Minutes of the Monetary Policy Meeting of the Reserve Bank Board
Sydney – 5 May 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)
David Emanuel (Secretary), Anthony Dickman (Deputy Secretary)
International Economic Conditions
Members' discussion of the world economy began with a review of global forecasts. The IMF had published revised forecasts for the global economy in April. World GDP was now expected to fall by 1.3 per cent in 2009, driven by a large fall in output in the G7 economies. The downward revision to forecasts for 2009 reflected the weak outcomes over the first few months of the year in many economies, with the forecasts implying a return to growth over the second half of the year. Growth was, however, expected to be low for some time; the forecast growth for 2010 was 1.9 per cent, with a return to around trend rates of growth not expected until 2011. Members observed that this meant that excess capacity in the global economy was likely to be wound back only gradually.
Industrial production was still falling in the United States and the euro area, though there were some signs that the rate of decline was slowing. However, conditions were brighter in Asia. Industrial production in China had recovered strongly in the past few months to surpass the previous peak. Production was also rising in other east Asian economies, after falling steeply late last year.
Turning to individual economies, members noted that preliminary data showed a fall of 1.6 per cent in GDP in the United States in the March quarter, similar to that recorded in the December quarter. There had been large declines in both dwelling and business investment in the March quarter, but consumption had increased by ½ per cent after sharp declines in the second half of 2008. The large falls in employment in recent months had led to a rise in the unemployment rate to 8½ per cent in March, although there were signs that the rate of deterioration in the labour market had stabilised. Members noted that there were also other signs that the rate of contraction in the US economy had slowed, with the ISM surveys of business conditions in the manufacturing and other sectors showing some improvement. It was also possible that the deterioration in the housing sector over the past three years was coming to an end, with housing starts levelling out and some measures of housing prices showing small increases, after large declines.
Output had fallen very sharply over the past year in the United Kingdom. Conditions in the manufacturing and housing sectors had been weak and the budget deficit had increased significantly. However, there were some tentative signs of the housing downturn coming to an end, with loan approvals picking up from very low levels and housing prices showing some signs of bottoming.
Economic conditions in the euro area remained very weak. Sentiment had remained at a very low level in the early months of 2009, and the unemployment rate had increased to 8.9 per cent in March. Labour market conditions had deteriorated significantly in Spain, where a substantial decline in construction activity was under way. The unemployment rate had also increased noticeably in Ireland.
Turning to Asia, confidence among consumers and businesses in Japan remained very low and industrial production was at the lowest level in 20 years.
In contrast, recent data in China had been much more positive. Output growth had picked up in the March quarter, after a substantial slowing in the second half of 2008. Industrial production had also recorded a significant increase recently. For members, a key question was whether this was due to domestic demand, reflecting the large public investment program, or a build-up in inventories. At this stage the answer was not clear.
Elsewhere in east Asia, exports had begun to pick up in most economies following the very steep falls in the fourth quarter of 2008. GDP had stabilised in Korea in the March quarter, following a fall of 5 per cent in the December quarter. Members noted that this would have been assisted by stimulatory macroeconomic policy settings and the depreciation of the exchange rate.
Domestic Economic Conditions
No new retail sales figures had been released over the past month. Liaison conducted by the staff suggested that retail conditions had been relatively strong in March, but mixed in April. Members noted that the sharp falls in expenditure on consumer durables over the past year in Australia had been preceded by an extended period of very strong growth in this component since 2002. This growth reflected, among other things, declines in the relative prices of many of these goods and substantial increases in household wealth. Trends in the US had been similar.
Consumer sentiment remained well below average, although it had improved a little recently and was considerably better than in other countries. Members noted that consumers' stated views on the medium-term prospects for the economy remained quite optimistic.
Turning to the housing sector, building approvals had recently picked up, which was confirmed by figures for March released during the meeting, with a significant increase in first-home buyers purchasing newly constructed homes. The latest ABS data on nationwide house prices showed a fall in the March quarter, though private-sector data for the same period had shown little change. Members noted that while house prices in the most expensive suburbs had fallen significantly over the past year, prices in the least expensive suburbs had risen recently.
