Minutes of the Monetary Policy Meeting of the Reserve Bank Board
Brisbane - 7 April 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), Philip Lowe (Assistant Governor, Financial System)
Anthony Dickman (Deputy Secretary)
International Economic Conditions
The economic data that had been released over the past month indicated that the sharp decline in output recorded in many economies in the December quarter had probably been repeated in the March quarter. Output in Australia's trading partners, weighted by their share in world GDP, therefore appeared likely to have declined by around 3 per cent over the year to the March quarter. Revised forecasts from international agencies such as the IMF and OECD now showed an expected fall in output in 2009, for the first time in at least 60 years. The IMF forecasts were for growth of around 2 per cent in 2010, which implicitly assumed a return to growth in the second half of 2009. The latest global growth forecasts of the Bank's staff were more pessimistic for the current year.
Members noted that there were some signs of growth in the latest international economic data. However, these were tentative and prospects for global recovery still depended on the financial sector being restored to health.
Turning to individual economies, members noted that recent data on consumption in the United States pointed to some recovery in retail spending in the first two months of 2009, following large falls in the December quarter. News in relation to the housing sector included a modest rise in housing starts in February and a further decline in the stock of unsold new houses. Labour market conditions remained very weak, with a further large fall in non-farm payrolls in March and a rise in the unemployment rate to 8½ per cent. Coincident indicators of activity suggested that GDP in the March quarter would be likely to fall by around the same rate as in the December quarter.
In Asia, the economic news from Japan remained very poor. A further sharp fall in industrial production in February took the overall decline in the past few months to nearly 40 per cent, with production now around the level prevailing in the early 1980s. In China, however, there had been signs of improvement in the economic data, with a key measure of business activity picking up relatively sharply in the past two months. Steel production had also increased, as had industrial production more generally, though the timing of the Chinese New Year meant these data needed to be interpreted with caution. Elsewhere in east Asia, key monthly indicators of production and exports appeared to have bottomed in the early months of 2009 after very sharp falls in the December quarter.
Members noted that the latest economic data from Europe were less encouraging. GDP growth and overall sentiment showed little sign of improvement in the euro area, and industrial production had fallen steeply in eastern Europe in the past few months.
Conditions in the New Zealand economy were weak. GDP was almost 2 per cent lower over 2008, having fallen in each quarter during the year.
Domestic Economic Conditions
Members were briefed on the main features of the December quarter national accounts, which had been released on the day following the previous meeting. Output had declined by 0.5 per cent in the quarter, though GDP rose by 0.3 per cent over the course of 2008. Non-farm GDP had been somewhat weaker in the quarter, and higher output in the farm sector had supported overall GDP. The latest set of indicators suggested that GDP was likely to have fallen again in the March quarter.
Members then considered in detail the information provided by the more timely data releases.
Retail sales had fallen in February, but, as this had followed strong growth in the previous two months, the level of sales was still higher than prior to the fiscal stimulus late in 2008. The year-ended growth of retail sales in New South Wales was now approaching that of the rest of the country, after a period of over a year in which it had lagged considerably. Household spending had been supported by a sharp decline in interest payments. As a share of household disposable income, these had fallen by several percentage points in the past six months. However, household net worth was estimated to have fallen further in the March quarter. Members noted that consumer sentiment in Australia had fallen by significantly less than the average for some major economies, where indicators of consumer sentiment were now well below those seen in the early 1990s. This was not the case in Australia.
In the housing sector, indicators pointed to weakness in building activity in the first half of this year, though increasing demand from first-home buyers was supporting parts of the established housing market. Building approvals had increased in February, but remained at low levels. There had been a sharp rise in the number of grants to first-home buyers, following the increase in the size of the grant. On house prices, indications were that the top end of the market was soft but the lower end had firmed, owing to strong demand from first-home buyers.
Members were briefed that business investment had continued to grow in the December quarter, with growth over the year of more than 10 per cent. However, survey information indicated that investment plans had been scaled back considerably in the past few months. This was likely to show up in the data on actual investment during the course of this year. Non-residential building approvals had fallen very sharply over the past year or so; although construction activity had increased over 2008, it was likely to fall in the period ahead.
Business conditions were weak in the early months of the year. Activity in the manufacturing sector remained well below average levels. Business debt funding had fallen, with businesses repaying debt in net terms in the past two months, for the first time in 15 years. There was some evidence that the decline in business credit was largely due to weaker demand for loans.
On a more positive note, members observed that metals prices had stabilised since late 2008, with prices for several base metals having risen noticeably in the past month or so. Indicators of freight costs had also stabilised after falling very rapidly in the second half of 2008, which suggested the decline in world trade had been arrested. Despite these signs of stability in external demand, the falls in commodity prices over 2008 meant that the terms of trade were forecast to fall during the period ahead, as new contracts for coal and iron ore came into effect. However, the expected level of the terms of trade over the next year or so was still relatively high.
Conditions in the labour market had continued to soften. While part-time employment had increased in recent months, the full-time component had fallen steadily since mid 2008 and the unemployment rate had risen. Further falls in employment and rises in unemployment were expected.
Despite the weakening labour market, wages, as measured by average earnings in the national accounts, had risen by around 6 per cent over 2008, well above its recent average. Members were briefed, however, that the wage price index gave a more accurate picture of wage developments. This series had increased by around 4¼ per cent over the year to the December quarter. Moreover, measures of labour costs from a range of business surveys indicated that wage growth was expected to moderate in the period ahead.
Members were informed that there had been further downward revisions to the staff forecasts for growth and inflation. GDP was expected to fall in 2009 but increase again in 2010. The revised outlook for growth, and the associated reduced level of capacity utilisation, would entail stronger downward pressure on medium-term inflation than previously forecast.
