Minutes of the Monetary Policy Meeting of the Reserve Bank Board
Sydney – 7 August 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
Members noted that escalating concerns regarding the fiscal and banking problems facing the euro area had weighed on confidence in many economies, and economic activity appeared to have slowed further in Europe. At the same time, growth in the United States and parts of Asia had slowed, while in China indicators generally pointed to growth stabilising. Financial markets remained volatile and the risks emanating from Europe continued to affect the outlook.
Members were briefed that the IMF had recently released forecasts for global growth of 3.5 per cent in 2012 and 3.9 per cent in 2013, marginally lower than the forecasts released in April. The forecast for growth in Australia's trading partners had also been revised lower, but remained almost 1 percentage point higher than the forecast for global growth, reflecting the larger share of trade with emerging market economies in Asia. The IMF continued to see the balance of risks to the global economy as skewed to the downside.
Members observed that there were signs that growth in the Chinese economy appeared to be stabilising at a more sustainable pace. Real GDP grew by 1.8 per cent in the June quarter, slightly faster than the March quarter, to be 7.6 per cent higher over the year. Earlier tight monetary conditions, property market restrictions and a normalisation of fiscal policies had led to a slowing in Chinese domestic demand. While total exports had continued to grow, exports to Europe had been weaker. Nevertheless, there were signs that investment growth had steadied and some early indications that conditions in the housing market had also improved a little in recent months. Meanwhile, real household consumption growth had remained broadly stable over the past few years.
In contrast to China, conditions were weaker in the rest of east Asia, with industrial production and exports broadly flat over the past year. Members noted that, with growth in demand having slowed in much of the region, inflationary pressures had eased across Asia. The Chinese authorities had adjusted monetary conditions to a more accommodative stance; there was scope for easier policies elsewhere and some countries had started down that path.
Growth in the United States slowed a little in the June quarter, and measures of household and business confidence remained at low levels in July. Employment and consumption growth had been slower in recent months than earlier in the year, and growth in business investment remained subdued. In contrast, the outlook for construction appeared to be marginally better, with activity and prices in the housing market starting to recover, albeit from very low levels. Nonetheless, members recognised that there remained large overhangs of household debt and properties for sale or in foreclosure in the housing market.
In Europe, timely indicators suggested that economic activity had contracted in the June quarter, with declines in both consumption and investment. Labour markets remained very weak, particularly in the crisis economies, where unemployment had risen further from already high rates. Measures of confidence had weakened further across most euro area economies recently. While the competitiveness of the crisis economies had been improving, members noted that further significant economic adjustment seemed necessary and the challenges ahead for the euro area remained substantial.
Commodity price movements had been mixed over the past month. Spot prices for iron ore and coking coal had declined recently, consistent with a softening in global demand and rising supply. However, prices for oil and some rural commodities had increased over the past month because of supply disruptions, with drought in the US and Black Sea cropping regions affecting the supply of grains in particular. In the June quarter, the terms of trade were estimated to have declined, though they remained at a high level.
Domestic Economic Conditions
Inflation in the June quarter was broadly in line with expectations, with the various measures showing underlying inflation of around ½ per cent in the quarter, and 2 per cent over the year, which was the lowest annual rate since the late 1990s. The CPI rose by 0.6 per cent in the June quarter on a seasonally adjusted basis, to be 1.2 per cent higher over the year. The quarterly outcome reflected strength in rents and a rebound in the prices of fruit and vegetables. Measured on an annual basis, inflation was held down by earlier large falls in the prices of fruit and vegetables. Domestic inflationary pressures eased a little in the first half of 2012, with broad-based disinflation across non-traded goods, such as food and new dwellings, and a range of market-based services, notably domestic travel and accommodation. Following substantial declines over recent years, tradables prices rose in the quarter, with stronger outcomes for cars, clothing, footwear and some household goods. More generally, the outcome for tradables prices suggested that the significant downward pressure on inflation from the earlier exchange rate appreciation was lessening.
Members noted that the domestic economy appeared to be growing at around trend pace in the June quarter, though activity continued to vary significantly across industries. Resource investment, which continued to evolve broadly in line with the Bank's forecasts, spurred activity in a number of industries, while the high Australian dollar and weak conditions in the housing market had weighed on activity in a number of non-resource industries.
Members were informed that additional large resource projects had commenced or received approval in recent months, thereby sustaining the very large stock of work in the pipeline. This had occurred despite some mining companies adopting a more cautious approach to potential, but yet to be approved, investment projects. Coal exports had declined in the June quarter following industrial disputes and weather-related disruptions, while iron ore exports had recovered from cyclone-related disruptions earlier in the year.