In the business sector, the measure of business confidence from the NAB survey had increased sharply in March, reversing much of the decline following the collapse of Lehman Brothers in September last year. However, business conditions remained relatively weak, with many respondents noting that a lack of demand was a significant restraint on output. A number of indicators suggested that the outlook for business investment was quite weak: imports of capital goods had declined sharply; business surveys revealed that expectations for business investment were well below average; and private non-residential building approvals had fallen sharply in the early part of 2009, though data released during the meeting suggested a significant rise in the month of March. Members noted that despite significant falls in investment expected in the current and following year, the level of investment as a share of GDP was not expected to decline to the levels seen in some previous downturns.
Business credit had contracted in three of the past four months, though total business debt funding was not as weak, as some companies had accessed capital markets directly. Members noted that both demand and supply factors were important; businesses were looking to reduce debt, but it was also more difficult for them to obtain funds in an environment in which lending standards were being tightened. Members also noted the difficulties in the securitisation market and recent trends in lending by different types of banks.
Turning to the external sector, the terms of trade were declining because of lower commodity prices, but even so were at a historically high level. Export volumes had held up much better than expected; they were estimated to have been stable in the March quarter. Members noted the key role of China in Australia's export performance.
Conditions in the labour market had continued to weaken, with the unemployment rate increasing by ½ percentage point to 5.7 per cent in March. Forward-looking indicators suggested further declines in total employment were in prospect in the months ahead.
Members were briefed on the March quarter CPI, which had recorded a small rise in the quarter, with the year-ended increase declining to 2½ per cent. The result was largely attributable to reductions in petrol prices and a large fall in the ABS estimate of the price of financial intermediation services, which has tended to move broadly in line with movements in the cash rate. Excluding this component, the CPI would have increased by 0.8 per cent in the March quarter. Measures of underlying inflation were around 1 per cent in the quarter, down from around 1¼ per cent in the middle of 2008. The effect of the earlier depreciation of the exchange rate had limited the reduction in inflation. Members noted that movements in producer prices in the March quarter, combined with reduced capacity constraints, suggested that pressure on prices was easing. Consumers' inflation expectations were also around the lowest level seen in the past decade, after being quite high in 2008.
There had not been any new official data on wages over the past month, but wage growth was expected to ease given the softening in the labour market.
The staff forecasts of growth and inflation had been updated following the release of the CPI. They had not changed materially from those presented to the Board at the previous meeting, and continued to show a gradual pick-up in the economy from late 2009. The recovery was, however, expected to be relatively subdued, reflecting developments abroad. Growth was not expected to be above trend until 2011. Inflation was forecast to decline gradually over the next few years to below 2 per cent, with the pass-through of the exchange rate depreciation last year continuing to hold up inflation over the remainder of 2009.
Sentiment in global financial markets had continued to improve during April. This was reflected in rises in global equity markets, better conditions in credit markets, and an appreciation of the Australian dollar and currencies of emerging market economies. There had also been an increased amount of non-guaranteed bond issuance by banks, including Australian banks. However, the improvement in sentiment remained vulnerable to setbacks, with the impending release of the results of stress tests for the 19 largest US financial institutions a potential hurdle. These results were due to be published in coming days and could indicate that several large banks required significant capital injections.
Global equity markets had risen sharply over the course of the past two months, with the large rises taking many markets back to the levels at the beginning of the year. There was a strong rally in equity prices in Australia, with rises across all market segments. Members noted that better conditions in equity markets had beneficial flow-on effects to other financial markets.
The improvement in financial market conditions had been bolstered by generally positive earnings reports from a range of large international financial institutions for the first quarter, despite further significant credit write-downs by the three largest US financial institutions.
The Australian banks remained in good financial health, in absolute terms and particularly in comparison with their overseas counterparts. However, provisioning had increased in line with the slowing economy. The aggregate return on equity had fallen over the past year, partly owing to increases in banks' capital ratios. But capital adequacy and profitability remained in strong shape.
Turning to government bond yields, the large fiscal stimulus in the United States and United Kingdom in recent months had resulted in a modest increase in yields, but yields were still historically low. Australian government bond yields had shown little net change over the past month, resulting in the spread to US yields narrowing.
Conditions in global money markets had improved noticeably, with short-term spreads having fallen back to close to the levels prevailing prior to the Lehman collapse. In Australia, spreads between bank bills and the expected policy rate were near the lowest points seen since the onset of the financial crisis.
Members were briefed about developments in the Reserve Bank's balance sheet. The main element was that improved conditions in domestic financial markets had allowed the balance sheet to contract. Exchange settlement balances had been reduced to around $2½ billion; term deposits had been reduced to zero; and there had been a large reduction in demand for US dollars provided under the swap agreement with the US Federal Reserve.
