Minutes of the Monetary Policy Meeting of the Reserve Bank Board
Sydney – 6 April 2010
Glenn Stevens (Chairman and Governor), Ric Battellino (Deputy Governor), Ken Henry AC (Secretary to the Treasury), John Akehurst, Jillian Broadbent AO, Roger Corbett AO, Donald McGauchie AO
Members granted leave of absence to Graham Kraehe AO and Warwick McKibbin in terms of section 18A 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
Recent data indicated that the global economy had continued to expand in early 2010. The recovery was still two-speed: growth was strong in the emerging and middle-income economies, particularly in Asia, but the expansion was less well-entrenched in some of the large advanced economies. Overall, Consensus forecasts suggested that global economic growth in 2010 would be around 4 per cent, which was about average.
In the United States, the housing sector remained weak and policy-makers faced significant fiscal challenges, but the labour market was gradually improving. It now appeared that the unemployment rate had peaked in late 2009, and private-sector employment had grown by an average of 65,000 jobs per month in February and March 2010. Although income growth and consumer confidence were still weak, household consumption spending had grown steadily for several months.
In China, data for January and February suggested robust growth in industrial production and fixed-asset investment. Members discussed the surge in investment in China in 2009, noting that it had been focused more on infrastructure than the manufacturing sector. Growth in industrial production and exports had been very strong elsewhere in east Asia.
The strong growth in Asia was contributing to some pick-up in core inflation in many countries in the region, most notably in India. Food inflation had also risen across Asia. Monetary policy in the region was still very accommodative, though central banks in India and Malaysia had announced increases of 0.25 percentage points in their policy rates in the period since the previous Board meeting.
Recent economic data for Japan had been relatively positive, easing concerns that had existed a few months ago that the recovery in that economy might be faltering. Information on the euro area, including significant upward revisions to monthly industrial production and retail sales data, also suggested some improvement. Nevertheless, spare capacity in both these economies and in the United States remained substantial.
Domestic Economic Conditions
The December quarter national accounts had been released the day after the March Board meeting. GDP growth was 0.9 per cent in the quarter, which was a little stronger than expected at the time of the February Statement on Monetary Policy. With some upward revisions to earlier quarters, growth in 2009 was 2.7 per cent. GDP growth was supported by growth in public demand in 2009, with private spending quite subdued, but the staff forecasts envisaged a reversal in this pattern through 2010 and beyond.
Conditions in the labour market were continuing to improve. While employment was estimated to have been unchanged in February, it had risen by around 200,000 since August. Jobs growth since mid 2009 was evident in a range of industries, including professional services, mining and financial services, though employment in the retail sector had fallen. Business surveys indicated an increase in hiring intentions, and data for job vacancies had also shown an increase.
Household surveys suggested that consumer sentiment had remained at a high level in recent months, though consumers appeared quite cautious in their spending; there had been little growth in retail spending over recent months.
The business surveys suggested that business conditions and confidence were both at above-average levels. However, there was some variation across sectors, and some caution in spending plans outside the mining sector. The non-residential building sector remained subdued and, abstracting from the surge in construction of educational facilities, new approvals were at relatively low levels.
Spot prices for coal, iron ore and other resources had continued to rise over the past month. The price negotiations for iron ore indicated a fairly broad-based shift to price-setting on a quarterly, rather than annual, basis. Although spot iron ore prices were below the high levels seen in 2007 and early 2008, contract prices were expected to rise to new highs. Initial indications for contract prices for coal also pointed to large increases. The strength in coal and iron ore prices over recent years was partly a reflection of the very large increase in global steel production over the past decade, which in turn reflected the high steel intensity associated with growth of the Chinese economy.
Developments in commodity markets meant that the increase in the terms of trade through 2010 was likely to be substantially larger than forecast in the February Statement on Monetary Policy. This implied strong growth in nominal incomes in the Australian economy over 2010. The increases in coal and iron ore prices, along with the developments in the LNG sector, were also contributing to a strong outlook for investment in the resources sector. Members noted that, while the Australian economy was benefiting significantly from developments in the resources sector, these would also pose challenges.