Members noted that sentiment in global financial markets had fluctuated during March. Initially, sentiment in the major markets fell as concerns about the health of financial institutions again came to the fore, but it improved following the announcement of details of the US plan to stabilise its financial system. Subsequent positive earnings announcements by some US banks had also helped.
As a result of the lift in sentiment, equity markets rose noticeably in net terms over the course of March. There was a strong rally in equity prices in emerging markets. In Australia, equity prices rose generally in line with those in other industrial countries, with most of the rise attributable to higher prices of shares in the resources and financial sectors.
Global bond yields had fallen after the announcement by the Federal Reserve that it would increase its bond purchases. However, some of this fall had subsequently been reversed.
Looking at monetary policy settings around the world, members were informed that although the European Central Bank had lowered its policy rate by 25 basis points, which was less than had been expected by the market, the effective euro area interbank rate had fallen significantly below the policy rate and the central bank's balance sheet had expanded. Along with the Federal Reserve, the Bank of Japan had moved further to implement unconventional policy measures to stimulate borrowing and economic activity in Japan. Elsewhere in industrial countries, the Bank of England and the Bank of Canada had lowered rates by 50 basis points, and the Swiss National Bank had reduced its policy rate by 25 basis points and was purchasing corporate bonds. While there was now little scope for lower policy rates in most industrial countries, over the past month there had been significant monetary policy easing in many emerging economies.
In Australia, conditions in credit markets had become more positive over the past month. Spreads on short-term debt had fallen considerably. In other signs of generally improving conditions, banks' demand for funds at the Reserve Bank had declined, leading to exchange settlement balances settling at around $3 billion and a run-off in term deposits at the Bank.
Turning to bond issuance, members noted that there had been strong non-financial corporate bond issuance in the United States in the first quarter of 2009 across the rating spectrum; financials had also done a considerable amount of issuance.
In Australia, there had been several large bond issues over the past month, including some retail issues. Spreads were high, but there were signs that investors' appetite for corporate debt may have improved somewhat. There had also been a high level of equity raisings in Australia in the first quarter, notably by non-financial companies. Members observed that activity in the syndicated lending market had been largely confined to refinancing of existing facilities, but both Australian and foreign lenders had participated.
Issuance of guaranteed bank debt had continued to grow rapidly globally, though issuance by Australian banks had dropped back somewhat in the past month after being very strong in the preceding three months. Recent issues by Australian banks had been mostly onshore and included an unguaranteed issue at a competitive spread relative to guaranteed issues. Overall, the Australian banks remained well ahead of schedule on bond funding; deposit growth had also been strong.
Turning to the major foreign currency markets, members noted that there had been a sizeable net depreciation of the US dollar over the past month. Nonetheless, the US dollar was still significantly higher than a year ago.
Improved sentiment in global markets had led to increased demand for the Australian dollar. The currency had appreciated against the US dollar over the past month, towards the peaks seen late in 2008. The trade-weighted index was about 7 per cent higher, with a particularly large appreciation against the yen.
Market expectations for the outcome of this meeting were divided, but the most common view was for a 50 basis points cut in the cash rate.
Considerations for Monetary Policy
It was clear from the information that had become available over the past month that the very sharp contraction in the global economy in the final quarter of 2008 had continued during the first few months of this year. Forecasts for growth in both the industrial and emerging economies for 2009 and 2010 accordingly had been marked down further. Members noted, however, there was now considerable economic policy stimulus in place in most countries, which could be expected to support recovery over time. Tentative signs of improvement could be seen in some indicators for several countries, but it was too early yet to judge how durable they would prove to be.
Conditions and sentiment in global financial markets had continued to improve gradually over the past month. The improvement, which had included a sizeable rally in equity markets, had been helped by the announcements of more detailed plans for a resolution of banking system difficulties in the United States and other major countries. However, it would take time for the world financial system to be restored to health. In the near term, the contraction in economic activity would affect the quality of assets on the books of financial institutions.
Domestically, information over the past month had confirmed that the economy had contracted in the December quarter, though the fall in GDP had been considerably less than that of Australia's trading partners. Data for the March quarter thus far suggested another weak outcome for demand and output, though members noted that consumption had held up relatively well following the boost to spending late in 2008. Credit growth had slowed, with both reduced demand and tighter lending standards playing a role. The exception to this soft picture was credit for owner‑occupied housing, which had picked up owing to increased lending to first-home buyers.
As a consequence of the contraction in aggregate demand and output, capacity utilisation had continued to decline and the demand for labour had weakened. Members noted that the staff forecast for growth had been revised lower from that published in the February Statement on Monetary Policy. Inflation over the medium term was expected to continue to decline.
Given this background, the question for the Board was whether there was a case for additional monetary easing. In discussing this question, members noted that there had already been a major easing in both monetary and fiscal policy in Australia in the past six months. Interest rates on loans to households and many businesses were now at low levels by historical standards. The interest rate reductions had lowered debt‑servicing burdens considerably, particularly for households. This stimulus, together with the substantial fiscal measures, would support demand and help to foster economic recovery in due course. Nonetheless, the effect of recent international and domestic information had been that the near-term outlook for demand and output in Australia was now weaker than earlier expected, though a recovery in demand was likely towards the end of the year. A period of low capacity utilisation and a weaker labour market was seen as increasing the likelihood of a decline in inflation over the medium term. As such, members saw scope for a modest reduction in the cash rate.
The Board decided to lower the cash rate by 25 basis points to 3.0 per cent, effective 8 April 2009.