Statement on Monetary Policy – November 2009
Domestic Economic Conditions
Over the past year, the Australian economy has performed better than was widely expected. While activity contracted around the turn of the year – as it did in all advanced economies – a range of indicators, including private-sector surveys and information from the Bank’s liaison program, suggest that the economy has expanded at a moderate pace over the past six months or so (Graph 35, Table 6).
This relatively good performance in what has been a very difficult international environment reflects a number of factors. These include the significant easing of both monetary and fiscal policy, the healthy state of the Australian financial system and the depreciation of the currency in the second half of last year. The comparatively strong performance of some of Australia’s major trading partners in Asia has also been important, with Australia’s export volumes consequently remaining broadly unchanged during a period when global trade has fallen sharply.
Notwithstanding these favourable factors, the Australian economy has experienced a period of significantly below-trend growth and is operating a little below its full capacity. Assessments of the exact rate of growth over the past year, however, have been complicated by large differences in the various measures of GDP. While the ABS estimates that GDP expanded by 0.6 per cent over the year to the June quarter, the income and production measures suggest a significantly weaker outcome and the expenditure measure suggests a significantly stronger outcome (Graph 36). In addition, measures of domestic income, as opposed to output, have contracted significantly over recent quarters, reflecting the 17 per cent fall in the terms of trade. Recently, the terms of trade appear to have stabilised, so the wide divergence between growth of domestic income and GDP is likely to narrow in the period ahead.
While Australian households have taken a more cautious approach to their finances over the past year or so, household spending has been relatively resilient, and the housing market has shown renewed strength. The better-than-expected economic conditions – including in the labour market – have helped support consumer confidence, and household spending has also been supported by a rise in household wealth, with both housing and equity prices recording significant gains over recent months after earlier falls (for details on recent developments in confidence, see ‘Box C: The Recovery in Confidence’).
In the first half of the year, household spending grew reasonably solidly, with household finances boosted by the Federal Government’s payments to households and, for indebted households, a significant decline in mortgage rates. Over the year to June, real household disposable income increased by 5.4 per cent, despite declines in labour and property income, and over the six months to the September quarter household wealth is estimated to have risen by 12 per cent, largely reversing the decline over the previous year or so (Graph 37).
Some slowing in spending growth is now in train as the boost to household incomes from the earlier fiscal stimulus is not repeated, although the slowing appears so far to have been less marked than earlier thought likely. While the volume of retail sales contracted by around ½ per cent in the September quarter, the level of spending was still around 3 per cent above its pre-stimulus level (Graph 38). The Bank’s liaison with retailers in October indicated mixed trading conditions, while sales of motor vehicles to households fell slightly in the month, to be 8 per cent above their trough.
Many households have used the boost to disposable incomes over the past year to increase saving and pay down debt, strengthening their balance sheets. On a year-average basis, the household saving ratio was 3.6 per cent in 2008/09, up from 0.7 per cent in 2007/08. Households with mortgages have increased their repayments, partly by maintaining the level of their payments when interest rates declined. As a result, the pace of monthly growth in housing credit has been broadly unchanged over the past year despite a noticeable increase in new housing loan approvals (Graph 39).
Conditions in the housing market have firmed notably since earlier in the year, with prices in most parts of the country now above their earlier peaks (Graph 40, Table 7). In the year to September, nationwide dwelling prices are estimated to have increased by between 6 and 8 per cent, depending on the measure used. The increases have been broad-based across detached houses and apartments, and across capital cities, with particularly strong growth in Melbourne. Price growth has also recently been seen in both higher- and lower-priced suburbs, suggesting that low interest rates and broader economic forces have been boosting the housing market in addition to the effect from first-home buyer grants. The latter were reduced at end-September and will return to their original levels at end-December.
There are also indications of a pick-up in dwelling construction, after the earlier sharp declines. Commencements of houses increased in the June quarter and building approvals for detached houses are now around 30 per cent higher than their late-2008 trough, boosted by low interest rates, the temporary increase in grants paid to first-home buyers and strong population growth (Graph 41). Other indicators of construction activity – including loan approvals for new construction – have also picked up since the start of the year. Over coming quarters, activity will be boosted by the almost 20,000 new homes to be built under the Federal Government’s Social Housing Initiative.