Investment in non-resource industries generally remained subdued, with firms slowing their investment spending in line with weaker cash flows. Nevertheless, following a period of deleveraging, business credit had picked up over the past few quarters to be growing at its fastest pace in three and a half years.
Members also observed that there were indications that consumer spending had retained some momentum in the June quarter, even though consumer sentiment remained at subdued levels. Growth in the volume of retail sales remained above its pace in late 2011, sales of motor vehicles to households increased strongly, and the number of Australians travelling overseas continued to increase. Information from the Bank's retail liaison suggested that various government payments made to households through May and June had had a noticeable effect on sales at some retailers.
Members noted that there were tentative signs that housing market conditions and residential building activity were starting to pick up after being weak for some time. Prices had increased a little in recent months, but remained somewhat lower than a year ago. Demand for housing finance was broadly unchanged over the year. With building approvals rising from low levels, the outlook for residential construction activity was more positive for the second half of the year. Earlier falls in interest rates and rising rental yields were likely to have increased the attractiveness of housing investment.
Employment growth picked up somewhat in the June quarter and there had been little change in the unemployment rate, which remained around 5¼ per cent. Members also noted that the dispersion of unemployment rates across regions remained relatively low. Employment growth continued to reflect the net effect of strong growth in resource, resource-related, health and education industries, and structural developments that had created pressure for labour shedding in some non-resource industries, including retail trade, manufacturing and construction. Leading indicators continued to suggest modest growth in employment in the period ahead; measures of vacancies and job advertisements had declined over recent quarters, but remained at relatively high levels.
Members were briefed on the updated staff forecasts. While the stronger-than-expected GDP growth in the March quarter boosted forecast growth over 2012 to 3½ per cent, employment growth in the near term was expected to remain relatively modest. The economy was then expected to grow at around 3 per cent over 2013 and 2014, largely unchanged from the forecasts presented in May. Resource investment was forecast to peak during 2013/14 and gradually decline over subsequent years, although the timing of the peak was uncertain, with the boost to growth coming from higher resource exports and a gradual rise in non-resource investment.
Members observed that the outlook for inflation was little changed. Reflecting the waning disinflationary impact of the earlier exchange rate appreciation and the introduction of the carbon price, the staff forecast was for underlying inflation to pick up gradually to the top half of the target range by mid 2013. The carbon price effect on year-ended inflation was forecast largely to have passed by late 2013, with underlying inflation forecast to decline a little to around the middle of the target range thereafter. Headline CPI inflation was forecast to rise to around 3 per cent by mid 2013 as a result of the passing of the earlier volatility in fruit prices and the introduction of the carbon price, before returning to around the middle of the target range over the remainder of the forecast period.
Developments in Europe continued to dominate financial market sentiment over the past month. Initially, the measures agreed upon at the euro summit in late June appeared to bring some stability to financial markets, but this proved to be short lived as developments in Spain and Greece again weighed heavily on European debt markets.
Members noted that yields on long-term Spanish government bonds reached a new euro-era high of over 7½ per cent during July, while shorter-term bond yields also increased sharply. Subsequent statements by European Central Bank (ECB) President Draghi that the ECB would do ‘whatever it takes’ to preserve the euro and that the ECB was considering direct purchases of short-term sovereign debt saw a marked decline in Spanish short-term yields in the days prior to the Board meeting and 10-year bond yields fell back below 7 per cent.
While Spain retained bond market access – issuing €6 billion of bonds in July – the Spanish authorities had acknowledged that Spain could not fund itself at current yields for an extended period. Members noted that foreign investors had markedly reduced their holdings of both Spanish and Italian sovereign debt over the past year.
Earlier in July, the deteriorating economic situation in Europe had led the ECB to lower its policy rates further. The decision to reduce the rate paid on its deposit facility to zero meant that an increasing number of money market rates within the euro area had become negative, which accentuated the desire to shift funds out of the euro, thereby triggering a further depreciation of the euro. It had also led several euro-denominated money market funds to announce their closure to new investments. In this context, members discussed the increasing difficulties that pension funds in the major economies were facing in the environment of extremely low – in some cases negative – interest rates.
A number of other central banks, including the People's Bank of China, also eased monetary policy in July. The US Federal Reserve did not take any action at its meeting in early August, but indicated that further measures would be forthcoming unless economic conditions in the United States improved.
