Statement on Monetary Policy – November 2008
Domestic Economic Conditions
After an extended period of strong growth, the pace of economic activity has now slowed noticeably. GDP increased by 0.3 per cent in the June quarter, to be 2.7 per cent higher over the year, a marked step down from the strong rates seen during 2007 (Graph 37, Table 7). More timely indicators suggest that activity has remained soft, a trend broadly confirmed in the Bank’s business liaison program.
The easing so far has been most evident in the household sector (Graph 38). Retail sales have been weak since early in the year, consumer sentiment has been falling, the pace of household borrowing has slowed, and conditions in the housing market have softened. In contrast, increases in commodity prices in recent years have provided a significant boost to business profits and investment. Nonetheless, as in the household sector, survey measures of confidence in the business sector have been softening and the pace of business borrowing has slowed significantly.
Looking ahead, weaker global growth and the recent sharp falls in financial and commodity markets are likely to lead to a further slowing in activity, including a scaling-back of investment plans in the mining, construction and other sectors. Business surveys as well as information from the Bank’s liaison suggest that difficulty accessing finance is also a growing constraint on firms’ investment plans. However, working in the opposite direction, the recent large depreciation of the exchange rate and the easing of monetary policy will support economic activity, with the Government’s fiscal measures – amounting to a little less than 1 per cent of GDP in 2008/09 – boosting consumption and home-building in particular.
Household spending slowed significantly in the first half of 2008. Consumption fell by 0.1 per cent in the June quarter, the first quarterly decline since 1993. This weakness was consistent with ongoing tightness in financial conditions, high petrol prices and subdued consumer confidence. More timely data as well as the Bank’s liaison suggest that consumption remained weak in the September quarter and into the month of October. Real retail sales appear to have increased by only around ½ per cent in the quarter, and motor vehicle sales declined by 8 per cent in the three months to October. While measures of consumer sentiment have been volatile, they remain around the low levels last seen in the early 1990s (Graph 39). However, the Government’s stimulus package – the bulk of which represents one-off payments to pensioners, carers and low-to-middle income families – is expected to support household consumption in the December and March quarters.
The weakness seen in household spending is in line with the slowing growth in real household disposable income and a decline in household net worth. Growth in real household disposable income, after subtracting interest payments, was 2.5 per cent over the year to the June quarter, which is the slowest pace since early 2003. Interest payments peaked at 14½ per cent of disposable income in the June quarter, although the recent cuts in interest rates and slower growth in household debt could see this ratio fall back to around 13 per cent by end 2008. Total household net wealth is estimated to have fallen by around 8 per cent from its level at the end of 2007. This mostly reflects a large decline in the value of equity wealth (Graph 40).
In response to the tight financial conditions and falls in equity prices, growth in household borrowing has slowed. The pace of household credit growth declined to an annualised rate of 6 per cent over the six months to September from an average of around 15 per cent over the past decade (Graph 41). This reflected weaker growth in housing credit and a contraction in personal credit, especially for margin lending. New lending for housing has slowed markedly, although the pace of decline has stabilised in recent months. Housing loan approvals in August were 26 per cent below their mid-2007 peak; as a ratio to the total value of the dwelling stock, new housing loans have fallen to their lowest level since the mid 1990s.
As a result of tighter financial conditions, residential property markets across the country have also weakened over 2008. According to the ABS measure, house prices fell by 1.8 per cent in the September quarter, with growth over the year slowing to 2.8 per cent (Table 8, Graph 42). Other house price measures, which use different techniques to control for changes in the composition of property transactions, display similar falls. Residential auction clearance rates, which are timely indicators of housing market conditions, have remained well below average levels in Sydney and Melbourne through October.
Housing construction activity has been subdued. Total dwelling investment increased modestly in the June quarter, reflecting a rise in the construction of new dwellings that more than offset a contraction in renovation activity. Forward-looking indicators and the Bank’s liaison point to ongoing softness in construction, particularly in New South Wales and Queensland. The number of private building approvals fell by 8.5 per cent in the September quarter, driven by falls in both houses and the medium-density sector (Graph 43). The Bank’s liaison suggests that housing construction is being constrained by reduced access to finance and subdued consumer confidence, although the recent falls in interest rates and the fiscal stimulus package – which includes an increase in the First Home Owner Grant for purchases of existing and new dwellings – are expected to boost conditions in this sector in the coming year.
Conditions in the business sector have eased, although this is more evident in information from business surveys and the Bank’s liaison program than in the less timely macroeconomic data available. The most recent data for aggregate profits are for the June quarter and showed an increase of 13 per cent over the year – reflecting the surge in global resource prices – taking the profit share to 32 per cent of GDP, its highest level since the 1970s. However, surveys suggest overall business conditions have softened to be below average levels (Graph 44). Survey measures of business confidence have fallen to levels that are well below long-run averages; mining sector confidence and conditions had been significantly stronger than in other sectors, but they too fell in the September quarter as global commodity prices declined. The NAB survey’s capacity utilisation measure also eased in the quarter.
