Statement on Monetary Policy – February 2010
Domestic Economic Conditions
The Australian economy has continued to perform better than had been expected, supported by stimulatory settings of monetary and fiscal policy, high population growth, strong trade links with Asia, and a sound financial system. Compared with the experience elsewhere around the world, the downturn in the Australian economy was relatively mild, with Australia one of only a few economies that did not record negative year-ended growth.
Estimates of GDP growth over the past year or so are subject to some uncertainty, given difficulties with the implementation of new statistical standards and the significant differences that remain between the various measures of GDP. Nevertheless, the September quarter national accounts suggest that GDP grew by around 1½ per cent over the first three quarters of 2009, after contracting in the December quarter 2008 (Graph 35, Table 6). Furthermore, a range of indicators, including employment, retail sales and various business surveys, suggest that the economy expanded at a solid pace in late 2009.
Household spending was quite resilient through the second half of 2009, contrary to earlier expectations that it would weaken as the support to spending from the Government’s cash handouts faded. A solid recovery in household wealth and much better than expected labour market conditions have been associated with a significant rise in consumer confidence (Graph 36). Household net worth is estimated to have risen by around 10 per cent over the second half of 2009, reflecting strong growth in both equity and dwelling prices, to be back around its peak in late 2007 (Graph 37).
The volume of retail sales increased by around 1 per cent in the December quarter to be 3½ per cent higher over the year (Graph 38). Spending on cafes and restaurants grew particularly strongly after having fallen sharply through 2008. In contrast, spending elsewhere in the retail sector has been softer, rising by 0.7 per cent in volume terms in the quarter, with a fall in the month of December. Sales of motor vehicles to households rose by 7 per cent in the quarter. Consumer sentiment increased in January, partly reversing the modest decline seen in the previous two months, to be again around an historically high level. The improvement in labour market conditions was reflected in the January surveys, with expectations of future unemployment falling sharply.
Real household disposable income (after interest payments) increased by 7 per cent over the year to the September quarter. Reduced interest payments by households made a significant contribution to growth over this period, with lower interest payments accounting for around 4 percentage points of the growth in disposable income. Many households took the opportunity to increase their saving and pay down debt: on average, households saved around 5½ per cent of their income over the year to the September quarter, compared with zero per cent in the prior year, and dissaving in the period from mid 2002 to mid 2005 (Graph 39). More recently, household disposable incomes are likely to have been supported by the improvements in the labour market.
Conditions in the housing sector have picked up quite strongly over the past year. A recovery in dwelling construction activity is now well under way and house prices have risen strongly, reflecting the temporary increase in first-home buyer grants, rapid population growth and below-average interest rates. Dwelling investment rose solidly in the September quarter, and should continue to increase in coming quarters. The increase in dwelling investment has been concentrated in detached houses, while forward indicators of apartment construction, including local government building approvals, have remained relatively weak (Graph 40). This is consistent with liaison reports that developers have found it difficult to access finance for large-scale property developments. In total, building approvals are estimated to have increased by around 40 per cent over 2009; it is possible there will be some upward revision to this estimate, consistent with the general pattern over the past few years, as loan approvals for new homes have increased considerably more than building approvals (Graph 41).
Over coming quarters, there will be an additional boost to dwelling investment from the almost 20,000 new homes to be built under the Federal Government’s Social Housing Initiative, as well as from the temporary increase in grants paid under the Energy Efficient Homes Package for ceiling insulation and solar hot water systems.
Conditions have been quite buoyant in the established housing market, with capital city housing prices increasing by around 3–4 per cent in the December quarter and by around 10–12 per cent over the year (Table 7, Graph 42). There are some signs that the pace of growth eased through the quarter, particularly at the lower end of the market, although some seasonal weakness in the month of December clouds the interpretation of the data a little. Nationwide housing prices were around 8 per cent above the early-2008 peak. Sydney and Melbourne have experienced particularly sharp increases, although housing prices have also risen in the other capital cities. While growth was broad-based within cities earlier in 2009, growth in the second half of the year was strongest in the more expensive suburbs. In the lower-priced suburbs, dwelling prices levelled out in the December quarter, consistent with an easing in demand from first-home buyers. Housing prices in many regional areas also appear to have risen significantly after falling through 2008.
