Statement on Monetary Policy – November 2008 International Economic Developments

The outlook for the global economy has deteriorated significantly in recent months, with many developed economies in or close to recession and growth slowing noticeably in the emerging economies. This has prompted an easing of monetary policy and expansionary fiscal measures in many countries. While it is too soon to see the full economic impact of the recent intensification of the turmoil in financial markets, it is likely to result in a further softening in economic conditions despite the various policy measures that have been taken to address the problems. Accordingly, global growth forecasts by a range of institutions have been lowered significantly.

The latest data indicate little, if any, growth in most developed economies. In the September quarter, GDP fell by 0.1 per cent in the United States and by 0.5 per cent in the United Kingdom. In Japan and the euro area, where GDP data for the September quarter are not yet available, partial indicators show that economic activity remained very weak, after contracting in the June quarter. While the slowdown in global growth was initially centred on the household sector, conditions in the business sector are now also clearly softening. Labour market conditions have deteriorated noticeably across most developed economies, while data on business and consumer sentiment – which are timelier and generally extend to October – have fallen further from already low levels (Graph 26).

Growth also appears to have slowed markedly across east Asia, reflecting both reduced demand for these countries' exports and more subdued domestic demand. Year-ended growth in China fell in the September quarter to a still-rapid 9 per cent, its lowest level since 2003. A number of other east Asian economies have also seen a noticeable moderation in GDP growth recently, and industrial production across the region fell over the six months to August (Graph 27).

The ongoing strains in international financial markets (described in the previous chapter) are increasingly weighing on economic conditions. Bank lending standards have been tightened substantially, particularly for residential mortgages but also for business borrowers (Graph 28). In addition, heightened uncertainty has significantly reduced the appetite of many businesses and households for debt. Global equity markets have fallen dramatically over the past couple of months, adding to earlier losses, and house prices have continued to decline in a number of countries, particularly in the United States and the United Kingdom. As a result, household wealth has fallen in many countries in the June and September quarters, with further substantial falls likely in the December quarter if the current weakness in equity markets is sustained.

Reflecting these developments, IMF forecasts published in October were for global growth to slow from 5 per cent over the past couple of years to around 4 per cent in 2008 and 3 per cent in 2009. This forecast for 2009 was considerably weaker than that published in July (almost 4 per cent growth), primarily reflecting an expectation that the recent financial turbulence will have significant negative effects on growth in the major developed economies. The Bank's forecasts, detailed in the ‘Economic Outlook’ chapter, embody a weaker outlook for 2009 than envisaged in most external forecasts (Graph 29).

Consistent with the rapid slowing in global growth and reduced confidence in the outlook, there have been sharp falls in the prices of many commodities over recent months. The fall in oil prices has been particularly rapid, from a peak of US$146 a barrel in early July to be trading recently at around US$65 a barrel. These price falls, together with the weaker outlook for global growth, have seen concerns about the near-term inflation outlook recede in many countries. Although still high, year-ended consumer price inflation has recently fallen in the G7, China and other east Asia.

Major developed economies

In the United States, real GDP fell by 0.1 per cent in the September quarter to be just 0.8 per cent higher over the year (Graph 30). More timely data and forward-looking indicators suggest this weakness has continued into the December quarter. The one area of strength has been exports, which have continued to grow strongly in recent quarters, reflecting the improvement in competitiveness arising from the depreciation of the US dollar from 2002 to early 2008.

Initially, the weakness in US growth was concentrated in the household sector, beginning with the downturn in housing construction and then spreading to consumer spending. Residential investment has now fallen by more than 40 per cent from its peak in late 2005. Household consumption fell by 0.8 per cent in the September quarter to be unchanged over the year; this was the weakest quarterly outturn for consumption since 1980. The monthly data for consumption spending also show a sharp fall through the course of the quarter, which appears partly to reflect the fading impact of the one-off tax rebates associated with the federal government's stimulus package paid to households largely between late April and the middle of July. More generally, falling house and stock prices, reduced access to credit and a decline in the pace of household income growth are clearly having a significant effect on spending.

More recently, the weakness in the US economy has spread to the business sector. Business investment declined slightly in the September quarter, after expanding at a moderate pace during the first half of the year. Conditions in the labour market have weakened further since the middle of the year, with the unemployment rate rising by 0.6 percentage points over the three months to September and by 1¾ percentage points since the trough in early 2007 (Graph 31). Employment has fallen in each of the first nine months of the year, and data for initial jobless claims have recently picked up sharply.

In Japan, GDP fell in the June quarter, and more recent data suggest economic conditions have remained subdued (Graph 32). The September quarter has seen a further weakening in business sentiment and a fall in industrial production. Slowing economic conditions are flowing through to some softening in the labour market, with the unemployment rate rising slightly and the participation rate falling. Consumer confidence remains low.

