Statement on Monetary Policy – February 2010
International Economic Developments
The world economy continues to recover from the large decline in output seen in late 2008 and early 2009. The recovery remains most advanced in emerging Asia, although output is estimated to have grown at a solid pace in the second half of 2009 in most regions of the world (Graph 1). World trade and global industrial production have both picked up, and the extreme risk aversion evident earlier has continued to ease.
Reflecting these developments, both private sector and official forecasts for the world economy have been revised up. The IMF is now forecasting that the world economy will expand by just under 4 per cent in 2010 – around ¾ percentage points stronger than had been expected in October – and by around 4¼ per cent in 2011 (Graph 2, Table 1). The Bank’s forecasts for world and trading-partner growth in 2010 (outlined in the ‘Economic Outlook’ chapter) have also been raised, although by a smaller amount, reflecting the fact that they were somewhat above those of the IMF at the time of the November Statement.
Notwithstanding this improvement in global activity, many advanced economies continue to operate at well below full capacity. While industrial production has picked up from the low levels of early to mid 2009, in many economies it has recovered only a relatively small proportion of its earlier sharp falls (Graph 3), and much of this recovery has reflected the inventory cycle rather than a significant pick-up in final demand. Capacity utilisation remains very low, with the IMF estimating that output in the major advanced economies is currently running at around 5 per cent below potential, and unemployment has reached double-digit rates in the United States and euro area. In contrast, the pace of recovery in many economies in Asia has been strong, following the sharp declines in growth in late 2008 and early 2009. As a result, the level of spare capacity is now much reduced and unemployment rates have begun to fall in most Asian economies. These differences are some of the factors contributing to different trends in consumer price inflation, with core inflation tending to pick up in Asia in recent months after earlier sizeable falls, in contrast to continuing gradual declines in the United States and across most of Europe. A more detailed discussion of recent and prospective trends in world consumer price inflation is provided in ‘Box A: Global Developments in Inflation’.
As noted, economic recovery is most advanced in Asia, where strong growth resumed in the second quarter of 2009. A broad range of indicators suggest that the Chinese economy continues to grow strongly and that price pressures have increased. Output is estimated to have expanded by around 2¼ per cent in the December quarter, to be 10¾ per cent higher over the year (Graph 4). Recent monthly activity data show that the composition of China’s growth is shifting away from investment and back towards the export sector, which had weakened sharply in late 2008. After expanding by around 35 per cent over the first three quarters of 2009, nominal urban fixed-asset investment fell by 4 per cent in the December quarter (Graph 5). In contrast, the recovery in exports under way since mid 2009 has continued, with export volumes estimated to have risen by 13 per cent in the December quarter, after growing by 7 per cent in the September quarter. Despite the recent slowing in investment spending, credit continued to expand at a rapid pace in the second half of 2009, with a moderation in business credit growth from the extremely high rates seen in the first half of the year partly offset by a strengthening in household credit growth. Retail sales data suggest that growth in household spending remains firm.
There has also been a strong bounce-back in India, where GDP growth in the September quarter exceeded 3 per cent. While growth looks to have moderated more recently, various indicators suggest that it has remained solid. Industrial production in October and November was around ½ per cent above its strong September quarter level. Wholesale price inflation has also picked up noticeably, reaching over 7 per cent in year-ended terms in December, compared with a negative rate in mid 2009, suggesting ongoing strength in domestic demand. Rapid growth over recent years in both industrial output and consumer demand has seen India become an increasingly important part of the world economy and destination for Australia’s exports, as discussed further in ‘Box B: The Growing Importance of the Indian Economy’.
Elsewhere in Asia (excluding Japan), growth in the December quarter appears to have been solid in aggregate, but slower than the rapid rate seen in mid 2009. Some differences in the pace of expansion are apparent, with growth slowing in Korea and Singapore, but looking to have firmed a little in Taiwan. Both exports and industrial production increased strongly across the region in December after tracking sideways in October and November. More broadly, following the extraordinary declines in trade observed in late 2008 and early 2009, growth in export volumes over the past nine months has been very strong in the higher-income economies (Hong Kong, Singapore, Korea and Taiwan), but more limited thus far in the ASEAN-4 nations (Graph 6).
With growth now well under way in most economies in Asia but macroeconomic policies still quite stimulatory, attention is turning to the buoyant conditions in some property and other asset markets, and the risk that consumer price inflation could rise further. While policy-makers in a number of economies are concerned about these risks, financial conditions, including the current settings of interest rates and exchange rates, generally remain accommodative. However, in several countries steps have been taken to contain credit growth. In China and India, the authorities have increased reserve requirements for banks, while in China they have reportedly also taken administrative steps to curtail recent rapid lending growth. Lending criteria for housing loans have also been tightened in a number of economies, including Hong Kong and Singapore, and a number of other steps have been taken to address pressures in housing markets.