Conditions in the business sector have strengthened over the past few quarters. The AIG and NAB business surveys generally report that trading conditions are firm, and capacity utilisation has risen noticeably to be back above longer-run average levels (see ‘Box D: Recent Developments in Capacity Utilisation’). Although business investment fell by around 6 per cent over the year to the September quarter, this was a significantly smaller fall than experienced in most other countries and smaller than had been feared early in 2009. Survey measures of investment intentions have recovered somewhat from the very low levels recorded a year ago, but near-term investment intentions remain relatively soft. This suggests that for the moment many businesses remain cautious in their spending plans, despite a fairly optimistic general view about the future.
Over recent quarters, engineering construction activity has been sustained at an historically high level, supported by mining-related investment. Mining investment stood at 4¼ per cent of GDP in 2008/09, compared with a peak of around 3 per cent in the early 1980s mining boom and 2¾ per cent in the boom in the late 1960s and early 1970s (Graph 43), with large projects in the oil & gas, coal and iron ore sectors (Graph 44). The outlook for mining investment remains positive, with construction work on the Gorgon liquefied natural gas (LNG) project having started in the December quarter and a number of other significant projects currently in the early stages of development. More generally, the robust outlook for growth in China and other trading partners in Asia suggests that strong demand for Australian bulk commodities will continue to underpin a high level of engineering construction activity in the period ahead.
In contrast, private non-residential building activity has declined noticeably over the past year, in part due to difficult financing conditions faced by developers and an increase in vacancy rates in the office sector (Graph 45). The national CBD office vacancy rate has risen from a trough of 3.7 per cent in early 2008 to nearly 8 per cent in the December quarter, which is a little above the decade average. Capital values have also fallen significantly from their peak in late 2007, although there are signs of some improvement in conditions in the second half of 2009 with estimates suggesting capital values have stabilised.
While non-residential approvals increased sharply in the second half of 2009, this was due to approvals associated with the Australian Government’s education infrastructure package (Graph 46). Construction of educational facilities by both the private and public sectors increased by nearly 60 per cent in the September quarter as work on the $16 billion education infrastructure program started. Public-sector spending on engineering construction also increased strongly in the September quarter, mainly in the areas of transport infrastructure and utilities (Graph 47). In terms of the broader economy, the maximum effect of the overall fiscal stimulus package on the level of GDP is estimated to occur in early 2010, although the maximum effect on growth is estimated to have been in the June quarter 2009.
While machinery and equipment investment fell significantly around late 2008 and early 2009 – in line with the global slump in demand for manufactures – it appears to have risen sharply towards the end of 2009, partly reflecting a boost from the temporary tax deductions for new tangible assets. In particular, motor vehicle sales to businesses increased by around 20 per cent in the December quarter, following a similar tax-incentive-related surge in the June quarter, although they have since eased (Graph 48).
Despite the improvement in business conditions, business credit fell over the second half of 2009 as many businesses sought to reduce leverage, partly by raising equity. While lending conditions remain tight, particularly in the commercial property sector, there is some evidence from liaison and business surveys suggesting that conditions for some borrowers have begun to ease. Firms have also been able to use internally generated funds to support investment and pay down debt, with business surveys suggesting that firms expect profit growth to continue, following a decline in profits in the first half of 2009 (Graph 49).
The 2009 winter crop is estimated to have been slightly below the average non-drought harvest over the past decade and a little lower than earlier expectations, due to adverse weather conditions toward the end of the cropping season (Graph 50). For 2009/10 as a whole, farm output is expected to be broadly unchanged as a small rise in crop production is expected to be offset by lower expected production of livestock and related products, such as wool and dairy. Heavy rain across parts of the eastern states toward the end of December and in early February has helped to alleviate earlier concerns about the impact of the El Niño weather system, and boosted inflows to the northern part of the Murray-Darling basin, which have subsequently progressed down the river system. The NSW Government has recently started to release flows downstream of the Menindee Lakes, which are gradually reaching the Murray River.
