Minutes of the Monetary Policy Meeting of the Reserve Bank Board
Sydney – 6 March 2012
Glenn Stevens (Chairman and Governor), Philip Lowe (Deputy Governor), Martin Parkinson PSM (Secretary to the Treasury), John Akehurst, Jillian Broadbent AO, Roger Corbett AO, John Edwards, Heather Ridout, Catherine Tanna
Guy Debelle (Assistant Governor, Financial Markets), Malcolm Edey (Assistant Governor, Financial System), Christopher Kent (Assistant Governor, Economic), Jonathan Kearns (Head, Economic Analysis Department), Anthony Dickman (Secretary), Peter Stebbing (Deputy Secretary)
International Economic Conditions
Members noted that recent indicators of global economic activity had picked up modestly after softening in late 2011, though sovereign debt concerns in Europe continued to weigh on the outlook. Conditions in most euro area sovereign debt markets had improved over the month and some progress had been made, with agreement on the Greek bailout package lowering the near-term probability of a severe financial event that many had feared late last year. Economic activity in Europe had been weak, but activity in the United States appeared to have picked up a little. Conditions had remained generally firm in China, but slowing exports to Europe and the disruption to supply chains from the floods in Thailand had weighed on activity in much of east Asia, though there were tentative signs that activity and exports had picked up since December.
Despite data on the Chinese economy being more difficult to read than usual owing to the early timing of the Lunar New Year, it appeared that the Chinese authorities had been successful in slowing growth to a more sustainable pace. The property market remained subdued, in large part reflecting administrative controls, including restrictions on access to credit by property developers and limits on purchases by existing property owners. These measures were having their intended effect of reducing property prices, but affordability for new buyers remained a concern of the central government. The People's Bank of China reduced reserve requirements again in February to offset a tightening in liquidity conditions.
The US economy had emerged from its soft patch in mid 2011. The labour market had showed further signs of improvement, as indicated by the trend decline in initial jobless claims to levels last seen in 2008. Housing activity had also shown some improvement, albeit from a low base. Even so, house prices had displayed little, if any, sign of recovery and the foreclosure process still appeared to have some way to go. Members noted that economic recoveries from financial crises tended to be slower, and that fiscal consolidation was also likely to be a drag on growth in coming years.
While output in the euro area fell in the last quarter of 2011, some indicators suggested signs of stabilisation in early 2012. Despite the slight improvement, sovereign debt concerns and fiscal consolidation efforts were seen as likely to continue to weigh on economic activity for the foreseeable future. The divergence across euro area economies remained marked, with indicators of activity having held up better in northern European economies.
As expected, the Australian terms of trade had declined from their peak in the September quarter, reflecting the fall in bulk commodity prices, but remained at historically high levels. Overall, commodity prices were broadly unchanged over the previous month. In contrast, oil prices had risen by around 7 per cent since early February owing to geopolitical tensions and increased demand, because of both the especially cold weather in Europe at the beginning of the year and the improvement in the US economy. Members noted that an increase in the price of oil related to supply concerns would be more contractionary for the global economy than the increases over the past decade when the price had risen in response to strong demand.
Domestic Economic Conditions
Members noted that the various forces shaping the Australian economy had resulted in divergent conditions across sectors. On the one hand, the terms of trade boom had underpinned strong investment in mining-related sectors. Investment intentions also remained strong, with the capital expenditure survey suggesting investment in the mining sector in 2012/13 would be well above the already elevated levels. Reflecting strong mining investment and the high exchange rate, the volume of capital imports was estimated to have increased by around 40 per cent over 2011. On the other hand, the associated high exchange rate had weighed on other trade-exposed sectors, including manufacturing, tourism and education, with services exports having fallen significantly since 2008. Investment intentions in the non-mining sectors remained subdued.
A survey-based measure of consumer confidence rose to around average levels in February, although consumers' perceptions about their personal finances were still reported as below average, partly reflecting some concerns about prospects for unemployment and general uncertainty about the global outlook. Retail sales growth had softened since mid 2011, with notable weakness in parts of the industry, including department stores and retailers of household goods. The housing market remained soft, with auction clearance rates in February broadly unchanged from late 2011. Housing credit continued to grow at a slower rate than nominal income.
