had continued to appreciate, to be at its highest levels since September 2008. It had reversed around two-thirds of the decline from the peak levels in July last year.
Considerations for Monetary Policy
On the basis of the available information, members judged that financial markets had improved substantially and that the global economic outlook was also better. Output was stabilising in the advanced economies and recovering quite strongly in Asia. Forecasts for global growth, while still low, were being raised for the first time in a year. The risks of a further large slump had diminished, though had not disappeared.
The strong rebound in China and some other countries in Asia was supporting the prices and volumes of Australia's exports, to a greater extent than expected earlier in the year. Domestic demand had also been stronger than expected. Although some of the recent strength in the domestic economy might be temporary, partly reflecting policy measures, the outlook for domestic spending had improved, given the significant recovery in measures of household and business confidence. Accordingly, the staff had revised their growth forecasts upwards. The revised forecasts were still for sluggish output performance in the near term, but embodied a strengthening of growth during 2010 and 2011. The latest CPI inflation figures showed that inflation had fallen in underlying terms as expected and further declines were still anticipated. The recent appreciation of the exchange rate would dampen the effects coming from the earlier depreciation, as well as dampening activity at the margin. But the upward revision to the growth forecasts meant that inflation was not expected to fall as low as previously thought.
Members noted that the cash rate had been reduced to the current very low level in anticipation of very weak economic outcomes. In recent months, members had left open the possibility of further reductions in the cash rate should further downside risks to the economy emerge. Given the recent improvement in the global and domestic outlooks, it now appeared unlikely that this would be necessary. In fact, if the economy evolved as anticipated in the forecasts, the Bank would in due course need to adopt a less expansionary policy stance.
In discussing the timing and process of removing some of the current expansionary policy setting, members noted that it would, when it began, involve balancing two risks. There was a risk of overstaying a very accommodative setting in a recovering economy, particularly when underlying inflation still needed to decline to reach the target. On the other hand, there was a risk of an early tightening choking off confidence and demand prematurely. A particular source of uncertainty was whether the recent growth in household spending was due mainly to the temporary fiscal measures, in which case it would probably soon fade, a more general decline in risk aversion, or the more persistent effects of lower interest rates. Information over the period ahead would be important in judging this.
Having considered the issues, the Board judged the current stance of monetary policy to be consistent with fostering sustainable growth and low inflation, while leaving adequate flexibility to respond to developments as needed over the period ahead.
The Board decided to leave the cash rate unchanged at 3.0 per cent.