Minutes of the Monetary Policy Meeting of the Reserve Bank Board
Sydney – 5 June 2012
Glenn Stevens (Chairman and Governor), Philip Lowe (Deputy Governor), Martin Parkinson PSM (Secretary to the Treasury), John Akehurst, Jillian Broadbent AO, John Edwards, Heather Ridout, Catherine Tanna
Members granted leave of absence to Roger Corbett 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)
Sentiment in global financial markets deteriorated in May, as political uncertainty in Greece and growing concerns about the fiscal and banking problems in Spain added to the pessimism surrounding the outlook for the euro area. Members noted that weaker-than-expected economic data, particularly for China, had also weighed on sentiment.
The inconclusive parliamentary elections in Greece and the public backlash against austerity measures there had increased public discussion about Greece's possible exit from the euro area. A critical issue if Greece were to exit would be the ability of the European authorities to limit the contagion to other euro area countries. In the case of Spain, members observed that there had been increased concerns about the sustainability of the country's fiscal position, with one of the largest banks having to be recapitalised by the Spanish Government. That task had complicated Spain's efforts to reassure financial markets that it could contain the problems in its banking system while strengthening public finances. As a result, Spanish bond yields had risen back to the highs recorded in the second half of 2011.
Reflecting the increased risk aversion across global financial markets, government bond yields in the United States, Germany and the United Kingdom fell markedly, with 10-year bond yields reaching historic lows during the month. In Australia, 10-year government bond yields also declined to a historical low level, below 3 per cent, with the spread to US government bond yields narrowing significantly. Yields on Australian state debt fell to historical low levels as well, despite spreads to Australian government debt widening further over the month.
Members noted that there were also widespread falls in equity prices across the major markets, with share price indices down by between 5 and 10 per cent over the month. Australian share prices fell broadly in line with overseas markets; resources stocks, in particular, declined with lower commodity prices and concerns over Chinese growth.
The Australian dollar had depreciated by around 5 per cent since the previous Board meeting – in contrast to the resilience it had displayed in the period of heightened risk aversion earlier in the year. European, emerging market and other commodity currencies had also depreciated against the US dollar, and by more against the Japanese yen. The renminbi had also depreciated slightly against the US dollar but, given the movement in the US dollar over the month, had appreciated in trade-weighted terms.
Notwithstanding the general widening in corporate bond spreads in Europe and the United States, there had been little sign of dislocation in Australian credit markets. There had been solid issuance in the asset-backed securities markets by both large and small banks. The major banks continued to access overseas markets, though they did not have to raise significant volumes given the large amount of funding that occurred in the March quarter and the modest growth in credit. Members noted that, as has been the case for the past couple of years, the Australian banks were using new bond issuance only to cover maturities and were funding credit growth through deposits.
Short-term interest rates in Australia had fallen sharply following the Board's decision in early May to lower the cash rate by 50 basis points. Following the cash rate announcement, most lenders had reduced their standard variable housing rates by between 30 and 40 basis points. As a result, the average interest rate on outstanding housing loans at present was about 40 basis points below the post-1996 average, while rates on small and large business loans were 30 and 60 basis points lower, respectively. Members discussed the strong competition among banks for term deposits and the continuing pressure this was having on the funding costs for Australian banks.
Renewed pessimism about Europe and weaker economic data in other major countries had led to expectations of further declines in the Australian cash rate, with the market pricing in a reduction of at least 25 basis points at the current meeting, as well as further sizeable reductions over the balance of the year.
International Economic Conditions
The international news over the past month was dominated by developments in Europe, particularly in Greece. As attention also shifted to the sustainability of Spain's fiscal position, European leaders were trying to develop a comprehensive policy response to the crisis, with Germany still reluctant to contemplate significant adjustments to the existing approach. Members observed that the growing tensions were occurring in the context of ongoing weakness in economic activity in the region, although the recently released economic data mostly pre-dated the latest developments. Euro area GDP was flat in the March quarter, with a rise in German GDP offset by falls in many other countries; the euro area PMIs declined significantly in both April and May; and unemployment rates outside of Germany had generally continued to rise, remaining well over 20 per cent in Greece and Spain.
Recent indicators suggested that the pace of recovery in the United States had eased slightly. March quarter GDP increased by 0.5 per cent, with modest growth in household consumption and a decline in public demand, while forward indicators of investment were somewhat weaker over recent months. There had been some slowing in the rate of employment growth and little change in the unemployment rate. In the housing market, there were signs that both activity and prices had improved, albeit from a low base. The outlook for the US economy remained clouded by the large fiscal consolidation that would start from next year unless Congress amended existing legislation.
Outside of China, economic activity in east Asia had strengthened in the early part of 2012 following the recovery from the natural disasters in 2011, but it remained difficult to gauge the ongoing pace of expansion. Recent indicators had suggested a pause in the recovery in Japan. The Indian economy had continued to expand at a moderate pace, though with weakness evident in the services and exports sectors and in the outlook for investment.
In China, the recent data indicated that the pace of growth had slowed a little further, which had prompted an easing in financial and fiscal policies. Industrial production in April was weaker than expected, controls on the property sector were weighing on construction activity somewhat and manufacturing PMIs fell in May. Even so, retail spending remained resilient. Exports to Europe – China's largest trading partner – continued to weaken in April, although the trend in exports to other destinations remained positive. In response, with inflation pressures having abated, the authorities there had taken measures to support demand: reserve requirement ratios were lowered by 50 basis points (for the third time since December), additional subsidies for household consumption were announced, and the Government appeared to be preparing to boost infrastructure investment. Members noted that there was some scope for an easing of China's fiscal and financial policies to ensure that growth did not slow much further over the near term. However, given the experience following the large fiscal expansion announced in late 2008 – in terms of the resulting housing boom and inflationary pressures more generally – the authorities were likely to ease policies in a more measured way than was the case in the earlier episode.
