Statement on Monetary Policy – November 2009
The global economy is growing again after contracting sharply late last year and in the early part of 2009. There has been some recovery in world trade and most of the major economies now look to be expanding. The risk aversion that was so evident earlier in the year, particularly in financial markets, has abated and confidence is gradually returning.
Asia is at the forefront of the global recovery. The region’s financial systems have not experienced the same dislocation as elsewhere, and the economies are benefiting from a recovery in domestic demand, underpinned by stimulatory settings of both monetary and fiscal policy. Growth in China and India has been particularly strong.
Most of the advanced economies look to have grown in the September quarter, after the earlier sharp falls. The dynamics of the inventory cycle are working to boost growth, and there has been a modest recovery in private final demand in some countries. Notwithstanding this, there is still a long way to go before conditions could be described as normal and monetary policy is expected to remain very accommodative for some time yet. Many of the advanced economies are operating with a high level of excess capacity and face significant medium-term fiscal challenges. Measures of core inflation are low in most countries.
The general improvement in the economic data and the decline in risk aversion have seen most equity markets record strong gains over recent months. Recent earnings results, both in the United States and Australia, have on average exceeded analysts’ expectations. Credit conditions continue to normalise, with spreads on corporate paper as well as emerging-market government debt narrowing considerably. Corporate bond issuance has picked up and the issuance of government-guaranteed bank debt has declined markedly as it has become more cost-effective to issue unguaranteed paper. In some countries, debt guarantee schemes are being wound back and central bank programs designed to support market functioning have also been terminated as usage has declined. Housing markets have improved in a range of countries, with prices rising reasonably strongly in some markets. Commodity prices have also generally moved higher over the past six months.
These outcomes are better than those thought likely earlier in the year and forecasts for global growth have been revised up, with growth in Australia’s trading partners expected to be close to trend in 2010. The large downside risks that were evident six months ago have also diminished. Significant risks, nevertheless, remain. Activity has recently been boosted by temporary fiscal measures and a slowing in the pace of inventory run-down, with the durability of the pick-up in growth remaining uncertain. Banking systems in a number of countries are still some way from full health and further bad news in the financial sector cannot be ruled out. Dealing with fiscal challenges is also likely to be a constraint on growth over the medium term in some of the advanced economies. In contrast, prospects for the Asian economies are noticeably better and downside risks appear to be lower.
Economic conditions in Australia have also been stronger than expected. In contrast to other developed economies, the Australian economy is estimated to have expanded, albeit modestly, over the first half of the year and recent data suggest that this expansion has continued into the second half. Confidence has improved and spending has been supported by stimulatory settings for both monetary and fiscal policy. The Australian economy has also benefited from the strong bounce-back in Asia, particularly in China, with export volumes remaining broadly unchanged during a period in which global trade fell markedly.
Investment in Australia has also held up reasonably well, underpinned by a strong expansion of the resources sector and various fiscal measures. While the latter have brought forward the timing of some spending on plant and equipment, investment over the coming year is likely to be stronger than earlier expected. Investment in the resources sector is at historically high levels and is expected to increase further, particularly as the LNG sector expands. This expected rise in investment – which is already at a high level relative to GDP and compared with other developed economies – should further boost the supply side of the Australian economy, although as it takes place, short-term capacity constraints could again emerge in parts of the economy.
One area of continuing weakness in the business sector is commercial property, where financing constraints remain a significant issue. The effect of this weakness on overall construction activity is, however, being partly offset at the moment by increased building in the education sector as the result of fiscal measures. More broadly, there has been a substantial shift in the structure of business financing over the past year, with many large firms raising external equity to reduce their leverage in an environment of tighter lending standards. Reflecting this, business credit has fallen over the course of the year although, unlike in the early 1990s when business credit last fell, the level of investment remains high.
Growth in household spending has been slower over the second half of 2009 than it was over the first half, when disposable incomes were boosted by government transfer payments. Nevertheless, spending has held up reasonably well, supported by high levels of consumer confidence and rising household wealth from higher asset prices. Housing prices have strengthened considerably over the course of the year, with prices in most areas now above their previous peaks. Lending approvals have risen noticeably, although the same pick-up is not evident in housing credit growth as many borrowers have taken advantage of low mortgage rates to pay down their mortgage more quickly than in the past.
A recovery in housing construction is now clearly under way, with leading indicators of house building well above the levels of late 2008, although financing issues are constraining activity in the apartment market. There are, however, likely to be ongoing pressures in the housing market over the next few years, with the Australian population growing at its fastest rate since the 1960s. Addressing these pressures will require further steps to improve the supply side of the housing market.
Conditions in the labour market have generally not been as weak as earlier forecast, with the unemployment rate steady at around 5¾ per cent for the past five months. While there has been no growth in employment over the past year, the rise in unemployment has been contained by greater flexibility in the labour market – with many firms and workers agreeing to reduce working hours as the economy slowed – as well as a decline in the participation rate. The general softness in labour demand over the past year has led to a significant slowing of wage growth, particularly in the private sector, and some further slowing is expected over the period ahead, notwithstanding tentative signs that the demand for labour is picking up again.
In underlying terms, inflation continues to decline gradually, broadly in line with the Bank’s expectations. Over the year to the September quarter, the Bank’s assessment is that underlying inflation was around 3½ per cent, compared with a little more than 4½ per cent a year earlier. In contrast, the CPI increased by just 1.3 per cent over the year, held down by earlier declines in petrol prices and the ABS measure of the cost of deposit and loan facilities used by the household sector. The slowdown in wage growth and lower prices for imported goods resulting from the recent appreciation of the currency suggest that a further moderation in underlying inflation is likely over the period ahead.
Given the resilience of the economy, GDP is now expected to increase by a little more than 2 per cent over the year to mid 2010, a considerably better outcome than thought likely earlier in the year. The central forecast is then for the economy to expand by 3¼ per cent over the year to mid 2011, with growth gradually increasing over the remainder of the forecast period. Growth in business investment and exports is expected to be strong, underpinned by the ongoing expansion of the resources sector. The outlook for Australia’s terms of trade has also improved, with some increase now expected over the next year or so. The various fiscal stimulus measures are also likely to continue to support the level of GDP in 2010, although their maximum effect on growth is likely to have already passed. One additional factor shaping the outlook is the appreciation of the exchange rate, which has occurred against the backdrop of brighter prospects for the overall economy and the recent lift in commodity prices, but is affecting prospects for some trade-exposed sectors of the economy.
As noted, underlying inflation is expected to moderate further over the year ahead as the lagged effects of the economic slowdown and the appreciation work their way through. The central forecast is for underlying inflation to decline to around 2¼ per cent by late 2010, before gradually increasing to around 2½ per cent over 2011. Year-ended CPI inflation is likely to rise over coming quarters as temporary factors that have held it down fade, and is expected to be similar to underlying inflation in 2010.
Conditions in the global and Australian economies are significantly better than was expected when the Board lowered the cash rate to 3 per cent earlier in the year. The Australian economy is operating with less spare capacity than earlier thought likely, and the outlook for the next few years has improved. Given this assessment, the Board has judged it prudent to lessen the degree of monetary stimulus that was put in place when the outlook appeared much weaker, increasing the cash rate by 25 basis points at both its October and November meetings. The cash rate remains at a low level, and a further gradual lessening of monetary stimulus is likely to be required over time if the economy evolves broadly as expected. The Board will continue to monitor developments closely and set monetary policy so as to promote sustainable growth in the Australian economy and keep inflation consistent with the medium-term target.