Information on the housing market suggested that conditions remained buoyant. Nationwide capital city price growth was running at around 1 per cent per month in early 2010, and auction clearance rates had remained high in March, especially in Melbourne. Members discussed the factors contributing to the recent strong price growth. On the demand side, population growth was strong, households had confidence about future income growth, and mortgage rates were at below-average levels. At the same time, the supply of new housing was not expanding sufficiently, partly because of the land usage policies of local and state governments and also because of the tightness of finance for developers. Members also noted that the current price growth was somewhat at odds with the falls in housing loan approvals over recent months.
Credit to the household sector had recently continued to grow at a moderate pace of around 0.7 per cent per month. The decline in business credit had slowed noticeably in early 2010, suggesting that the period of corporate deleveraging was coming to an end. This was consistent with information from liaison, which had pointed to a gradual easing in financing conditions for businesses.
There had been limited new data on inflation over the past month, but the March quarter CPI would be released prior to the next meeting. The various measures of inflation expectations were around or a little above their average levels over the inflation-targeting period.
Members discussed developments regarding sovereign debt in the euro area. As at the time of the meeting, there had been some modest abatement in concerns over the situation in Greece following news that euro area leaders had agreed on an emergency funding package that would be available if required. However, details of the package were not clear and there could be an extended period of uncertainty in financial markets.
The easing in concerns over Greece and a general increase in risk appetite had been reflected in increases in global equity markets over the past month. Yields on government debt in the major economies had been little changed, with the exception of some pick-up in yields on US government bonds following stronger economic data.
In Australian markets, the Government guarantee for bank debt issuance had ceased at the end of March. There had been some use of the guarantee program in its final month, mostly by branches and subsidiaries of foreign banks. The major domestic banks had undertaken a solid amount of unguaranteed issuance.
The issuance of Kangaroo bonds (domestic issuance by non-residents in Australian dollars) in the March quarter had been the second highest on record. This had reflected a strong appetite for Australian dollar assets and a favourable cross-currency basis swap spread for foreign issuers. There had also been some further issuance of residential mortgage-backed securities (RMBS) over the past month. While three of the issues had some support from the Australian Office of Financial Management program, there had been strong private-sector demand. Members noted that RMBS spreads in the secondary market had continued to fall this year, helping to bolster investor appetite for new primary market issues.
In foreign exchange markets, the US dollar had appreciated against the currencies of the major advanced economies, though it remained quite low in a longer-run perspective. Members noted the significant discussion during the month about the possibility that the Chinese authorities might soon allow some appreciation of the renminbi against the US dollar. The Australian dollar had tended to appreciate over the past month and was at multi-year highs against the euro, pound sterling and New Zealand dollar.
The increase in the cash rate in early March had been passed through in full to most variable lending rates. Members noted that lending rates for housing and business were a little below their averages for the period since 1997.
Considerations for Monetary Policy
Recent data for the world economy suggested that the recovery in the major advanced economies was still tentative, but that the expansion in most of Australia's major trading partners in Asia was proceeding strongly. This was feeding through into significant increases in the prices of resource commodities, including increases in the contract prices for coal and iron ore, which were larger than had been expected a few months ago. While there were a number of risks to the outlook for the global economy, the most likely scenario was one where growth in global output was close to trend over the next few years.
In the view of the Board, with forecasts suggesting that growth in the domestic economy in 2010 would be around trend and that inflation would be around 2½ per cent, consistent with the medium-term target, the level of interest rates in the economy would be expected to be close to average. This remained the underlying rationale for consideration of any adjustment to the cash rate in the current period. Since lending rates were still a little below average, members expected that they would probably need to rise further in the period ahead.
On the question of timing, the fact that the prospective rise in the terms of trade was now likely to be noticeably stronger than had been expected was a factor suggesting that it might be prudent not to delay adjustment. Overall, members considered that the outlook for the economy suggested that there was a case for a further step in the process of returning interest rates to more normal levels.
The Board decided to raise the cash rate by 0.25 percentage points to 4.25 per cent, effective 7 April.