Financial institutions had continued to issue government-guaranteed bonds in April, though issuance had slowed from the high levels in previous months. Issuance had been more subdued in Australia. An important development in the past month had been some successful domestic non-guaranteed bond issuance by several Australian banks. The banks had continued to record strong deposit inflows, which they had used to reduce reliance on short-term wholesale funding.
In corporate bond markets, issuance in the United States had slowed in April following its high level in the March quarter. Corporate bond spreads had narrowed over the past month, in line with generally improved market sentiment.
Activity in the Australian syndicated loan market was subdued in the March quarter. The share of participation by domestic and foreign lenders in refinancing syndicated loan facilities in the quarter was roughly unchanged from the previous few quarters.
Members noted that corporate gearing in Australia remained relatively low and debt-servicing burdens were at manageable levels.
Looking at monetary policy settings around the world, members noted that market expectations were for the European Central Bank to lower its policy rate later in the week. There was little scope for lower policy rates in most other industrial countries, notably the United States, the United Kingdom, Canada, Sweden and Switzerland. Unconventional measures had been adopted, as foreshadowed, in several countries. The Reserve Bank of New Zealand had lowered its policy rate by 50 basis points to 2.5 per cent. In an attempt to reduce longer-term rates, which are heavily used by borrowers, the central bank had announced that it would keep its policy rate low until the end of 2010.
In the major foreign currency markets, members noted that the yen had depreciated early in the month. There had been an appreciation of emerging market currencies and narrowing in spreads, as investors' risk appetite had increased and several countries sought access to the IMF's new lending facility for emerging market countries.
Improved sentiment in global markets had led to increased demand for the Australian dollar, which had reached its highest levels since October last year. The net fall over the past year on a trade-weighted basis was about 15 per cent.
Members discussed developments in financial intermediaries' lending rates and funding. They noted that, as had been expected, the 25 basis point cash rate reduction at the April meeting had been only partly passed through to housing lending rates, with more pass-through to business indicator rates on this occasion. On the deposits side, competition among banks had remained strong, which meant that interest rates on deposits had fallen less than the cash rate, particularly for term deposits at ‘special rates’.
Market prices suggested only a small probability was attached to a cut in the cash rate at this meeting.
Considerations for Monetary Policy
The wide range of economic data considered by the Board generally pointed to some improvement in confidence and economic activity in a number of countries. The strongest signs were in Asia, with production in China rebounding particularly quickly. While it was too early to be confident about the durability of this trend, the evidence was accumulating that the maximum rate of global economic contraction may have passed.
Members also noted the much better tone in financial markets. Share prices had risen strongly in all countries in recent weeks and credit spreads were declining noticeably. Businesses had been able to raise more debt in capital markets and banks, including those in Australia, had been able to issue some non-guaranteed debt in their home markets. Sentiment nevertheless remained fragile and could easily be disturbed by adverse news.
While members noted that Asian economies were showing signs of a recovery, the best that could be said for the global economy as a whole was that output was beginning to stabilise after the earlier sharp falls. Partial indicators and market developments were consistent with forecasts of an increase in global output in the second half of the year. But given the damage that had been done to the financial sectors in the northern hemisphere, the most likely scenario was that growth would remain below trend for some time, leading to a further build‑up in excess capacity and, therefore, a decline in global inflation.
In the case of the Australian economy, members observed that there were signs that the economic stimulus that had been applied was supporting demand. Nonetheless, substantial growth was not expected to resume until around the end of the year. They noted that the coming year would see higher unemployment and falling inflation, though the earlier depreciation of the exchange rate would slow the decline in prices for some time. Overall, the Australian economy was likely to record better outcomes than most other advanced economies in 2009 and 2010, reflecting the healthy state of the domestic banking system and effectiveness of the macroeconomic policy stimulus to date.
The question faced by the Board was whether monetary policy should be eased further at this stage, or whether the cash rate should be maintained at its current level pending further information on how economic and financial conditions were unfolding.
Taking into account the economic and market developments that had come to light over the past month, the major easing in monetary policy that had already taken place and the substantial fiscal stimulus that was being implemented, members judged that the best course for this meeting was to leave the cash rate unchanged. They would continue to monitor the strength and durability of the tentative signs of an improvement in the global and domestic economies.
The Board decided to leave the cash rate unchanged at 3.0 per cent.