Statement on Monetary Policy – November 2006
International Economic Developments
The world economy has been expanding strongly. Growth is estimated at above 5 per cent for 2006, around the fastest rate in recent decades (Graph 1). The outlook for 2007 is for some moderation in growth in all major regions, but overall growth is still forecast to be above average. Some of this moderation already appears to be underway, including in the United States and in parts of east Asia. Growth in the euro area has picked up, rapid growth in China is continuing, and growth in other emerging economies has generally been firm. Despite these strong growth outcomes, oil prices have eased from peaks of over US$75 per barrel in July to below US$60 recently.
One question currently being asked is whether a greater-than-expected slowing in the US economy would have a major effect on global growth. Many commentators seem to be suggesting that the global expansion is sufficiently broad-based that it should be fairly resilient to the effects of such a slowdown. One key element in this has been the strong rate of growth in the Asian region. The pattern of Australia’s international trade has shifted significantly towards Asia, and especially China and India, in recent years. Asia now accounts for over 60 per cent of Australia’s exports (see Box A: ‘The Changing Country Composition of Australia’s Trade’ for more details). Accordingly, demand in this region is now a more important determinant of the impact of the global economy on Australia than had been the case in previous cycles.
The US economy is operating at close to full capacity following strong growth in previous years, but growth has moderated somewhat since the beginning of 2006. Real GDP expanded by a below-trend 0.4 per cent in the September quarter, while year-ended growth declined to 2.9 per cent (Graph 2). The recent slowing mainly reflected the downturn in residential investment, which fell by almost 8 per cent over the year to the September quarter.
Recent falls in new housing starts and permits suggest that further falls in residential investment are in prospect, and conditions in the existing housing market have also weakened (Graph 3). Home sales have fallen significantly since late 2005 and in September the stock of unsold existing and new houses was at just under seven months of current monthly sales, around the highest ratio since October 1992. This has put downward pressure on house price growth; in the June quarter, growth in the Office of Federal Housing Enterprise Oversight (OFHEO) repeat-sales house price index was the lowest in three years. Median house prices, which do not control for compositional change, fell slightly over the year to September. However, mortgage rates have fallen in recent months, retracing more than half of the rise in the first part of the year, which should provide some support to housing demand. There are tentative signs that new mortgage applications and home sales have stabilised since August, after falling over the preceding year.
The softening of conditions in the housing market has removed an important stimulus to consumer spending; easing house price growth has been associated with slower growth in households’ wealth and less housing equity withdrawal. Nonetheless, the recent fall in petrol prices, as well as a tight labour market, appear to be supporting solid growth in spending and reducing the impact of the housing downturn. Recent employment and wages data indicate the labour market has been firm; the payrolls measure of employment grew by 1.5 per cent over the year to October, and at 4.4 per cent in the month of October, the unemployment rate was at its lowest reading in five years.
Business conditions remain healthy, with growth in business investment picking up to around 2 per cent in the September quarter. Equipment investment grew solidly, following a weak June quarter outcome, and continued growth in core capital goods orders suggests this strength should be maintained. Conditions for business investment are favourable: capacity utilisation is high; the corporate profit share reached its highest level since the early 1960s in the September quarter; and long-term bond yields have fallen in recent months. Although business sentiment is well down from recent peaks on most measures, it is at levels that have traditionally been associated with a moderate expansion in activity.
Core inflation has picked up, and reached an annualised rate of 3.6 per cent over the three months to June. This gave rise to concerns that price increases for oil and other raw materials were feeding through into more generalised inflation, although these concerns have eased somewhat as core inflation moderated to an annualised 2.7 per cent over the three months to September. Headline inflation has been volatile, recently falling significantly, from 3.8 per cent over the year to August to 2.1 per cent in September, reflecting recent declines in oil prices and base effects from the impact of Hurricane Katrina on oil prices in 2005 (Graph 4).
The Japanese economic expansion has been sustained for several years now, with solid growth in demand across the business, household and external sectors. GDP increased by 2.5 per cent over the year to the June quarter and more timely indicators remain positive.
Business investment increased in the June quarter, lifting year-ended growth above 9 per cent, and recent data point to continued investment growth. Corporate balance sheets are much stronger than they were for many years, reflecting solid profits and historically low debt levels, and business borrowing has been increasing over the past year (Graph 5). Year-ended growth in industrial production has been running at rates around 5 per cent in recent months, and capacity utilisation remains high. In the September quarter Tankan survey, reported business conditions were at their highest level in almost 15 years, and investment intentions were again revised up.
Conditions also remain favourable in the household sector. Consumption increased by 1.8 per cent over the year to the June quarter, supported by continued strength in the labour market. The unemployment rate was around an eight-year low at 4.2 per cent in September and the job-offers-to-applicants ratio is around a 14-year high. Surveys show that both employers and employees report positive sentiment about future employment conditions.
Overall consumer prices continue to increase modestly in year-ended terms. Headline CPI inflation was 0.6 per cent over the year to September. Core inflation, as measured by the CPI excluding food and energy, was still negative following the updating of the CPI weights in August. Upstream price pressures remain, with year-ended growth in corporate goods prices picking up to 3.6 per cent in September.
