Statement on Monetary Policy – November 2009
International Economic Developments
Conditions in the world economy have continued to improve over recent months, with global output now growing again following very large falls in late 2008 and early 2009. Growth is strongest in the Asian region, and activity in a number of Latin American economies also appears to be bouncing back solidly. Conditions in most of the major advanced economies have begun to pick up after the earlier sharp declines (Graph 1).
The current strengthening in global activity in part reflects the gradual unwinding of the marked pessimism that took hold in late 2008 as well as the progression of the inventory cycle. In many economies, inventories were run down sharply in late 2008 and the first half of 2009 in response to the dramatic decline in demand, increase in uncertainty, and disruption to credit markets around that time (Graph 2). The period of acute inventory adjustment now seems to be over and a slowing in the pace of de-stocking has probably lifted production levels in many countries in the September quarter.
While this adjustment should continue to boost global growth in coming quarters, in the advanced economies a further pick-up in underlying final demand is required for a sustained recovery to take hold. In this regard, stimulatory monetary and fiscal policy around the world is helping to boost growth. Domestic final demand has stabilised or begun to rise in most economies, and there are signs of solid growth in some parts of the world, particularly in Asia, where demand picked up strongly in the June quarter and appears to have risen again in the September quarter (Graph 3). The economies of Asia have not experienced the severe disruptions to their financial systems witnessed in some advanced North Atlantic countries and typically face fewer medium-term fiscal challenges.
Official interest rates remain very low in all the major advanced economies. Notwithstanding these accommodative settings, and the fact that core inflation has generally fallen only modestly to date in many of these countries (Graph 4), further declines in core inflation appear likely given the considerable excess capacity built up over the past 12 to 18 months. The IMF estimates that the major advanced economies are currently operating at around 5 per cent below their potential level of output, with little reduction in this degree of slack expected in 2010. In China and elsewhere in east Asia, further near-term declines in core inflation appear less likely in view of the strong rebounds in activity under way in these economies. In headline terms, year-ended consumer price inflation is currently negative or very subdued in the bulk of both advanced and developing economies, although this largely reflects the sharp falls in oil and other commodity prices in late 2008.
The recent recovery in activity has been most pronounced in the Chinese economy, where GDP rose by around 2¼ per cent in the September quarter, after growing by 4 per cent in the June quarter, to be around 9 per cent higher over the year (Graph 5). While a quarterly breakdown of growth by expenditure components is not available, monthly indicators suggest growth has become more broad-based in the September quarter (Graph 6). Nominal urban fixed-asset investment rose by 3 per cent in the quarter, following two quarters of exceptional strength, with investment in the residential construction sector particularly strong, consistent with the earlier sharp recovery in sales of residential property. Retail sales continued to grow robustly, partly boosted by fiscal incentives, while Chinese external trade has also begun to grow strongly again after falling sharply in late 2008 and the early part of 2009. Export volumes are estimated to have risen by around 10 per cent in the September quarter, and imports to have grown by around 7 per cent. A more detailed discussion of the recent recovery in trade in east Asia is provided in ‘Box A: The Recovery in Asian Trade’.
Strong growth in credit continues to be an important factor supporting the recovery in the Chinese economy, although credit growth has slowed from the extraordinary pace seen earlier in the year. While much of this earlier expansion in credit flowed to businesses, growth in lending to this sector moderated in the September quarter, but household borrowing has picked up. Overall, the amount by which credit has expanded in the first nine months of this year exceeds the corresponding increase in 2008 by around 5 trillion renminbi, or more than 15 per cent of annual nominal GDP, far outstripping the scale of fiscal expansion.
A solid recovery also appears to be under way in the Indian economy after what was only a relatively mild slowdown. Industrial production increased by 8 per cent over the three months to August, following little growth over the first half of the year (Graph 7). The services sector continues to grow solidly, and it now appears that agricultural output – which still constitutes one-sixth of the economy – may be somewhat less adversely affected by deficient monsoon rainfall in key growing areas than feared some months ago.
Elsewhere in Asia, conditions also continue to improve. Industrial production fell modestly in August across the region after earlier significant rises, but looks to have increased strongly again in September. GDP rose by nearly 3 per cent in Korea in the September quarter, in large part driven by a turnaround in inventories, which contributed more than 2½ percentage points to growth after subtracting 7½ percentage points over the preceding three quarters (Graph 8). Domestic final demand also increased solidly in the September quarter, after rising strongly in the June quarter, and exports continued to recover.
In the advanced economies, output growth also generally appears to have resumed, although greater uncertainty remains about both the pace and durability of recovery once the effects of fiscal stimulus and the likely near-term boost to activity from the inventory cycle fade. In the United States, GDP expanded by 0.9 per cent in the September quarter, the first increase since the June quarter 2008, but is still down by 3 per cent from its peak (Graph 9). A slowing in the pace of de-stocking accounted for ¼ percentage point of this growth. Household consumption rose by 0.8 per cent in the quarter, although more than one-third of this reflected the 20 per cent increase in auto sales associated with the Federal Government’s car scrappage program, which operated from late July to late August. Business investment fell again in the quarter, to be nearly 20 per cent lower over the year, and the ongoing contraction in credit to the private sector suggests that firms and consumers remain intent on reducing their debt levels.
While recent data have been mixed, a mild recovery in the US housing market, both in prices and activity, appears to be under way (Graph 10). Although the pick-up in housing starts remains very modest, dwelling investment increased solidly in the September quarter for the first time since late 2005. In addition, the recent small rise in house prices should, together with share price gains, have seen household wealth record a second solid increase in the September quarter, providing some support to household sentiment and consumption. Conditions in the labour market, however, remain very weak. Employment fell at an annualised rate of 3 per cent over the six months to September, with a larger decline in total hours worked, and the unemployment rate has risen to 9.8 per cent, the highest rate since 1983. While weekly initial jobless claims have fallen markedly from their peak in late March, they remain well above the level that has in the past been associated with a stabilisation in employment.