Members observed that the labour market reflected these opposing cross-currents in the Australian economy, with the manufacturing and retail sectors, for example, shedding labour, and the household services (particularly health services) and mining sectors recording solid increases in employment over the past year. These adjustments had broadly offset each other over the year, with little net employment growth in the economy. Members noted that population growth had slowed, reflecting a decline in the rate of immigration. In January, total employment grew by 46,000, broadly offsetting the decline in employment recorded late in 2011, and contributing to a small fall in the unemployment rate to 5.1 per cent.
Overall, wage growth remained firm although below the pace seen in the 2006–2008 period. Private-sector wages, as measured by the wage price index, grew by 1.0 per cent in the December quarter and by 3.8 per cent over the year, which was above the average over the past decade. Public-sector wage growth had slowed, in part reflecting delays in settling several new enterprise bargaining agreements.
Members began their discussion on financial markets by noting that conditions had continued to improve in February, supported by additional policy easing by a number of central banks and an agreement on the second Greek financial assistance package, although significant uncertainty about its implementation remained.
Under the second assistance package for Greece, the European Union and IMF would provide Greece with a further €130 billion in loans. One important pre-condition was a restructuring of private-sector holdings of Greek debt with a haircut of effectively more than 70 per cent, which was to occur later in the week. Other key near-term policy actions included more expenditure cuts, tax administration reform, reductions in labour costs, and legislation to enhance bank restructuring and recapitalisation. As a result of these actions, Greece's public debt-to-GDP ratio was projected to be around 120 per cent by 2020, though this projection was subject to a large degree of uncertainty.
The European Central Bank had undertaken its second three-year liquidity operation in which it provided €530 billion in (secured) loans. This, together with the €490 billion provided in its first liquidity operation, left European banks well positioned to fund their bond maturities for at least the first half of this year. As these bonds mature, the need for investors to reinvest the funds could provide a further boost to other asset markets. Pressures on European banks' total balance sheets, including US dollar assets and liabilities, had also eased recently. A key question remained as to whether these developments would increase the capacity and willingness of European banks to lend.
The Bank of England and Bank of Japan had undertaken further quantitative easing of monetary policy, announcing increases in their respective asset purchase programs. The Bank of Japan also introduced an explicit medium-term inflation goal. Following the announcement, the yen depreciated by around 5 per cent both against the US dollar and in trade-weighted terms, after having generally moved sideways from around the middle of 2011.
The Australian dollar rose further over the past month, to around its highest level in trade weighted terms since early 1985 and only a little below its post-float high against the US dollar. The dollar's strength reflected ongoing foreign interest in Australian government debt, given the shrinking global pool of high-quality assets. Interest in Australian state government debt had picked up recently, with spreads narrowing, though this interest appeared to have come largely from domestic sources.
Reflecting the further improvement in sentiment, global equity markets had risen by almost 10 per cent since the beginning of the year. The main US index was at its highest level since mid 2008, and only 13 per cent below its 2007 peak, although other equity markets, including in Australia, were still well below their pre-crisis levels. Members noted that the relative weakness in the Australian market was due to several factors, including a larger weighting on the mining sector, which had tended to underperform broader indices in most economies over the past year.
Following the Board's decision at the February meeting to leave the cash rate unchanged, most lenders had raised their housing indicator rates, by an average of around 10 basis points. Conditions in local credit markets continued to improve and the banks issued $12 billion in bonds in February, with two-thirds of that debt unsecured, and sizeable issuance had continued in early March. Members noted that the relative cost of issuance had continued to decline since the beginning of the year, though it remained higher than in mid 2011.
At present, the Australian market was pricing in a small chance of a policy easing in March. In contrast to late 2011, when the market expected the cash rate to be lowered to 2¾ per cent by late 2012, the market now expected the cash rate to decline from 4¼ per cent to around 3¾ per cent by the end of the year.