In contrast to the pick-up in the construction of houses that is clearly underway, data on approvals for apartment buildings have, to date, remained weak. This is particularly apparent for high-rise apartments (buildings greater than three storeys) and for holiday-related developments outside the state capitals, consistent with liaison reports that developers continue to find it difficult to access finance for large-scale property developments.
Taking account of both houses and apartments, housing commencements in the first half of the year were running at an annual rate of around 125,000 dwellings, well below estimates of what is required if the average number of people living in each household is not to increase. While building approvals are picking up, it appears that the general underbuild in dwellings will continue over the year or so ahead, unless the recovery in housing construction turns out to be much stronger than currently thought likely.
Business confidence and conditions have continued to improve, and firms report that capacity utilisation has stabilised (Graph 42). Overall, business investment spending is now expected to fall only modestly from its recent peak, and to remain high as a share of GDP compared with investment in other countries and with past experiences in Australia. However, there are differences in the outlook at the sectoral level, with mining investment likely to be very strong and investment in commercial property likely to be weak.
More broadly, conditions in the business sector have improved since earlier in the year. Following the extreme risk aversion of late 2008 – which led to cut-backs in production and imports in anticipation of a sharp fall in domestic demand – survey measures of new orders and production have recovered. Survey measures of business conditions and confidence are currently at, or above, long-run average levels. This improvement in sentiment has been fairly broad-based, with conditions in the retail and wholesale sectors having been particularly strong, although conditions in the manufacturing sector have remained below average.
The strength in surveyed business conditions and the relative resilience in investment spending reflect a number of factors, including the improving outlook for the resources sector and the stimulatory settings of both monetary and fiscal policy. Profits of non-mining companies increased solidly in the first half of the year, although mining profits fell sharply as commodity prices pulled back from their record highs (Graph 43). The level of machinery & equipment investment in the June quarter was strong, especially motor vehicle sales that were boosted by the temporary tax deductions for new tangible depreciating assets (Graph 44). After rising sharply in June, motor vehicle sales to businesses have eased, but remain at a higher level than earlier in the year, supported by the 50 per cent tax deduction for small businesses that will continue until year-end, along with the broader recovery in business sentiment.
Engineering construction in the first half of 2009 was strong, especially in the mining sector. Furthermore, the medium-term outlook for this type of investment has improved significantly, with the joint-venture partners in the Gorgon liquefied natural gas (LNG) project committing to spend $43 billion over the next four to five years. More generally, the robust outlook for China and other trading partners in Asia suggests that demand for Australian bulk commodities will continue to underpin a high level of engineering construction in the period ahead (for further details, see ‘Box D: Investment in the Resources Sector’).
In contrast, private non-residential building activity has declined noticeably due to difficult financing conditions faced by developers and a modest rise in vacancy rates (Graph 45). Capital values are estimated to have fallen by 30 per cent in real terms since their late 2007 peak, although this is still a significantly smaller fall than the 60 per cent real decline seen in the early 1990s. While non-residential building approvals have increased sharply in recent months, this is entirely due to approvals associated with the Federal Government’s education infrastructure package (Graph 46).
Fiscal policy has provided a significant boost to output over the past year. While the $21 billion of cash payments to households provided the initial stimulus, spending is now being boosted by public investment, notably for school buildings and public housing. The peak effect on growth of these discretionary measures is estimated to have been in the June quarter 2009 – at almost 1 percentage point in that quarter. Thereafter, the estimated effect of fiscal policy is expected to fall back as these measures run their course; the stimulus measures in aggregate are expected to subtract from quarterly growth in 2010, although they would still be boosting the level of GDP.
Reflecting the improvement in the economic outlook, updated budget figures released in the Mid-Year Economic and Fiscal Outlook show that budget deficits over the next few years are expected to be smaller than projected at the time of the May Budget. While the underlying cash deficit in 2009/10 is expected to be broadly unchanged (at $57.7 billion and 4.7 per cent of GDP; Graph 47), thereafter the stronger outlook for the economy is projected to boost revenue. In line with the lower expected deficits, the projected profile for net debt now peaks at 10 per cent of GDP in 2013/14, compared with the peak of 13.8 per cent projected in the May Budget.