Within this environment, bond yields plumbed new historic lows for many of the major sovereign issuers during July. The decline in yields on Commonwealth Government securities was particularly pronounced, with the 10-year yield briefly falling to a historic low just below 2.7 per cent. Offshore purchases of Australian government bonds appeared to have continued apace and, in part reflecting these purchases, the Australian dollar had appreciated over the past month, increasing through periods of both strength and weakness in ‘risk-sensitive’ assets. Members noted that this had put the trade-weighted measure of the currency back near its post-float high, notwithstanding the decline in the terms of trade and the weaker global outlook.
The further decline in the euro exchange rate put additional pressure on the Swiss National Bank in maintaining the franc's peg against the euro to avert deflationary pressures. Members noted that the Swiss National Bank had purchased around €100 billion over May and June, with further sizeable purchases likely to have occurred in July. While some of these purchases were retained in euros, a sizeable share was converted into other currencies, including a modest amount in the Australian dollar. In contrast, members noted that the level of Chinese foreign reserves fell in the June quarter, as capital outflows occurred.
Share prices globally had been volatile but buoyed late in the month by the prospect of more forceful policy measures by the ECB. A notable exception was the Chinese stock market, which continued its decline from earlier in the year. While banking shares had performed poorly in European and US markets, amid investigations into the fixing of benchmark interbank rates, these declines were largely reversed following the comments by ECB President Draghi. In contrast, the share prices of Australian banks had generally been firmer during the past month.
While global debt market activity was reasonably subdued during July, Australian banks accessed both onshore and offshore term funding in sizeable volume and at spreads little changed from earlier in the year. Domestically, the banks continued to focus on generating additional deposits to fund lending growth, resulting in spreads paid on deposits relative to wholesale benchmark rates remaining elevated. Members noted that Australian banks' net exposures to LIBOR were low, as positions priced off these reference rates were largely offsetting. The market convention in Australia is to reference most financial products against the domestic bank bill swap reference rate.
The improvement in sentiment after President Draghi's announcement had seen money market participants in Australia curtail their expectation of further cuts in the cash rate target. Current market pricing did not indicate any expectation of a change in monetary policy at this meeting.
Considerations for Monetary Policy
The global economic environment remained fragile, with the uncertainty emanating from the euro area affecting financial markets and potentially delaying spending by firms and households. The latest forecasts for global growth had been revised down a little, reflecting further deterioration in Europe and slower growth in the United States and parts of Asia. Economic developments in China, however, had been a little more positive, with tentative signs that growth was stabilising at a more sustainable pace. The forecast for global growth in 2012 was close to its long-term average and growth was expected to pick up somewhat in 2013. Nevertheless, the risk of significant economic and financial disruption in the euro area continued to cloud the outlook.
Domestically, the economy was forecast to grow around trend pace over the medium term. Resource investment was projected to continue to increase rapidly over the next year or so, broadly in line with earlier expectations. The eventual decline in resource investment was expected to be roughly offset, in the forecasts, by a ramp-up in resource exports as projects were completed, and a gradual strengthening in some parts of the non-resource economy that had been relatively weak. Members noted that there was a good deal of uncertainty surrounding the forecast timing of these shifts.
Domestic financial conditions had eased in recent months as a result of the earlier reductions in the cash rate, which had seen borrowing rates fall a little below their medium-term averages. While the full effects would take some time yet to become apparent, there were tentative signs of an effect on the housing market. There had also been a noticeable pick-up in business credit growth over recent months. Consumption growth had strengthened, though this probably reflected, in part, the government payments made over recent months. At the same time, however, the exchange rate had remained at a relatively high level, notwithstanding the weakening in the global outlook and decline in many commodity prices.
The inflation data for the June quarter were broadly in line with expectations, and confirmed that underlying inflation was around the bottom of the target. This reflected the lagged effects of the earlier appreciation of the exchange rate and weakness in demand in some parts of the non-resource economy, which had seen inflation of non-tradable prices ease in the first half of 2012 to its average over the inflation-targeting period. Inflation was forecast to increase a little as the effects of the earlier exchange rate appreciation continued to wane, and it would also temporarily be pushed higher by the introduction of the carbon price. Inflation was nonetheless forecast to be around the middle of the target range by late 2013 and to be consistent with the target over the medium term.
With inflation expected to be consistent with the target and growth close to trend, but with a more subdued international outlook than was the case a few months ago, the Board judged that the stance of monetary policy remained appropriate.
The Board decided to leave the cash rate unchanged at 3.50 per cent.