Minutes of the Monetary Policy Meeting of the Reserve Bank Board
Sydney – 6 November 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), Christopher Kent (Assistant Governor, Economic), Jonathan Kearns (Head, Economic Analysis Department), Anthony Dickman (Secretary), Peter Stebbing (Deputy Secretary)
International Economic Conditions
International economic news over the past month was, on balance, more positive than in recent months, though earlier weak data had led forecasters to expect further delay in a pick-up in global activity. The pace of growth in China appeared to have stabilised in response to the earlier fiscal and monetary stimulus, with a pick-up in infrastructure construction. Timely measures of production and spending were mixed, but had generally been stronger in recent months.
Members observed that the US economy continued to expand at a moderate pace. Growth in GDP and consumption picked up a little in the September quarter, although business investment had weakened. Employment growth had improved in the past four months relative to earlier in the year, and housing prices and commencements continued to rise, albeit from low levels. While significant uncertainty remained over the extent and effect of fiscal consolidation from early 2013, members noted that a positive resolution of this matter could result in better growth prospects.
Economic activity in Europe remained weak. The PMIs and household and business sentiment remained at low levels across the region, including in France and Germany, which until recently had been more resilient.
The Japanese economy had weakened in the September quarter, with falls in consumption and exports. Growth in the rest of east Asia was also relatively subdued in the quarter, partly reflecting weakness in consumption, especially for the higher-income economies. Exports and industrial production were soft, though more recent data generally showed a slight improvement. In response to weaker growth, monetary and fiscal policies had been eased a little over recent months in some countries in the region.
Commodity prices had been mixed over the month. Members noted that the spot price for iron ore had recently increased in line with a rise in steel production and prices, but remained well below levels seen earlier in the year. In contrast, spot prices for both thermal and coking coal had declined further. Global food prices were higher and base metals prices remained broadly unchanged from the middle of the year. The terms of trade were estimated to have declined further in the September quarter, and were forecast to be 15 per cent below their 2011 peak by the end of 2012.
Domestic Economic Conditions
Members noted that inflation in the September quarter was a little higher than had been expected. Various measures suggested that underlying inflation was around ¾ per cent in the quarter and around 2½ per cent over the year. The headline CPI rose by 1.2 per cent in the September quarter on a seasonally adjusted basis, and was 2 per cent higher over the year. These outcomes reflected, in part, the introduction of the carbon price, which had had a noticeable effect on electricity and gas prices. New dwelling prices had picked up unexpectedly, as had grocery prices. Inflation in health prices had increased as a result of a tightening in the eligibility for the private health insurance rebate. Partly offsetting these effects was a softening in the inflation of rents in the quarter and subdued rises in the prices of a range of market services.
Tradables inflation picked up in the September quarter, partly owing to strong increases in fruit and vegetable prices. Members noted that there had been small increases in many other tradables prices over the past two quarters after earlier declines. This suggested that the downward pressure on tradables prices from the earlier appreciation of the exchange rate was waning.
After a long period of stability, the unemployment rate increased in September, which was consistent with other indicators that had suggested the labour market had softened in recent months. There had been a substantial fall in construction employment over the past year, reflecting a somewhat delayed response to persistently weak conditions in parts of that sector. Leading indicators of labour demand had softened a bit further, suggesting modest near-term employment growth was likely.
Overall, growth of the Australian economy had slowed from an above-trend pace earlier in the year, with recent indicators of activity suggesting that economic growth was more moderate in the September quarter.
Household consumption appeared to have slowed from the strong pace seen earlier in the year to a pace around, or a little below, trend in the September quarter, in line with income growth. Retail sales values increased through the quarter, although sales volumes fell slightly following the fading of the impetus from earlier government household assistance payments. Nevertheless, members observed that sales of motor vehicles to households had been strong in recent months. Liaison suggested that the value of retail spending rose in October, though some of this may have reflected higher prices rather than higher volumes.
There were tentative indications that housing activity may be reaching a turning point. Over recent months, the number of private residential building approvals had increased, as had dwelling prices, and auction clearance rates in Sydney and Melbourne had continued to rise.
Members observed that business surveys suggested that conditions were a little below their long-run average level. Conditions in the mining sector had declined since earlier in the year, but had improved in retail and manufacturing to around long-run average levels. Weaker sentiment in mining apparently reflected the decline in bulk commodity prices over recent months and was consistent with the outlook for more modest growth in mining investment. Outside the mining sector, indicators of private non-residential investment remained relatively subdued, although business credit grew in September, after two months of essentially no growth, and non-intermediated funding had increased. Exports were estimated to have been weak in the September quarter, owing to softer global demand for coal.
The Government had recently released its mid-year economic update. Newly announced policy changes did not materially alter the assessment (from a range of sources) that the move from a Federal budget deficit to a small surplus could subtract somewhere between ¾ and 1½ percentage points from growth in 2012/13.