The Australian Bureau of Agricultural and Resource Economics (ABARE) is forecasting a wheat crop of around 22½ million tonnes in 2009, up modestly from last year’s crop, although conditions vary across the country (Graph 48). South Australia, Victoria and Western Australia have generally experienced average to above-average rainfall, while Queensland and New South Wales have experienced fairly dry conditions with consequent reduced yields and some crop failures. Total farm output is expected to increase in 2009/10, with modest growth in crop production and livestock partly offset by lower production of dairy products and wool. Inflows into the Murray Darling basin have risen significantly since June, but remain well below long-run averages. There are recent indications of the emergence of a weak El Niño weather pattern, which would impact negatively on future farm output.
After increasing by 3 per cent in the first half of the year, export volumes are estimated to have increased slightly in the September quarter. This pattern stands in contrast to developments in many other economies, where export volumes fell very sharply in late 2008/early 2009, but have since partially recovered. Australia’s relatively good performance reflects both the lesser reliance on exports of manufactured goods and the strong recovery in a number of Australia’s major trading partners in Asia.1
Resource export volumes appear to have increased in the quarter and values have largely stabilised as the impact of lower contract prices has largely worked its way through. As noted in previous Statements, China’s demand for resources has been an important factor explaining the overall resilience of Australia’s export volumes during the global recession. While China remains Australia’s largest destination for resource exports, demand from other countries has recovered noticeably in recent months (Graph 49). Exports of iron ore and coal to Japan are back near the levels prior to the start of the global recession in 2008, while iron ore export volumes to Korea have also grown. These outcomes are in line with a recent pick-up in steel production outside of China. More broadly, following the increase in Australian production over the year to date, exports of some key commodities appear to be again near capacity. As discussed in Box D, the large amount of investment in the mining sector is significantly increasing capacity, providing the opportunity for strong export growth now and in the years to come.
Rural and service exports have been broadly stable this year despite the global recession, while manufactured exports have fallen significantly, in line with developments in global manufactures trade (Graph 50).
Import volumes are estimated to have increased strongly in the September quarter, following a 2 per cent rise in the June quarter. This marks a substantial turnaround from the 15 per cent fall in import volumes in the six months to March. Recent growth in import volumes has partly reflected growth in domestic demand, some rebuilding of inventories, as well as the appreciation of the exchange rate. Travel service imports have been particularly strong, with short-term resident departures up 17 per cent since January (Graph 51).
The labour market has held up better than had been expected earlier in the year and there are indications that conditions are starting to improve. Aggregate employment has been broadly flat over the past year. While full-time employment has been weak, declining by 2½ per cent over the year to the September quarter, part-time employment has grown by nearly 6 per cent over the same period.
Much of the adjustment in the labour market during the current downturn has occurred through a reduction in average hours worked. Flexibility in the labour market has enabled firms and workers to reduce working hours in an effort to lower labour costs while retaining employees, a trend also observed in some other advanced economies. There are, however, signs that total hours worked has stabilised in recent months (Graph 52).
While the unemployment rate increased sharply in early 2009, it has been steady at around 5¾ per cent for the past five months, 1¾ percentage points above the low point reached in early 2008 (Graph 53). This recent stability of the unemployment rate in the face of flat employment but ongoing strong population growth in part reflects a fall in labour force participation. Nevertheless, the participation rate remains high by historical standards and compared with trends seen during previous downturns.
Forward-looking measures point to a gradual improvement in labour market conditions. The Bank’s liaison with firms indicates that hiring intentions have picked up after the decline in confidence around the start of the year. This is consistent with a range of other indicators, such as job advertisements and business surveys, which also point to a pick-up in labour demand (Graph 54).
- For further details, see discussion in the ‘Domestic Economic Conditions’ chapter in the May 2009 Statement on Monetary Policy, pp 37–39.