Minutes of the Monetary Policy Meeting of the Reserve Bank Board
Melbourne - 5 March 2013
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 data indicated more positive global conditions, on balance, than some months ago. Growth in Australia's major trading partners strengthened in the December quarter, despite a decline in activity in the advanced economies.
Indicators suggested that growth of the Chinese economy had stabilised at a sustainable pace, although activity data were limited over the past month and the available data were difficult to interpret owing to the Spring Festival holiday. The Chinese authorities had expressed some concerns about the pace of house price growth. Financial conditions in China remained accommodative, with strong growth in total financing over recent months, much of which had been from sources other than banks' balance sheets. Output growth in India had picked up somewhat from low rates.
Elsewhere in east Asia (excluding Japan), growth had been a little stronger recently and inflation had remained contained for the region as a whole. Japanese economic activity remained weak in the December quarter, but more timely data pointed to some improvement in early 2013, with both consumer and business sentiment rising following the Government's earlier announcement of more stimulus measures.
Members noted that the US economy appeared to have continued to grow moderately, with further improvement in the housing market, and continued growth in payrolls. The automatic government spending cuts came into force in full from 1 March, in contrast to most forecasters' earlier expectation that not all of the cuts would be implemented.
Economic activity in the euro area contracted further in the December quarter, with falls in output in Germany and France, and larger contractions in the economies most affected by sovereign debt problems. Although there had been some improvement in sentiment and activity over recent months, conditions were expected to remain weak, partly reflecting further fiscal consolidation over the balance of the year.
Prices for iron ore remained relatively high, although this strength was still expected to be temporary, in part because of an expected increase in supply. Spot prices for coking coal had picked up slightly, while rural and base metals prices were a little lower over the past month.
Domestic Economic Conditions
With the national accounts scheduled for release the day after the Board meeting, members noted that information to hand at the meeting suggested that the pace of output growth in the December quarter had been around trend. Coal and iron ore exports had grown strongly in the quarter, and most components of domestic demand were estimated to have recorded moderate growth.
While mining investment was reported to have grown further in the December quarter, it still appeared that mining investment as a share of GDP was approaching its peak and mining firms remained focused on containing costs. The gradual shift away from investment towards production and exports in the period ahead was expected to lead to some reduction in the demand for labour in the resources sector.
Investment outside the mining sector was estimated to have declined in the December quarter. However, there were indications that it would pick up in 2013/14, although this was expected to be modest, as business surveys of investment intentions and capacity utilisation were at below-average levels and liaison suggested that some firms were investing only to cover depreciation. Consistent with this, non-residential building approvals remained low and office vacancy rates had risen over recent quarters, reflecting softening demand for office space. Members noted that business profits had declined a little and business debt had been growing at a moderate pace of about 4 per cent per annum.
Members observed that dwelling construction activity had picked up further in the December quarter. Forward-looking indicators such as building approvals pointed to further growth in construction in the months ahead. The increase in approvals had been geographically widespread and the Bank's liaison with builders also suggested there had been an improvement in buyer interest in some states. Overall, recent housing market developments pointed to a further moderate increase in dwelling construction in the period ahead.
Indicators of consumption had been mixed but, overall, growth appeared to have been only modest in the December quarter. The value of retail spending was unchanged over the December quarter, although figures released during the meeting indicated that spending had increased in January, which was consistent with liaison contacts reporting stronger retail spending in early 2013. Motor vehicle sales to households were flat in February but remained at a robust level, while measures of consumer sentiment had increased further over recent months, to be a bit above their long-run average levels.
Members noted that conditions in the labour market remained subdued. The unemployment rate in January was steady at 5.4 per cent, but the rate of growth of employment remained modest, the trend in total hours worked remained flat and the participation rate had declined a little further. While leading indicators of labour demand were down from earlier levels, they remained consistent with modest employment growth in the near term.
As expected, the year-ended pace of wage growth continued to slow, with the wage price index increasing by 3.4 per cent over the year to the December quarter. This slowing had been broad-based across states and industries, and was particularly pronounced in the household services and retail sectors. Information from liaison and business surveys was consistent with private sector wage growth on a quarterly basis remaining around current rates over the period ahead.
After a relatively quiet period over previous months, volatility in financial markets had increased somewhat through February, amid greater political uncertainty in Europe, particularly in Italy.
Members noted that the expectation within financial markets remained that forthcoming changes to the Bank of Japan's executive would usher in a more aggressive policy stance. There was a further decline in the balance sheet of the European Central Bank as early repayments of its three-year lending operations continued, with Spanish and French banks accounting for a large part of the decline to date.
Government bond yields in major markets declined over February, with Japanese 10-year bond yields falling to their lowest level in around a decade. Bond yields in the United Kingdom also fell, notwithstanding a downgrading of the UK's sovereign credit rating by one of the rating agencies. In contrast, yields on Italian government bonds rose sharply immediately after the Italian election as the lack of a decisive result became clear, although there had been little change since.
After increasing significantly in earlier months, share prices in most major markets were little changed over the past month, although those in Italy fell sharply after the election. Members observed that the Australian share market had continued to rise, with corporate earnings in the current reporting season generally meeting expectations. Members noted that despite the large increases in share prices since the middle of last year, price-earnings ratios in most markets, including Australia, were around their long-run average levels.
In foreign exchange markets, the yen had depreciated a little further over the past month and the pound sterling had continued to depreciate, reflecting the recent run of weak economic data as well as the UK's sovereign credit downgrade. The Australian dollar was slightly lower against the US dollar and on a trade-weighted basis in February, but it remained at a high level.