Members were briefed on the updated staff forecasts. The forecast for GDP growth was a little lower than that presented three months earlier, largely reflecting the change to the profile for mining investment. Over the year to June 2013, growth was expected to be a little below 2¾ per cent, before gradually picking up to around 3 per cent over 2014. The slightly softer outlook for economic activity overall was expected to be reflected in the labour market over the near term. Employment growth was consequently forecast to remain relatively modest over the course of the next year, before rising gradually towards the end of the forecast period.
Members observed that the inflation forecast was largely unchanged from three months earlier, with underlying inflation expected to remain consistent with the inflation target over the next two years. Although the rate of inflation over the year to the September quarter was a little higher than had earlier been forecast, raising the starting point for the projections, the effect of this on the inflation forecast was offset by the slightly weaker outlook for domestic economic activity and employment. Based on earlier Treasury modelling, the carbon price was expected to boost underlying inflation by around ¼ percentage point over 2012/13, and headline inflation by around 0.7 percentage points. The combination of the carbon price effect and volatility in fruit and vegetable prices was expected to see headline inflation rise above 3 per cent in year-ended terms in the first half of 2013, before declining to around 2½ per cent thereafter.
While there was relatively little news affecting financial markets over the past month, market conditions generally continued to improve, supported by the better-than-expected flow of economic data, along with the ongoing effects of the actions taken earlier by the European Central Bank (ECB) and Federal Reserve. Members were briefed on the recent experience internationally with unconventional monetary policies and the potential lessons they held, including for Australia.
Members noted that the lack of unsettling news out of Europe in the past month had also supported financial markets, despite the absence of substantive progress by European policymakers in dealing with the underlying issues. Spain had not yet decided whether to apply for a precautionary financial assistance program, a pre-condition for the ECB to purchase sovereign bonds under its recently announced Outright Monetary Transactions program. Italian and Spanish government bond yields fell further over the month to be around their lowest levels since early 2012. On Greece, the outcome of the review by the troika of officials from the IMF, ECB and EU was expected soon.
Yields in major government bond markets, currencies and equities were all little changed over the past month. After falling over much of the past six months, share prices in China had risen in October, supported by better-than-expected economic data. The Australian share market was also higher, in part reflecting the stronger Chinese economic data. The Australian dollar was little changed over the month, both against the US dollar and on a trade-weighted basis, and remained at a high level.
Members were briefed on credit conditions, which continued to improve for both US and European corporates in October. Spreads on bank bonds had narrowed significantly since mid year. Issuance remained solid, particularly for non-financial firms in the United States that had taken advantage of extremely low yields to refinance their existing debt. Australian corporates maintained good access to debt markets, with secondary market bond spreads tightening further over the month.
Following the October cash rate announcement, most lenders in Australia had reduced their standard variable housing loan rates by around 20 basis points. The average interest rate on outstanding housing loans was now about 75 basis points below the post-1996 average, while rates on small and large business loans were 75 and 125 basis points below average. Competition for deposits remained strong, with deposit funding accounting for more than half of total bank funding.
The Board's decision to lower the cash rate by 25 basis points at the October meeting had been largely anticipated by the market and did not have a large effect on the yield curve. Members noted that current market pricing implied around an even chance of a 25 basis point easing in monetary policy at this meeting.
Considerations for Monetary Policy
For the global economy, data received over the previous month had been somewhat more positive. In particular, the US economy continued to expand at a moderate pace and there were signs that the pace of growth in China may have stabilised. Recent policy announcements in Europe had helped to bolster financial market conditions, though economic activity there remained weak. A significant deterioration in financial and economic conditions in the euro area remained a downside risk for global growth, although risks elsewhere were more balanced.
For Australia, a range of indicators suggested that the economy had been growing around trend pace over recent months, having slowed from above-trend growth earlier in the year. The staff forecast for GDP growth over 2013 was revised down, largely because of a change to the mining investment profile. However, there was considerable uncertainty about the timing of spending for mining investment projects, given their size and complexity. While a gradual recovery in both dwelling and other business investment was anticipated, assisted in part by the lower level of interest rates, there was also uncertainty about the timing and magnitude of this pick up. Hence, there was uncertainty about the overall pace of growth of demand in the economy over the forecast period.
Members noted that the staff's forecast was for underlying inflation to remain close to 2½ per cent over the next two years, apart from the temporary effect of the carbon price. With the disinflationary effect of the earlier exchange rate appreciation on tradable prices waning, this forecast was predicated on the assumption of ongoing productivity growth and some moderation in the growth of wages to contain domestic cost pressures.
The Board's decision at the October meeting to reduce the cash rate had pushed borrowing interest rates a little lower relative to their average levels. The effects of the earlier reductions in the cash rate were, meanwhile, continuing to work their way through the economy, and members expected that further effects of these changes were yet to be observed. Members considered that further easing may be appropriate in the period ahead. However, at this meeting, with prices data for the September quarter slightly higher than expected and recent information on the world economy slightly more positive, the Board judged that the stance of monetary policy was appropriate for the time being.
The Board decided to leave the cash rate unchanged at 3.25 per cent.