The Chinese economy has continued to grow rapidly. Year-ended growth in real GDP was reported at 10.4 per cent in the September quarter, down a little from the exceptionally high rate of 11.3 per cent recorded in the previous quarter. Year-ended growth in fixed-asset investment and industrial production slowed in the September quarter, though both series still recorded rates similar to those seen over the past couple of years (Graph 6). The slight decline in year-ended rates of growth may indicate that measures taken by the government to cool the pace of investment growth are having some effect. Most recently, these measures have included increases in property-related taxes and banks’ required reserves. The People’s Bank of China also raised both deposit and lending rates by 27 basis points in August, although financial conditions still appear stimulatory. Despite some moderation, growth in the money supply and credit remains relatively high.
The external sector continues to support Chinese growth. Year-ended growth in exports was about 30 per cent in September, compared with around 20 per cent for imports. As a result, the trade surplus widened to a record US$45 billion in the September quarter, from US$26 billion a year earlier. In contrast, the pace of Chinese accumulation of foreign reserves has been moderating, suggesting that net capital inflows have slowed.
Input cost pressures have persisted, with rapid wage growth, especially for skilled workers; growth in urban incomes has been in the 12–15 per cent range for some time. Despite this, consumer price inflation remained modest at 1.5 per cent over the year to September. Rapid productivity growth appears to be helping to keep inflation under control. Chinese export prices appear to be growing only modestly, with prices of goods re-exported through Hong Kong increasing by around 1 per cent over the year to the June quarter.
Growth in the rest of east Asia has eased somewhat; real GDP growth in the region moderated over the first half of 2006, to be 5.4 per cent over the year to the June quarter (Graph 7). Investment growth has been subdued and growth in ITC-related exports has eased. Growth in world semiconductor sales has eased a little recently and the US semiconductor equipment book-to-bill (orders-to-sales) ratio fell in the September quarter. Domestic demand in the region is being supported by private consumption and strong growth in government expenditure, although Taiwan is an exception following the credit card problems earlier in the year. A pick-up in growth in non-ITC exports has been recorded across the region, and year-ended growth in total merchandise exports was around 17 per cent in August. Low unemployment rates are supportive of household demand and real interest rates are fairly low in most countries in the region despite earlier tightenings in monetary policy. Consensus forecasts for growth in Thailand and in the region have been little affected by recent political developments.
Growth remains strong in the Indian economy, driven by domestic demand. GDP increased by 8.9 per cent over the year to the June quarter. Although growth in industrial production has softened in recent months, it was still 10 per cent over the year to August, and business confidence remains high. India’s imports and exports have been expanding rapidly as the country continues to integrate with the rest of the world economy; this has been particularly evident in its trade with Australia (see Box A). Wholesale price inflation in India has picked up recently, driven largely by food prices, to be 5.4 per cent over the year to September.
In New Zealand, GDP growth slowed to 0.5 per cent in the June quarter, to be 1.4 per cent in year-ended terms (Graph 8). Nevertheless, the labour market remained tight in the September quarter, with the unemployment rate close to record lows and year-ended growth in labour costs high. Although consumer confidence picked up in the September quarter, it is still below its long-run average and growth in retail sales remained relatively soft in August, at 2.8 per cent in year-ended terms. Similarly, business confidence remains well below the long-run average, although it picked up in the most recent readings. Consumer prices increased by 0.7 per cent in the September quarter, to leave year-ended inflation at 3.5 per cent.
GDP growth in the euro area picked up in the first half of 2006, with the year-ended rate reaching 2.7 per cent in the June quarter (Graph 9). Much of the strength in the June quarter was driven by investment, and indicators of business conditions suggest that the outlook for investment remains positive. Industrial production continues to grow solidly, increasing by 5.1 per cent over the year to August and measures of business sentiment remain at high levels. The positive conditions in the business sector have fed through to improvements in the labour market. The unemployment rate declined from 8.5 per cent to 7.8 per cent over the year to September, and area-wide employment has been growing solidly. Strong external demand appears to have been a factor behind the positive business sentiment in the euro area, although year-ended growth in exports has softened recently.
Demand from the household sector has been slow to recover, despite the improvement in the labour market. Consumption growth eased to 0.3 per cent in the June quarter. This largely reflected weakness in Germany, where consumption fell by 0.4 per cent in the quarter, and slowing growth in Italy. In contrast, consumption remained robust in France and Spain, as strong house price growth over recent years has boosted household wealth. Indicators of consumption for the euro area as a whole remain positive; growth in retail sales remains solid, and consumer confidence has risen further above its long-run average.
Headline inflation has fallen noticeably in the euro area recently, to be 1.6 per cent over the year to October, reflecting the easing in world oil prices. Core inflation, which excludes the effects of energy prices, has remained contained at around 1½ per cent.
Growth in the United Kingdom picked up further in the September quarter, with GDP expanding by 2.8 per cent over the year. Consumption spending has recovered solidly, supported by rising house prices and above-average levels of consumer sentiment. Employment has been growing moderately, but this has been outstripped by a significant expansion in the labour force due to immigration and increased participation by female and older workers, so the unemployment rate has risen over the past year.