Statement on Monetary Policy – May 2006
Domestic Economic Conditions
GDP growth in the Australian economy is estimated to have been 2.7 per cent over 2005 (Table 6). While this was somewhat below trend, there were broad-based increases in the prices of resource commodities over the year, which were reflected in a 13 per cent increase in the terms of trade. As a result, Australia’s income grew strongly, with real GDP adjusted for the terms of trade rising by 5.2 per cent over the year. Growth in demand continued to run ahead of that in production. Domestic spending was characterised by strong growth in business investment, and relatively subdued growth in household spending, following the levelling out of house prices (Graph 24). Growth in household consumption was relatively moderate and there was a fall in dwelling investment. Growth in the resource-intensive states of Western Australia and Queensland continued to outpace that in the rest of the country (see ’Box B: Regional Economic Performance’).
More timely data suggest reasonably buoyant conditions in the early months of 2006. The available indicators of household consumption picked up in the first months of the year, and businesses have continued to report healthy conditions, with profitability and capacity utilisation at high levels. Looking ahead, domestic demand is expected to grow at a solid pace, although somewhat slower than the rate recorded last year. Growth in household consumption and a gradual turnaround in dwelling investment should offset some easing in the recent rapid growth in business investment. A recovery in exports growth is also anticipated, supported in part by new productive capacity in the resources sector.
For much of 2005, households were more cautious in their spending than in preceding years. Household consumption increased by 0.7 per cent in the December quarter 2005 and by 2.9 per cent over the year, somewhat below the growth in real household incomes and well down from the higher rates seen during the period of rapid house price increases. The somewhat more cautious attitude on the part of households was reflected in a slowing in the growth of household debt. The debt-servicing ratio was broadly flat in the December quarter, at 10.8 per cent (Graph 25).
More recently, there were signs of a strengthening in spending in early 2006, with retail sales up by 1.6 per cent in the three months to February and 4.6 per cent higher over the year (Graph 26). Motor vehicle sales increased by 1.2 per cent in the March quarter compared with the December quarter. Consumer sentiment, as measured by the Westpac-Melbourne Institute survey, has also risen in recent months and is currently above its long-run average level.
Housing construction activity has continued to decline. Dwelling investment fell by 2.7 per cent in the December quarter, bringing the fall since the peak in early 2004 to 7 per cent. The decline reflected a fall in investment in new dwellings; expenditure on alterations and additions was broadly flat in the quarter. Available indicators of housing activity point to further falls in the first half of 2006. The number of dwelling commencements fell by 8 per cent in the December quarter, mostly due to a sharp decline in medium-density dwellings, while the number of private residential dwelling approvals was down 0.8 per cent for the three months to February compared with the previous three months (Graph 27).
Nonetheless, the data continue to suggest that the current downturn has been comparatively mild by historical standards and dwelling investment as a share of GDP has remained high (Graph 28). This reflects both the increase in the relative price of housing construction over recent years and shifts towards larger and higher-quality dwellings, with a one-quarter increase in the average size of new houses and a rise in the importance of expenditure on alterations and additions to existing dwellings over the past decade.
Financing and prices
Housing finance has shown a modest pick-up in recent months. The value of housing loan approvals increased by 2.9 per cent in the three months to February to reach $14.6 billion, with growth in both the owner-occupier and investor components. Housing credit grew at an annualised rate of 14.5 per cent over the six months to March, up from 11.5 per cent over the six months to September (Graph 29). This reflected a pick-up in the owner-occupier component, although the slowdown in investor credit growth also appears to have abated.
Conditions in the established housing market have firmed modestly (Graph 30, Table 7). The APM composition-adjusted measure of nationwide house prices was flat in the March quarter and increased by 1.7 per cent over the year. The various measures suggest house prices have generally stabilised in most capital cities, but continue to increase strongly in Perth. Recent auction clearance rates in Sydney and Melbourne have been around their highest levels of the past two years, although they remain well below the peaks seen earlier in the decade. Residential rental markets have also been tightening, with rents rising and the nationwide vacancy rate around its lowest level since the late 1980s. REIA data suggest nationwide rents increased by 6.8 per cent over the year to the December quarter, while the ABS series indicated growth of 2.8 per cent over the year to the March quarter.