While most advanced economies are now also expanding, economic conditions generally remain quite weak. Consumer confidence remains below average in most economies, especially the United States (Graph 7). Nevertheless, US GDP expanded by 1.4 per cent in the December quarter, the strongest outcome since the September quarter 2003 (Graph 8). In addition to a major contribution from inventories – as firms sharply reduced their pace of de-stocking – growth was supported by strength in exports (especially to China) and by a modest pick-up in business investment following a decline of more than 20 per cent over the preceding five quarters. While prospects for further recovery in investment appear to have improved, credit continues to decline, contracting by around 8 per cent over 2009. Credit is declining not only to businesses but also to households, reflecting both tighter lending standards and reduced demand associated with deleveraging. While the pace of job losses has slowed markedly over recent quarters, US payrolls employment has continued to fall, with a cumulative decline over 2008 and 2009 of 7¼ million jobs, or more than 5 per cent.
Labour demand also remains weak in Europe. In the euro area, the unemployment rate reached 10 per cent in December for the first time since mid 1998; in the United Kingdom it stands at close to 8 per cent, although it has stabilised at that level over the past six months. Retail sales remain weak in the euro area, although exports and inventories are likely to have contributed to moderate growth in GDP in the December quarter. Output in the UK economy expanded by 0.1 per cent in the December quarter, after six successive contractions (Graph 9).
Like the rest of Asia, the Japanese economy has seen firm growth in exports and industrial production in recent quarters. However, machinery orders data suggest that firms’ investment intentions remain weak, despite the level of business investment having fallen by over 25 per cent since early 2008, and a number of indicators of business conditions have weakened over recent months after earlier bouncing back. Similarly, consumer sentiment declined over the December quarter to retrace some of the improvement that had occurred earlier in 2009.
While the large advanced economies have seen significant upward revisions in growth forecasts for 2010, there are a number of factors that are likely to weigh on growth and contribute to more subdued recoveries in these countries than usually occurs after a large recession. Much of the recent strengthening seen in the pace of activity reflects the influence of temporary factors that are boosting output, namely the inventory cycle and the highly stimulatory fiscal and monetary policy settings. For the recovery in the advanced economies to strengthen further and be self-sustaining, a key requirement is that there is a pick-up in the pace of private final demand growth that is not reliant on ongoing policy stimulus. In this regard, consumer demand still remains weak in many advanced countries and may be vulnerable to the withdrawal of fiscal support measures (Graph 10). In the euro area, retail sales volumes continue to contract by around ¼–½ per cent per quarter, a pace little changed over the past two years, while in the United States the modest recovery in retail sales since mid 2009 has been underpinned by a large reduction in the amount of taxes paid and an increase in government transfers to households. In this environment, deciding the appropriate pace at which to withdraw the current very stimulatory monetary and fiscal policy settings represents a significant challenge for policy-makers in many advanced economies, especially those with high and rising public debt levels (Graph 11).
In line with the strong recovery in emerging Asia, commodity prices have continued to rise over the period since the November Statement, to be significantly above the levels prevailing in early to mid 2009 (Graph 12). Spot prices for bulk commodities have shown particular strength, with iron ore prices up by around 40 per cent and coking and thermal coal prices up by around 20–30 per cent since November (Graph 13). Current spot prices represent substantial premiums over 2009/10 contract prices, and market analysts on average expect contract prices to settle between 20–40 per cent higher for 2010/11. Higher prices for bulk commodity exports would provide a substantial boost to Australia’s terms of trade over the coming year.
Bulk commodity prices have been supported by robust demand from China, while demand from other traditional destinations such as Japan and Korea has also been recovering. Chinese end-user demand for steel products has remained solid, with spot steel prices 6 per cent higher since November and steel mills seeking to restock ahead of expected contract price increases. With major miners and ports operating at or near capacity, increased demand has underpinned a significant price response.
Base metals prices are also higher, due to strengthening industrial demand and various concerns over supply disruptions. Rural prices have increased, with price rises fairly broad-based across commodities. Sugar prices have risen particularly sharply, driven by concerns of a global sugar shortage. India, having been a sugar exporter in recent years, is expected to be a significant importer for the second year running in 2009/10, as production has been hampered by a weak monsoon. Oil prices have traded in a relatively wide range, and are currently a little lower than their levels at the time of the November Statement.