The softening in global activity had been associated with a general decline in commodity prices. Spot prices for iron ore, thermal coal and crude oil declined significantly over the month. While part of the fall in iron ore prices reflected an easing in earlier supply disruptions in Australia and Brazil, economic weakness in Europe and an easing in Chinese steel prices had raised concerns about near-term demand. Coking coal prices were a little higher in the month after falling earlier in the year.
Domestic Economic Conditions
Members noted that indicators of recent economic activity had been mixed but, on balance, suggested continued moderate growth. Taking the past two months together, ABS data suggested a pick-up in the growth rate of retail sales; nominal retail sales declined by 0.2 per cent in April, but this had followed a strong rise of 1.1 per cent in March. Consumer confidence rose slightly in May, but remained below its long-run average level. In aggregate, housing prices continued to decline and activity in the housing market remained weak, with a sharp fall in dwelling approvals in April partly accentuated by the introduction of new legislative guidelines in Western Australia.
Surveys of business conditions generally fell in April, to average or below-average levels. Much of the reported strength in business conditions continued to be in mining-related and transport industries, with the weakness concentrated in the retail, construction and manufacturing industries. Members were briefed on the March quarter capital expenditure survey, which suggested a continuation of the very large pipeline of committed mining investment in coming years, notwithstanding recent announcements by some mining companies that they were re-considering the viability of a number of resource projects to which they had not yet committed. The data also showed that non-mining investment intentions remained weak. The pace of business credit had been increasing gradually to an annualised rate of around 4 per cent over the six months to April.
Some modest strengthening in the labour market over the year to date was apparent, as employment increased by 15,000 in April, the unemployment rate declined to below 5 per cent and the trend measure of average hours worked edged up. However, other indicators and information from liaison continued to suggest that hiring intentions outside mining-related activities remained relatively subdued.
Recent data indicated that private wage growth had been relatively steady in the past few quarters. The wage price index for the private sector increased by 0.9 per cent in the March quarter, to be 3.7 per cent higher over the year; growth of public-sector wages slowed a little in the quarter and was running at 3.1 per cent in year-ended terms. In line with differences in labour market conditions across the country, the pace of private-sector wage growth had picked up across a broad range of industries in Western Australia, although, relative to other states, the difference in the rate of growth of wages was less marked than it had been in 2007–2008. Fair Work Australia's annual wage review announced a 2.9 per cent increase in the minimum wage and award wages.
The underlying cash balance of the Australian Government Budget was expected to shift from a deficit of 3 per cent of GDP in 2011/12 to a surplus of 0.1 per cent of GDP in 2012/13. However, various publicly available estimates suggested that the direct impact of the fiscal consolidation on the economy was likely to be considerably less than the headline figures implied. In part, this reflected a shift in the timing of some payments into the current financial year from 2012/13 and, to a lesser extent, the nature of expenditure patterns, including cuts in spending offshore. A range of estimates suggested that the budget may subtract around ¾–1½ per cent from growth in real GDP, before allowing for any offsetting factors.
Considerations for Monetary Policy
Members observed that developments in the euro area over the past month had increased the probability of a sharp deterioration in economic conditions in response to ongoing concerns about the sustainability of sovereign debt obligations and stability of banking systems in the periphery of the region. More generally, information received over the past month suggested some weakening in the global outlook in the near term. In addition to indicators of weaker economic activity in Europe, data from China suggested a further slowing in growth, although the Chinese authorities had responded by easing financial and fiscal policies. The recovery in the United States was proceeding, but at a moderate pace. Weaker global prospects had led to lower commodity prices, which, combined with a reduction in the global appetite for risk, had led to a depreciation of the Australian dollar. Members noted, however, that the deterioration in financial market conditions globally had, to date, not led to a noticeable tightening in the cost or availability of funds in Australia.
Domestically, recent indicators of economic activity had been mixed. Data on retail sales, the labour market, mining investment and business credit were consistent with a degree of resilience in the domestic economy, while business confidence had weakened in non-mining sectors, along with indicators of activity in the construction industry. Overall, data on the domestic economy appeared to be broadly consistent with the Bank's most recent forecasts. In particular, employment growth was picking up gradually, but the unemployment rate was still expected to move somewhat higher over the coming quarters. Output growth was expected to increase towards trend over the remainder of this year, and inflation (excluding the impact of the carbon tax) was expected to remain in the lower part of the 2–3 per cent range.
The Board considered whether the recent information warranted a further reduction in the cash rate.
The arguments were finely balanced. Recent domestic data generally had not suggested a significant weakening in conditions compared with the forecasts a month earlier. Moreover, there had not been time to assess the effects of the earlier reductions in the cash rate. However, there was clear evidence suggesting a softening in global conditions, and uncertainty about the future in Europe had increased significantly. While spillovers had been limited thus far, there was a reasonable likelihood that the tendency toward precautionary behaviour both abroad and at home would intensify. Given this, and with inflation expected to remain in the lower part of the targeting range over the next year or so, members considered that there was scope for monetary policy to be a little more supportive of domestic activity. Members judged that a reduction in the cash rate of 25 basis points, combined with the earlier reductions, would mean that monetary policy would be providing a measure of stimulus that would be expected to flow through to the domestic economy over the coming months.
The Board decided to lower the cash rate by 25 basis points to 3.50 per cent, effective 6 June.