Buoyed by strength in the mining sector, business investment has recently been at a very high level as a share of GDP (Graph 45). However, forward-looking indicators of investment have been mixed. The latest capital expenditure (Capex) survey, conducted in July and August, pointed to strong growth in 2008/09, in the mining sector and a range of other sectors. In contrast, private-sector surveys suggest the pace of investment growth could weaken materially, with the net balance of firms planning to increase investment over the coming period at below the long-run average in most surveys (Graph 46). The Bank’s liaison suggests that many commercial building projects in the early stages of planning have been put on hold and, consistent with this, the value of non-residential building approvals has weakened over recent months. The Bank’s liaison suggests that some mining investments at the early stage of development may also be postponed.
Growth in businesses’ external funding has slowed sharply over the past six months – in response to the higher cost of debt, tighter lending standards and restricted access to funding markets – which will weigh on investment activity. Business debt funding grew by 8 per cent in six-month annualised terms over the year to September, down from average annual growth of 13 per cent over the prior five years. Firms have indicated in business surveys and the Bank’s liaison that they are having more difficulty obtaining finance and that this is having an impact on their investment plans (Graph 47). Nonetheless, at the aggregate level, balance sheets in the non-financial corporate sector remain in good shape; corporate gearing is around the average of the past 15 years, and aggregate net interest payments as a share of profits remain at low levels (see also the ‘Domestic Financial Markets’ chapter).
Australian Government Budget
The Australian Government released updated economic forecasts and budget estimates in the Mid-Year Economic and Fiscal Outlook. The expected underlying cash surplus for 2008/09 was revised down compared with the May Budget, to $5.4 billion, or 0.4 per cent of GDP (Graph 48). The downward revisions mainly reflected lower expected taxation revenue and the fiscal stimulus package. In subsequent years, the Budget surplus has also been revised down compared with the May Budget, largely reflecting a weaker outlook for the global and domestic economies.
Conditions in the rural sector have deteriorated slightly over the past few months, as a number of regions – particularly in South Australia and Victoria – experienced below-average rainfall in recent months. As a result, a number of rural agencies have revised down production forecasts for wheat and other winter crops. Flows into the Murray-Darling river system have been low, suggesting that water availability for irrigation is likely to remain modest (Graph 49). Based on information from the Australian Bureau of Agricultural and Resource Economics (ABARE) and other rural agencies, farm output is expected to rise by 14 per cent in 2008/09, mainly reflecting an increase in wheat and other cereals crops (Graph 50).
The large increases in this year’s bulk commodity contract prices have provided a significant boost to export revenue. As a consequence, the trade balance has moved from a deficit of 2½ per cent of GDP in early 2008 to an estimated surplus of ½ per cent of GDP in the September quarter, and the current account deficit has narrowed (Graph 51).
This turnaround in Australia’s trade accounts can mainly be traced to a more than 50 per cent rise in the value of mining exports over the year to the September quarter (Graph 52). While this primarily reflects the recent large increase in the 2008/09 contract prices for iron ore and coal exports, resource volumes are estimated to have also increased in the September quarter. Looking forward, ABARE forecasts the volume of iron ore exports to rise by 15 per cent in 2009 as a number of projects begin production. LNG exports are expected to be boosted by the completion of a number of gas fields in late 2008 and early 2009, with the largest being the Angel gas field that will supply the recently completed North West Shelf Project’s fifth compression train.
Import volumes are estimated to have increased by around 2 per cent in the September quarter, to be roughly 12 per cent higher over the year. The moderation in the quarter is broadly consistent with the slowdown in the pace of domestic demand growth, with solid growth in capital imports partly offset by a decline in consumption imports.
The sharp decline in the value of the Australian dollar has been reflected in a 21 per cent fall in the real trade-weighted index since its peak in June 2008. The index is now around its post-float average after a protracted period above that level. The large depreciation of the exchange rate will provide a stimulus to export volumes over the period ahead, particularly for manufactured and service exports, providing some offset to the effect from the slowing growth in Australia’s trading partners (see ‘Box C: The Exchange Rate and the Economy’). It is also expected to boost demand in the import-competing sector. While the terms of trade increased by almost 20 per cent over the year to the September quarter, they are expected to fall back over 2009 in response to falling global commodity prices (for further details, see the ‘Economic Outlook’ chapter).
Labour market conditions have eased in recent months. Employment grew by 0.4 per cent in the three months to October, down from a quarterly pace of around 0.7 per cent through 2007. After falling significantly over 2006 and 2007, the unemployment rate has remained broadly constant for much of this year, at around 4¼ per cent (Graph 53).
Recent employment growth has been weakest in New South Wales and Victoria, while the unemployment rate in the former has been trending upwards since early this year (Graph 54). In contrast, the resource‑rich states of Western Australia and Queensland continue to record firm employment growth and the lowest unemployment rates among the mainland states.
Forward‑looking indicators of labour demand have also eased, suggesting the market will soften further in the period ahead. Job vacancies, as reported by the ANZ Bank, have declined significantly since the start of the year, with both the number of newspaper and internet advertisements falling. Reports of softer hiring intentions are becoming more widespread in the Bank’s liaison, and business surveys indicate that firms’ hiring intentions have eased to a little below long‑run averages (Graph 55).