The advance estimate of UK GDP for the September quarter was weaker than expected and suggests that output contracted by a further 0.4 per cent, the sixth successive decline, to be down by nearly 6 per cent from its peak in March quarter 2008. In contrast, near-term growth prospects for the euro area and Japan appear to have improved somewhat. Both Germany and France recorded modest increases in activity in the June quarter, and seem likely to have grown again in the September quarter; industrial production (excluding construction) in the euro area was 1.7 per cent higher in July and August relative to the June quarter; and business and consumer sentiment continue to improve, although the volume of retail sales fell in the September quarter. The Japanese economy also appears to have recorded its second consecutive quarter of growth in the September quarter, driven by a continued revival in exports and a modest further pick-up in household consumption.
Notwithstanding these signs of improvement, there is considerable excess capacity in both Japan and the euro area that is likely to weigh on business investment for some time. In Japan, the unemployment rate reached a record high of 5.7 per cent in July, although it has since fallen back with employment increasing modestly in recent months. In the euro area, the unemployment rate has risen by around 2½ percentage points since its trough in March 2008, with a large part of this increase reflecting developments in Spain, where the unemployment rate has risen by around 10 percentage points to reach 19 per cent (Graph 11). Excluding Spain, the unemployment rate has increased by around 1¼ percentage points – a very different outcome from the United States, where the corresponding rise has been more than 5 percentage points even though the peak-to-trough GDP decline has been smaller. A substantial part of this difference is explained by government incentives in various European countries, including Germany and Italy, to encourage firms to retain workers on reduced hours rather than dismiss workers. Accordingly, the difference between the United States and euro area in terms of the decline in total hours worked during the current episode is much smaller.
In its latest forecasts, released in early October, the IMF again revised up its outlook for global growth in 2010. Following an expected contraction in output in 2009 of just over 1 per cent in year-average terms – which would be by far the worst annual outcome for at least the past 50 years – the IMF now forecasts world output to expand by a little more than 3 per cent in 2010 (Table 1). This is around 1¼ percentage points stronger than the IMF expected six months earlier, but would still represent relatively weak global growth by pre-crisis standards. The IMF then expects slightly above-trend world growth of a little more than 4 per cent in 2011. These forecasts are a little weaker than those of the RBA staff for 2009 and 2010, which are outlined in the ‘Economic Outlook’ chapter.
Notwithstanding the recovery now under way, the outlook for global growth in 2010 remains subject to considerable uncertainty. On the one hand, recoveries from previous recessions in the major advanced economies have often been quite strong. On the other hand, in many countries balance-sheet and financial-sector problems may constrain the pace of the rebound in activity in this episode more than in earlier ones. Abstracting from these considerations, one key influence on the sustainability and speed of medium-term recovery in many countries is likely to be the pace of fiscal consolidation. Among the major advanced economies, the IMF projects budget deficits to have increased by around 5½ percentage points of GDP in 2009 relative to 2008, to 10 per cent of GDP, and to remain elevated at around 9 per cent of GDP in 2010 (Graph 12). As a result, net debt levels in these countries are forecast to rise by around 20 percentage points of GDP between late 2008 and late 2010, to reach almost 80 per cent of GDP, with further significant increases in prospect in subsequent years. In some countries, concerns about fiscal sustainability may require governments to take additional steps to put their public finances on a sounder footing.
Commodity prices have risen substantially from their levels earlier in the year, but have been broadly flat over the past few months. Prices of exchange-traded commodities have mostly been steady or somewhat stronger since the August Statement. Spot prices for the bulk resource commodities have tended to soften somewhat, but expectations for upcoming contract negotiations have generally been revised upwards. Australia’s terms of trade are estimated to have fallen somewhat in the September quarter, after large falls in the first half of the year.
Prices for iron ore on the spot market fell significantly in August but have recovered somewhat recently, to be around 18 per cent below the levels of mid August. This has occurred in the context of falls in Chinese spot market prices for steel (Graph 13). These price falls have reportedly reflected a run-up in steel inventories to relatively high levels, and production restarts by previously-idled Chinese iron ore mines. However, Chinese inventories of iron ore appear to have grown at a more modest pace and have not increased relative to steel production (Graph 14).
Despite the fall in spot prices, expectations of contract prices for Australian exports of bulk commodities have risen (Graph 15). Private-sector forecasters expect that Australian producers will negotiate higher contract prices in 2010/11 with major steel mills across Asia. Market analysts are forecasting around a 10 per cent rise in iron ore and thermal coal contract prices and a 20 per cent increase for coking coal, although it is possible that there will be a gradual shift away from the system of annual contracts. Negotiations for 2009/10 iron ore contracts between Australian producers and major Chinese steel mills remain unresolved, although ‘provisional’ contracts are reportedly in place, with prices in line with those settled with Japanese and Korean mills.
Base metals prices are broadly unchanged from early August, having fluctuated on news regarding the pace of growth in demand and inventory-building in China (Graph 16). Although inventories of both crude oil and refined products are currently at relatively high levels, crude oil prices have recently risen to around US$80 per barrel, boosted by an improved outlook for global demand and a weaker US dollar. Rural commodity prices have been more mixed; wheat prices have fallen due to favourable Northern Hemisphere harvests and a modest improvement in the outlook for the Australian crop, while sugar prices have risen, due to current and expected supply difficulties in Brazil and India.