Minutes of the Monetary Policy Meeting of the Reserve Bank Board
Sydney – 3 July 2012
Glenn Stevens (Chairman and Governor), Philip Lowe (Deputy Governor), Martin Parkinson PSM (Secretary to the Treasury), John Akehurst, Roger Corbett AO, John Edwards, Heather Ridout, Catherine Tanna
Members granted leave of absence to Jillian Broadbent AO in terms of section 18A of the Reserve Bank Act 1959.
Guy Debelle (Assistant Governor, Financial Markets), Christopher Kent (Assistant Governor, Economic), Jonathan Kearns (Head, Economic Analysis Department), Anthony Dickman (Secretary), Peter Stebbing (Deputy Secretary)
International Economic Conditions
Members were briefed on data received over the month, which suggested that the recovery in the United States had lost some momentum and activity in Europe had declined again in the June quarter. In contrast, developments had been more positive for the Chinese economy following some weaker data released the previous month. The election outcome in Greece and announcements regarding recapitalisation of Spanish banks provided some reprieve from mounting fears of a near-term escalation of the crisis in Europe. Nevertheless, members noted that the possibility that the situation in Europe could deteriorate again and spill over to other economies remained a substantial risk.
With the recovery in the United States appearing to have lost some momentum, the Federal Reserve had revised down its forecasts for growth. Payroll employment growth had slowed and the unemployment rate had ticked up again. Consumption growth had also slowed, with retail sales only a little higher in recent months and consumer sentiment having fallen in June. A more positive development was that there were further signs of stabilisation in the housing market; house prices were no longer falling and activity was trending up modestly, albeit from historically low levels.
Chinese exports continued to grow after softness through most of 2011. Members noted that a number of indicators suggested that growth in domestic activity in China may not be slowing much further, although the outlook remained uncertain. The property market had shown tentative signs of stabilising, with total sales volumes picking up. As inflation had eased further, authorities had shown their willingness to provide some additional support to economic activity, including through reductions in benchmark lending interest rates.
Growth in economic activity in the rest of east Asia had been subdued after recovering from the supply disruptions last year. Industrial production had been broadly unchanged since January, and outside of Japan there were signs that growth in domestic demand had slowed a little. Members observed that exports had also been affected by lower demand from Europe and the United States. In Japan, indicators of domestic demand had generally been a little stronger in recent months and concerns about electricity shortages over the summer had been alleviated somewhat by the scheduled re-opening of two nuclear reactors.
While commodity prices overall had been broadly unchanged over the past month, earlier declines meant that Australia's terms of trade were estimated to have declined a little further in the June quarter, although they remained at historically high levels. Iron ore prices were little changed over the past month, after falling sharply in May. Reflecting weaker global demand, prices for oil and thermal coal had fallen substantially. In contrast, spot prices for coking coal had increased, in part owing to supply concerns related to industrial action in Australia.
Domestic Economic Conditions
Members noted that data released over the past month suggested that the domestic economy had been growing more strongly since the middle of 2011 than had previously been indicated. According to the national accounts, which were released the day after the June Board meeting, GDP grew by 1.3 per cent in the March quarter and by 4.3 per cent over the year, with the annual outcome boosted by the recovery in coal exports following the floods in early 2011. The stronger-than-expected annual outcome also reflected an upward revision to growth in the second half of 2011, to around trend pace. Business investment and consumption both grew faster than expected in the March quarter. However, consumer and business sentiment and other timely indicators of activity suggested that the economy was likely to record slower growth in the June quarter.
The divergence between the resource and non-resource economies was apparent in the national accounts and continued to be reflected in business surveys, with conditions in mining and transport well above average, while conditions in construction, retail trade and manufacturing were well below average. Members, however, noted that according to one major business survey, the dispersion of business conditions across industries was well within historical norms.
Although survey measures of overall business conditions remained somewhat below average levels, members observed that the pace of business credit had picked up noticeably over the past four months after a long period of weakness. In response to the recent reductions in the cash rate, business lending rates had fallen to below average levels.
Household consumption grew strongly over the year to the March quarter, across both goods and services. The strength in goods consumption was somewhat at odds with a range of partial indicators and the Bank's retail liaison over the same period, though more recent liaison had a stronger tone. One possibility discussed by members was that discounting had increased sales volumes but this meant that the growth in the value of sales had been modest. Members were informed that, despite weak consumer sentiment in recent months, recent data suggested that some of the strength in consumption observed earlier in the year had continued into the June quarter.
Members noted that household incomes continued to be supported by relatively favourable conditions in the labour market. The unemployment rate remained a little above 5 per cent in May, and the ratio of employment to population had picked up since the beginning of the year. The ABS had recently indicated that it had had difficulties deriving accurate real-time estimates of the working-age population used to calculate employment estimates from the labour force survey. Because of this, the published estimates appeared to be slightly understating employment growth. Forward-looking indicators and liaison implied modest employment growth over coming months.
In contrast, indicators suggested that the housing market remained subdued. Dwelling activity was likely to have fallen further in recent months and indicators generally suggested that activity would remain relatively weak in the near term. Notwithstanding an apparent tick-up in June, dwelling prices were around 6 per cent lower than in early 2011, with the largest falls in Melbourne and Brisbane. Household credit continued to grow at around the pace of the past year (broadly in line with incomes). Interest rates on housing loans were around 50 basis points below their 15-year average.