Export volumes are estimated to have risen solidly in the December quarter after falling by 2 per cent in the September quarter, to be up modestly over the year (Graph 51). This is a considerably stronger outcome than for almost all other major economies, where exports suffered large falls in late 2008 and early 2009.
In recent months, resource export volumes appear to have levelled out after a period of strong growth to mid 2009, particularly in the case of bulk commodities (Graph 52). This primarily reflects supply-side constraints, with port and rail facilities generally operating near capacity and maintenance occurring at LNG plants on the North West Shelf. Demand conditions for resource commodities remain strong, with Chinese imports of bulk commodities around record highs, and demand from other traditional trading partners continuing to improve. Demand for many resource commodities has recently been boosted by cold weather in many parts of the northern hemisphere, which has disrupted production there and boosted demand for energy commodities. Looking ahead, significant expansions over the next few years in production capacity and transport infrastructure for resource commodities are expected to result in substantial growth in Australia’s resource export volumes.
Manufactured exports have grown somewhat over recent quarters, largely due to higher motor vehicle exports, which look to have risen by nearly 50 per cent over the past six months, but remain well below their previous peak. While manufactured exports are likely to be boosted by the global recovery, the appreciation of the Australian dollar will work in the opposite direction. The appreciation of the currency is also likely to weigh on service exports.
Import volumes have continued to rise, increasing by more than 10 per cent over the second half of the year (Graph 53). Imports have now reversed most of the nearly 15 per cent fall that occurred between mid 2008 and early 2009. This has reflected stronger domestic spending and some inventory restocking, as well as substitution toward imported goods as a result of the appreciation of the exchange rate. Imports of transport equipment have shown particular strength due to a rise in motor vehicle sales and dealer restocking, while imports of major capital items such as aircraft and large engineering components have also been strong. Service imports have also risen, particularly travel services, in line with strong growth in short-term resident departures.
The terms of trade are estimated to have risen moderately in the December quarter. Although they are around 15 per cent lower than the peak in the September quarter 2008, this is a smaller fall than was expected a year ago, and the terms of trade are currently around 60 per cent higher than the average for the 1984–2000 period. With significant price increases expected for coal and iron ore this year, the terms of trade are likely to strengthen further. These trends in commodity markets, together with a recovery in global investor sentiment, have contributed to a considerable appreciation since early 2009 of the exchange rate, which in real terms is now around its highest level in the post-float period (Graph 54).
Conditions in the labour market have improved noticeably in recent months, and the labour market continues to perform better than had been expected. The number of people employed increased strongly in the December quarter, rising by 0.7 per cent after being largely unchanged over the previous year. Full-time employment accounted for around half of the increase in recent months, but is still well below its peak in mid 2008, while part-time employment continues to grow at a rapid pace (Graph 55). By state, the recovery in the labour market has been most pronounced in Victoria, which accounted for the bulk of the increase in aggregate employment over the second half of 2009.
Average hours worked by full-time and part-time employees also picked up in the December quarter. This follows a significant decline in average hours worked during the downturn, when firms attempted to lower labour costs and save jobs. Reflecting both the recent strength in full-time employment and the pick-up in average hours worked, total hours worked in the economy increased by 1.0 per cent in the December quarter (Graph 56).
The unemployment rate declined to 5.5 per cent in December, having been at 5¾ per cent for much of the previous nine months. Broader measures of labour underutilisation, which take into account the reduction in hours worked during the recent downturn, point to a higher level of unused resources in the labour market than the unemployment rate, although this divergence is likely to narrow as labour market conditions improve and average working hours increase. Labour force growth has remained robust, driven by strong population growth, and the rising participation of older workers has contributed to a relatively high overall participation rate.
Forward-looking measures point to solid employment growth in coming quarters. Business survey measures of hiring intentions have rebounded in recent months, and are now at above-average levels (Graph 57). This is consistent with the Bank’s liaison, which suggests that a greater proportion of firms are intending to increase employment over the coming year. The number of job advertisements has risen from its recent trough, although it remains well below the levels of early 2008. This improvement in labour market conditions is also being reflected in an improvement in consumers’ expectations about unemployment over the next year.