Most business surveys indicate that overall conditions in the first quarter of 2006 were at or above long-run average levels, but below the high levels recorded in 2004 (Graph 31). The NAB survey of the non-farm sector reported that business conditions improved in the March quarter, and that capacity utilisation remained around a historically high level (Graph 32). Generally positive business conditions were reported in most other surveys, such as the Sensis and St. George-ACCI surveys. Liaison indicates that activity in the services sector has been especially strong, particularly in industries supplying services to businesses.
Conditions in the manufacturing sector continue to be weaker than in the rest of the economy. The AIG’s quarterly manufacturing survey indicates that activity strengthened a little in the March quarter, but remains below long-run average levels, while the ACCI-Westpac survey shows business conditions in the manufacturing sector were around long-run average levels. Liaison suggests that reduced export competitiveness and intense import competition are inhibiting output growth for some trade-exposed manufacturers, while those geared towards local markets have been affected by the slowing of the housing cycle and more modest pace of household spending.
The overall outlook for farm output remains positive. The summer crop harvest is likely to have increased sharply from last year, particularly for cereals, and favourable weather conditions are enabling livestock producers to rebuild herds. Cyclone Larry, which struck north Queensland in mid March, is expected to have reduced national sugar cane production by around 10 per cent and banana production by around 90 per cent, as well as affecting some other crops. However, these crops are a relatively small share of Australia’s overall farm output.
Business investment has been strong for several years, buoyed by the high level of capacity utilisation and a favourable funding environment due to high profitability and relatively low borrowing interest rates. Business investment increased by 14.5 per cent over 2005 and by 4.3 per cent in the December quarter, driven by strong growth in machinery & equipment investment and engineering construction (Graph 33). Growth in capital spending over 2005 was particularly rapid for resource-related industries, although strong increases were also recorded across a range of other industries.
The outlook for business investment is favourable, given the good prospects for growth in the domestic and world economies. Although the December quarter capital expenditure (Capex) survey suggested a relatively subdued outlook for the period ahead, recent experience has been that the profile presented in the Capex survey has been significantly upgraded as the year has progressed. Accordingly, machinery & equipment investment growth is likely to be solid, but possibly slower than the pace recorded in 2005. The latest Rabobank survey suggests that investment intentions for farm equipment (which are not covered in the Capex survey) remain strong, at close to their pre-drought levels. Forward-looking indicators of non-residential construction also suggest a high level of activity over coming quarters, following the upswing over the past year. Non-residential building commencements increased in the December quarter, and the amount of work approved continues to run well above the current level of work done. Engineering construction activity has been supported by the large amount of resource-related work underway, particularly in Western Australia.
Business profitability has been strong, with total private-sector profits – measured by corporate gross operating surplus plus gross mixed income – increasing by 10 per cent over 2005. The profit share has increased to around 30 per cent of GDP, its highest level for more than 30 years (Graph 34). In the corporate sector, both financial and non-financial enterprises posted strong earnings growth over 2005. Aggregate corporate profit growth was driven by the mining industry, reflecting the strength in commodity prices. Profit growth in the non-mining non-financial corporate sector was less strong. Profits of unincorporated enterprises – which comprise a little less than one-third of total private-sector profits – have also been relatively weak.
Employment growth resumed in early 2006, following a pause in the second half of 2005. Employment increased by 0.3 per cent over the three months to March and by 1.6 per cent over the year. More generally, labour market conditions remain strong; the participation rate has been at a high level of 64.4 per cent for the past six months, and the unemployment rate has stayed within the 5 to 5¼ per cent range for the past year and a half (Graph 35).
Over the year to the March quarter, employment growth was mainly concentrated in the construction and services sectors, with growth in the property and business services sector particularly strong. Employment growth in the wholesale, retail and manufacturing industries was weaker. Labour market conditions are favourable across all states, and unemployment rates are generally close to the national average (Table 8).
Survey-based indicators and vacancy data suggest that labour market demand has strengthened recently and that labour supply remains relatively tight. The ABS measure of job vacancies shows a nationwide vacancy rate of 1.3 per cent, around its highest level for over 25 years (Graph 36). In addition, the ACCI-Westpac survey of manufacturers and the NAB survey suggest that hiring intentions increased in the March quarter, and remain well above long-term average levels. However, these surveys also show an increase in the proportion of firms having difficulty finding suitable labour, and employers note that this difficulty remains a key factor constraining their output. Liaison indicates that, while labour shortages are broad-based across industries and skill levels, these shortages are most pronounced among skilled workers in the non-residential construction and resources sectors, and in much of the business services sector.