Members began their discussion of financial markets by noting that the resolution of uncertainties surrounding the Greek election and the long-awaited Moody's downgrade of global banks had helped ease some of the recent tensions in financial markets. While the announcement by Spain of a request for support for the banking sector had done little to alleviate concerns about Spain's fiscal problems and the plight of the euro area more generally, the subsequent announcement by European leaders at the end of June about plans to establish a separate pan-European banking supervisor did substantially boost market sentiment, at least for a time. Members noted that the creation of such a supervisor might lead to financing being provided by the European Stability Mechanism directly to European banks, rather than through sovereign governments, and thereby avoid increasing the leverage of individual sovereigns. In response to recent developments, Spanish 10-year government bond yields fell to around 6.4 per cent at the end of June, after having reached a euro-era high of more than 7 per cent during the month.
The European developments also caused major equity markets to rise noticeably and government bond yields in the major advanced economies to increase from their historic lows. In Australia, members noted that bond yields had also increased from their historic lows, reflecting both offshore developments as well as stronger domestic economic data. Foreign demand for Australian bonds continued to rise, with foreign investors holding slightly more than three-quarters of Commonwealth Government bonds on issue at the end of March.
Corporate bond spreads in the United States and Europe had generally narrowed a little in June, although issuance in Europe had been very low, with little unsecured issuance by banks in particular. Moody's downgraded the ratings of 15 global banks by between one and three notches during the month, with one bank downgraded by three notches. This outcome was, at the margin, a little better than feared and therefore did not have a significant effect on the market.
In foreign exchange markets, members noted that, despite the situation in Europe, the euro had appreciated slightly against the US dollar. There had, however, been substantial outflows from the euro to the Swiss franc, particularly in May, which had led the Swiss National Bank to make large purchases of foreign exchange to defend its ceiling of 1.20 Swiss francs to the euro. Similarly, the Japanese authorities had reiterated their willingness to intervene in the foreign exchange market to limit upward pressure on the yen. The Australian dollar appreciated over the month, bolstered by positive domestic economic data and further buying of Australian government debt by offshore investors.
The difficulties in Europe, together with the run of generally weaker-than-expected global economic data, had led the major central banks to take a number of policy actions over the past month to provide further monetary stimulus. The Federal Reserve had announced a continuation of its Treasury securities purchase program. In China, the People's Bank of China had cut lending rates. The Bank of England, together with the UK Treasury, had announced a plan to provide support to finance for businesses.
In Australia, competition for bank deposits remained strong, with the deposit share of bank funding rising a little further to 53 per cent. The rising share of deposits had allowed the Australian banks to continue to be selective about accessing global wholesale funding markets. Bank paper remained well supported in secondary markets and the banks were able to access market funding as required, with reasonable levels of both secured and unsecured issuance over the month. Overall, there had been no sign of dislocation in Australian financial markets.
Following the June cash rate announcement, most lenders reduced their standard variable housing rates by around 20 basis points. As a result, the average interest rate on outstanding housing loans was about 60 basis points below the post-1996 average, while rates on small and large business loans were 50 and 75 basis points lower.
Members noted that financial markets were pricing in a small probability of a further 25 basis point reduction at the present meeting, with the cash rate now expected to be reduced by less over the rest of the year than had previously been anticipated.
Considerations for Monetary Policy
Members observed that recent data had pointed to weaker prospects for global growth: exports from east Asia (excluding China) remained flat over the past year; the pace of the recovery had slowed in the United States; and activity in Europe appeared to have declined further in the June quarter. On a more positive note, data for May suggested that growth in the Chinese economy was not slowing to the extent that had been suggested by the weak data for April, and policies had been eased further. Members also noted that markets had viewed the recent announcements by European leaders more favourably.
Domestically, members noted that the March quarter national accounts data implied that the economy had had more momentum since mid 2011 than had previously been indicated. Recent data suggested that growth had probably slowed a little from that reported for the first quarter to be around trend pace. Mining investment had been a little stronger than had been expected, and members noted that growth in much of the non-resource economy had remained modest, particularly in those industries under pressure from the high exchange rate and the weakness in the housing sector. The measured strength of consumption growth in the March quarter was at odds with a number of partial indicators for that period, but consumption was being supported by a favourable labour market and recent liaison had a firmer tone.
Members noted that indications were that inflationary pressures overall remained contained, notwithstanding the evidence of somewhat stronger economic growth over the past few quarters. In part, this was likely to reflect the still high level of the exchange rate and a softening in global prices, in particular for oil and other commodities. The weak conditions in parts of the economy for most of the past year – such as retailing and housing – also appeared to have played a role. Members observed that there was also tentative evidence that productivity growth had picked up over this period.
Members continued to view it as appropriate for interest rates to be a little below average given evidence of slower global growth and the low rate of inflation in Australia. But with a material easing in monetary policy having occurred over the preceding six months or so, and with recent signs that the domestic economy had a little more momentum than had earlier been indicated, members saw no need for any further adjustment to the cash rate at this meeting.
The Board decided to leave the cash rate unchanged at 3.50 per cent.