Members observed that spreads on corporate debt generally remained low, following a significant contraction globally during the second half of 2012. Domestically, there had been a substantial volume of asset-backed debt issued during February, with spreads on residential mortgage-backed securities reaching their lowest levels since prior to the financial crisis. Funding conditions for Australian banks remained as favourable as they had been for some months. In time, this improved environment should see some moderation in banks' strong demand for deposits but, for the present, spreads between deposits and comparable wholesale benchmarks remained elevated.
The Board's decision to leave the stance of policy unchanged in February had been anticipated by financial markets. Members noted that current pricing implied that the market expected only a small chance of the cash rate being lowered at the March meeting.
Members were briefed on the Bank's half-yearly assessment of the financial system.
Internationally, risks to global financial stability had eased over the past six months as global financial market sentiment had improved significantly. This mainly reflected various policy developments in Europe, which had increasingly demonstrated a strong commitment on the part of the European authorities to deal with their sovereign debt and banking sector problems while maintaining the monetary union. Also boosting confidence had been the partial resolution of the US ‘fiscal cliff’ around the end of the year and further signs of recovery in some of the major economies.
Overall, members noted that the improvement in sentiment had led to more favourable conditions in funding markets in the major economies (and Australia), although they recognised that the euro area, in particular, still faced significant stability challenges from its fiscal and banking sector problems. Therefore, it was too early to say whether the improved market sentiment was the beginning of a sustained recovery, or merely a temporary upswing.
Members observed developments in a number of broad indicators for commercial banks in several countries and regions – covering variables such as share prices, profits and indicators of asset quality – which showed that banks in Australia and Canada, as well as in several Asian economies, continued to perform more strongly than those in the United States, Europe and Japan. Members discussed the possible risks emanating from a change in behaviour of banks in the low credit growth environment.
The Australian banks, in particular, had continued to record strong profitability in recent periods, which had helped them to strengthen their capital positions further. Wholesale funding cost pressures on the banks had, at the margin, eased with the improved global market sentiment. This would take some time to be reflected in average costs. Banks' asset performance had also been improving, though at a gradual pace owing to the challenging conditions being experienced in some parts of the Australian business sector.
Both household and business borrowing had been relatively restrained over the recent period. Members noted that households' net wealth had risen recently with the recovery in asset markets and continued high saving rates and borrowing restraint. Debt-servicing capacity had also been boosted by lower interest rates, which had helped to keep housing loan arrears and other aggregate measures of financial stress low, despite the unemployment rate recording a modest rise over the past year. Over the same time, aggregate business profitability had fallen – particularly in the mining sector – and business failure rates had increased somewhat under the influence of a high exchange rate and a return to more traditional saving and borrowing behaviour by households over recent years. Overall, though, gearing ratios were low and deleveraging was continuing in some sectors.
Members were updated on the current state of international regulatory reforms, where the focus was now shifting to implementation of the agreed reforms at the national level (particularly the Basel III capital standards) and monitoring the consistency of implementation internationally through various assessments and peer reviews.
Considerations for Monetary Policy
Global economic conditions continued to be more positive than they had been for much of 2012. Growth had stabilised in China at what appeared to be a sustainable pace, while picking up in the rest of Asia (excluding Japan) and recording a moderate pace in the US economy. Conditions in Japan and the euro area had been particularly weak in the second half of 2012, although some recent indicators had been a little more positive. Risks to the global outlook appeared more balanced than they had been in the previous year, although vulnerabilities remained, particularly in Europe.
Global financial market conditions remained very accommodative, with expansionary monetary policies contributing to rising asset prices over recent months. In Australia, asset prices were also rising, although household and business debt continued to grow at a moderate pace. The response of financial markets to political developments in the United States and Europe had been muted over the past month.
The available partial indicators suggested that the Australian economy grew at close to trend pace over the year to the December quarter. While mining investment had made a further contribution to growth, it appeared to be approaching its peak. Survey-based measures of business conditions were below average and non-mining business investment had, to date, remained subdued. That was likely to continue in the near term, but recent data suggested a modest increase in non-mining business investment was in prospect during 2013/14. There were signs that dwelling investment was growing and it was likely to continue to do so at a moderate pace in the period ahead, and exports were strengthening. Overall, the staff's assessment remained that GDP growth would be a little below trend this year, with a pick-up after that.
Members noted that further moderation in the year-ended growth of wages, evident in recent data, was consistent with the staff forecast of inflation remaining around the middle of the target. Given that the effect of the earlier exchange rate appreciation had waned, the inflation forecast assumed a combination of ongoing productivity growth and wage growth remaining around the more moderate pace seen in recent quarters. The latter was consistent with the softer conditions in the labour market evident since mid 2012.
Given the economic outlook, the Board considered it appropriate that the stance of monetary policy should be accommodative. After six cash rate reductions since late 2011, lending rates were close to the historically low levels of 2009 and clearly below normal levels. Interest-sensitive parts of the economy continued to show signs of responding to these low rates and it was likely that this still had further to run, though the exchange rate remained high. With inflation likely to remain around the middle of the inflation target, members judged that there would be scope to cut the cash rate further to support demand, should that be necessary. At this meeting, the Board's assessment was that, while further reductions may be required, on the information currently to hand it was appropriate to hold rates steady, and to assess further developments over the period ahead.
The Board decided to leave the cash rate unchanged at 3.0 per cent.