Members were briefed on the Bank's half-yearly assessment of the financial system. The escalation in sovereign debt problems in the euro area over the second half of 2011 had largely reflected market concerns about debt sustainability in a wider group of countries, particularly Italy and Spain. This turbulence spread to global financial markets, leading to tighter wholesale funding conditions for banks in many countries, including Australia. Even though conditions in financial markets had improved since late December, the ongoing difficulties in Europe, as well as the subdued outlook for global growth, continued to pose risks to global financial stability in the period ahead.
Members noted that the Australian banking system remained in a relatively strong condition. The larger banks were in a better position than a few years ago to cope with the tighter funding conditions given the improvements made to their funding, liquidity and capital positions. Their wholesale funding task had also become more manageable, with deposit growth continuing to outpace growth in bank credit by a wide margin. Banks' non performing asset levels had come down a little recently, but remained elevated, especially for business loans. Overall, the Australian banks had continued to record robust profits, although the slow credit growth environment was likely to constrain the pace of future profit growth.
The household sector had continued to show a more cautious approach towards its finances in recent years, thereby helping to improve its resilience to possible shocks. The household saving rate had remained higher at around 10 per cent, and members discussed the apparent shift towards more conservative investment preferences as well as the decision of many households to repay their debt more quickly than required. Strong income growth had also helped to increase households' debt-servicing capacity. As a result, aggregate measures of household financial stress remained low, though mortgage arrears rates remained somewhat higher than a few years ago.
Conditions continued to vary significantly across the business sector, with the divergent experiences helping to explain why banks' non-performing business loans and business failure rates were somewhat higher than average. Overall, though, the business sector was in a better financial position than several years ago, having delevered considerably and improved its liquidity position. Members were informed that while business credit had picked up somewhat recently, demand for debt overall remained subdued. The commercial property market, traditionally a source of vulnerability for banks, had continued to improve after the recent downturn, though construction activity remained muted and financing activity weak.
Considerations for Monetary Policy
Members noted that the past month had seen an improvement in the prospects for the global economy, with European policymakers making progress in addressing the region's debt and financial problems. Major downside risks were seen to remain, but the probability of a very bad outcome in the near future had receded a little further.
At the same time, the domestic economy continued to undergo significant structural adjustment in response to the very high terms of trade and the accompanying high exchange rate. A key question was whether the necessary adjustment was occurring at an overall pace of growth that kept the economy close to trend and inflation close to target. In this regard, most information thus far had indicated that weakness in parts of the economy – including manufacturing, building construction and parts of the retail sector – was being approximately balanced by the strength in the mining sector and some services industries.
Inflation in underlying terms was around the midpoint of the target range and was expected to remain within the target range over the forecast horizon. Members observed that this forecast was reliant on some improvement in productivity growth to hold down domestic cost pressures.
Over the month, the major banks had passed on some of their higher funding cost pressures that had been building since mid 2011. The increases were relatively small, largely confined to housing loan interest rates, and did not materially change the current stance of monetary policy. Following the two reductions in the cash rate late last year, lending rates, including for businesses, were around average levels.
The clearest downside risk to the outlook for Australia remained a sudden worsening in the situation in Europe and its flow-on effects to the rest of the world through trade, financial and confidence channels. Members noted that a sharp slowdown, particularly in east Asia, would have significant implications for commodity prices and demand for Australian exports. A major flight from risk in global capital markets would see significant changes in credit conditions, the exchange rate and confidence. So long as inflation remained well contained, there would be ample scope for the Bank to ease policy in such a scenario. Overall, members noted that while this downside risk could still materialise, this seemed somewhat less likely than a few months ago.
Members were also alert to the uncertainties inherent in assessing the response of the domestic economy to the disparate forces at work, including the very large rise in resources investment and the high exchange rate. To date, the unemployment rate had remained at a low level and inflation broadly consistent with the medium-term target.
On balance, the Board considered that it was appropriate for interest rates to be around their average levels, which was judged to be the case at present. The Board would continue to monitor both how the global economy evolved and the course of domestic economic activity and prices.
The Board decided to leave the cash rate unchanged at 4.25 per cent.