Statement on Monetary Policy – February 2010 Economic Outlook

The international economy

The outlook for the world economy has improved since the November Statement, although some of the risks to global growth (in both directions) have come more clearly into focus over recent months. Overall, global output is now expected to grow by around 4 per cent in year-average terms in both 2010 and 2011. These forecasts are a little stronger for both years than expected three months ago and, if achieved, would be around the average rate of global growth over the past decade or so. However, by historical standards this would still represent a relatively modest recovery given the scale of the downturn in activity in 2008 and 2009 and the significant degree of spare capacity in many economies. Growth is projected to be around trend over the forecast period both in China and most other emerging economies, and in the advanced economies (Graph 86). The risks to these forecasts are discussed below.

Australia's terms of trade are forecast to increase over the coming year, reflecting higher prices for Australia's commodity exports and subdued growth in the prices of manufactured imports (Graph 87). Consistent with the improved outlook for the world economy, spot prices for a range of commodities have risen further over recent months. Contract prices for coal and iron ore are expected to increase strongly, supported by the increase in demand from China, as well as the ongoing recovery in demand from more traditional trading partners including Japan and Korea.

Domestic activity

As discussed in earlier chapters, conditions in the domestic economy have been somewhat stronger than was expected in mid 2009. The economy has benefited from the rebound in growth in Asia, the significant stimulus delivered by fiscal and monetary policies and strong population growth. Despite the fading of the effects of the fiscal payments to households, consumption has continued to grow, supported by growth in household wealth and the resilience of the labour market. Business conditions and capacity utilisation have both risen over recent months, while business investment has only fallen modestly and is expected to strengthen over the forecast period, driven by developments in the resources sector.

The central forecasts are summarised in Table 12. In year-ended terms, growth is forecast to be 3¼–3½ per cent from late 2010 out to the end of the forecast period in mid 2012. In year-average terms, GDP is forecast to grow by 2 per cent in 2009/10 and 3½ per cent in 2010/11 and 2011/12. The forecasts are based on the technical assumption of a rise in the cash rate over the forecast period, with the assumed path broadly consistent with market expectations as the Statement was finalised. As noted in the August Statement, this technical assumption for the cash rate should in no way be viewed as a commitment by the Board to any particular path for policy. The exchange rate is assumed to remain constant over the forecast period after having appreciated strongly over the second half of 2009, reflecting the improved outlook for the domestic economy and the resources sector.

The solid growth in the economy through most of the forecast period is expected to absorb some of the spare capacity generated during the period of below-average growth in 2008 and 2009. Public demand is expected to make a significant contribution to growth in the early part of the forecast period, reflecting spending on education, health, public housing, communications and transport infrastructure. However, the maximum effect of the full package of fiscal stimulus measures (including the payments to households) on the growth rate of output is estimated to have already passed, although the level of output is still being boosted.

As the stimulus fades, private demand will become a more important driver of growth, reflecting solid household spending and strong business investment. Dwelling investment is also expected to grow strongly through 2010, reflecting the pick-up in demand for housing, particularly from first-home buyers. Mining investment is expected to increase further from its already very high level, reflecting the strong recovery in commodity prices, improved investor sentiment, the recent commencement of the Gorgon LNG project and a pipeline of other significant projects. Resource exports are expected to grow strongly, reflecting capacity increases resulting from the high level of mining investment over recent years. However, growth outside of the mining sector is expected to be only modest, reflecting the reallocation of productive resources within the economy. This is partly due to the high level of the real exchange rate, which has reduced the international competitiveness of import-competing and exporting sectors, including the manufacturing and tourism sectors.

As noted in the ‘Domestic Economic Conditions’ chapter, recent labour market outcomes have been stronger than had been expected three to six months ago. The unemployment rate is now forecast to decline modestly over the period to mid 2012. In the near term, it is likely that growth in labour demand will be reflected in hours worked recovering at a faster pace than the number of employees, given that much of the downturn in the labour market occurred through reduced working hours rather than redundancies.


Underlying inflation has slowed noticeably in year-ended terms from its peak in September 2008, to around 3¼ per cent over 2009. The quarterly outcome for underlying inflation in the December quarter was a step-down from the rates recorded earlier in the year and was well below the peak rates seen in 2008.

This decline in quarterly inflation rates reflects the significant easing in wage growth and capacity pressures over 2009, as well as the substantial appreciation of the exchange rate. Given the lags, these factors are expected to contain inflation for some time. Year-ended underlying inflation is expected to be around or below 3 per cent in the March quarter and to fall to around or slightly below 2½ per cent in late 2010 and early 2011. Underlying inflation will probably then pick up a little towards the end of the forecast period, reflecting both a pick-up in wage growth from low levels as the labour market tightens and higher levels of capacity utilisation in the economy. The dampening influence on inflation of the appreciation is also likely to wane through the forecast period. Overall, the central forecast is a small upward revision relative to the expectation in November, reflecting the recent strengthening in the labour market and hence the outlook for wage growth, and also the stronger outlook for demand in the economy.

In contrast to underlying inflation, year-ended CPI inflation has been around or below 2 per cent for the past three quarters, largely due to sharp declines in the volatile automotive fuel and deposit & loan facilities prices in 2008/09. By late 2010 it is expected to be moving broadly in line with the forecast for underlying inflation. Within the CPI, there are a few items that are expected to contribute significantly to inflation. Rent inflation is expected to be firm, and large increases in some utilities prices are scheduled. In addition, based on historical behaviour of the deposit & loans category, the recent and assumed increases in the cash rate could be expected to add temporarily to the measured CPI increase.


As always, there are uncertainties around the forecasts. One issue is whether the stronger-than-expected performance of the economy over the past few quarters is largely accounted for by a bring-forward of spending. If so, underlying growth would be soft into 2010 as the effects of the temporary fiscal stimulus fade. On the other hand, the peak effect of the cash payments component of the fiscal stimulus passed some time ago, and household consumption is likely now being supported by the firmer labour market and increases in household net worth. Moreover, the improvement in the outlook in the resources sector is clearly not due to temporary policy factors.

Overall, risks around the central forecasts appear to be fairly balanced. Perhaps the most likely scenario in which growth and inflation are both significantly higher than expected is one in which confidence continues to build on the back of a further pick-up in commodity prices and there is a larger increase in investment in the resources sector than currently expected. In this scenario, non-residential construction might also pick up more quickly than is currently expected as credit constraints ease. If this were to occur, capacity constraints, particularly in the construction sector, would be likely to emerge and wage growth would be likely to accelerate more quickly than currently expected. The result would be higher inflation.

The most likely scenario in which growth turns out to be much weaker than the central forecast involves a significantly slower recovery in the world economy than currently expected. The dynamics of the inventory cycle are generating much of the initial recovery in the advanced economies, as expected, but private demand will have to pick up for sustained growth. Moreover, many of these economies face significant fiscal challenges: early steps to rein in budget deficits could limit growth in the short term at a time when there is already significant excess capacity, while the failure to take credible steps in this direction could also limit growth by undermining confidence and forcing up borrowing costs. There is also a risk that uncertainty about the future shape of the financial system could further reduce banks' willingness to lend and that this could restrain growth.