In the euro area, GDP fell by 0.2 per cent in the June quarter and a range of indicators suggest little, if any, growth in the September quarter (Graph 32). Retail sales were unchanged in the September quarter, while industrial production remained weak. Consumer and business sentiment have fallen to around the lows last seen in the early 2000s recession, employment growth has slowed significantly and unemployment has started to drift higher. Conditions are looking particularly weak in the housing sector where overbuilding in some countries has resulted in a significant downturn in euro-area housing approvals for new construction, which have now fallen by nearly 20 per cent over the past year. Together with reduced access to credit, this is putting downward pressure on house prices in a number of countries. The United Kingdom is also undergoing a significant economic slowdown (Graph 32). Real GDP fell by 0.5 per cent in the September quarter after no growth in the June quarter, house prices have fallen by 15 per cent since October 2007, housing credit growth has slowed sharply and unemployment has increased.

Other major trading partners

The Chinese economy, while still growing at a fast pace, appears to have slowed noticeably, reflecting both weaker demand from developed economies for Chinese exports and the earlier efforts of the Chinese authorities to rein in inflationary pressures. China's GDP rose by 9 per cent over the year to the September quarter, down from more than 12 per cent in mid 2007 and the slowest pace of growth in more than five years (Graph 33). While China does not publish quarter-on-quarter growth rates, growth in the September quarter itself looks to have been quite soft, consistent with anecdotal reports and developments in global freight rates and commodity prices. Chinese data for exports and the corresponding import data for the United States, the euro area and Japan (which collectively account for around one-half of China's exports) also suggest a significant slowing over the past few years (Graph 34). The pace of growth in industrial production has fallen from 18 per cent a year ago to 11 per cent over the year to September – the slowest pace in more than six years – with steel production falling and cement production little changed. On the other hand, growth in real retail sales appears to have accelerated to around 18 per cent over the year to September and growth in fixed-asset investment spending remains strong. While the weakening in some of the Chinese data may be partly due to weather- and earthquake-related disruptions as well as production shutdowns associated with the staging of the Olympics, overall it seems likely that underlying growth has fallen noticeably. Reflecting these developments and the fall in consumer price inflation, the People's Bank of China has eased monetary policy, cutting its reserve requirement ratio for banks for the first time since 1999 and lowering its benchmark interest rate.

Growth has also weakened in India, with industrial production growth falling below 5 per cent in smoothed year-ended terms in August for the first time since 2002. With conditions subdued in the agricultural sector, GDP growth slowed to 7.9 per cent over the year to the June quarter, which is the slowest pace since 2004. Partly reflecting concerns about liquidity in the banking system, the Reserve Bank of India has eased monetary policy significantly by reducing its reserve requirement ratio for banks and cutting its benchmark interest rate.

Elsewhere in Asia, growth continues to moderate from its rapid pace of recent years. Preliminary estimates for the September quarter suggest that output contracted for a second consecutive quarter in Singapore and that GDP growth remained subdued in Korea. Over the six months to August the level of industrial production in east Asia (excluding Japan and China) fell slightly, and growth in employment has continued to ease. Declining oil and food prices have relieved inflation pressures somewhat across the region, increasing the scope for central banks to ease policy, with recent cuts to policy rates in Korea, Taiwan, Hong Kong and Vietnam.

The New Zealand economy contracted in the first half of the year, and indicators of activity remained weak in the September quarter. House prices continue to fall, and in September were 6 per cent below their peak in late 2007. While recent personal tax cuts, increased government spending and an easing in drought conditions should provide some boost to activity in coming quarters, the Reserve Bank of New Zealand has cited weakness in the growth outlook in its decisions to reduce the overnight cash rate by a cumulative 175 basis points since mid year.

Commodity prices

In line with the weakening in the global economy, commodity prices have fallen sharply in recent months. Spot prices for iron ore and coal – Australia's two largest exports – have fallen particularly sharply and there have also been broad-based falls in base metals, rural and oil prices.

The price of iron ore on the spot market has fallen by 60 per cent since the end of July, reflecting a noticeable slowing in growth of steel production and increased global supply. After adjusting for freight costs, the iron ore price on the spot market is now around 30 per cent below the level of the 2008/09 contract price (Graph 35). Thermal coal prices on the spot market have also fallen significantly over recent months, to be around 25 per cent below this year's contract price. As a result, market analysts have significantly revised down their expectations for next year's contract prices for coal and iron ore, with falls now expected.

The RBA index of base metals prices has fallen by 30 per cent over the past three months, to be around its lowest level since late 2005 (Graph 36). Evidence of soft demand, including a sizeable increase in inventory levels, has contributed to a sharp fall in copper and aluminium prices. Nickel prices have also fallen sharply since the August Statement, to be 75 per cent below their peak recorded in May last year. Nickel prices have fallen below the production cost of some producers, leading to the temporary closure of several operations. Meanwhile, gold prices have held up somewhat better, benefiting from demand as a ‘safe-haven’ asset during the recent volatility in financial markets. Oil prices have fallen by 45 per cent since the time of the August Statement, and by 55 per cent from their peak of US$146 a barrel in early July, to be currently trading at around US$65 a barrel (Graph 36).

Rural commodity prices have generally fallen over recent months, led by a 15 per cent fall in wheat prices (Graph 36). Expectations of a strong increase in global wheat production this season continue to weigh on prices, with recent forecasts pointing to a record global crop of roughly 680 million tonnes, more than 10 per cent above last season's crop. Wool prices have also softened noticeably in recent months, primarily reflecting softer demand.