Statement on Monetary Policy – February 2009 Domestic Economic Conditions

Conditions in the Australian economy have continued to weaken significantly as the global economy has entered a deep recession. GDP data for the September quarter showed the economy grew by 0.1 per cent, to be 1.9 per cent higher over the year (Graph 34). While the December quarter national accounts will not be available until early March, more timely information – including from private-sector business surveys and the Bank's business liaison program – suggest little, if any, growth in the December quarter (Graph 35).

Until recently, the slowing in the domestic economy had largely been centred on the household sector. There was little growth in household consumption in the June and September quarters as rising interest rates, higher petrol prices and falling equity and house prices reduced households' willingness and ability to increase spending. However, the business sector remained strong, with the resources sector benefiting from very high commodity prices and expansions in export capacity, which then flowed through to other industries, providing a significant boost to business profits and investment.

Conditions in the business sector have deteriorated sharply in recent months as a result of the continuing crisis in global financial markets and deepening recession in the world economy. In particular, there has been a significant reappraisal of future demand for commodities, resulting in cuts to production and exports and a growing number of mining companies announcing reductions in their capital expenditure intentions for 2009. More broadly, the problems in financial markets have made it difficult for some firms to access finance, which is affecting their investment plans, particularly in the property sector. Meanwhile, conditions for households have improved somewhat given the sizeable falls in mortgage rates in recent months, sharp falls in petrol prices, and the significant boost to household income from the Government's stimulus measures.

Household sector

After slowing sharply in the first half of 2008, household consumption grew by 0.1 per cent in the September quarter, to be 1.7 per cent higher over the year. This weakness reflected a number of constraining factors at work. Tight financial conditions and higher petrol prices, and high inflation more generally, eroded the purchasing power of household incomes, while softening house prices and sharp declines in equity values reduced household wealth. Reflecting these factors and growing concerns about job security, consumer sentiment fell to its lowest levels since the early 1990s recession.

More recent data, however, suggest that household consumption picked up in the December quarter as falling interest rates, lower petrol prices and the Australian Government's fiscal stimulus package provided a significant boost to real household disposable income (Graphs 36 and 37). Interest payments have fallen from a peak of 15 per cent of disposable income in June quarter 2008 to around 10 per cent in the March quarter and petrol prices have fallen by nearly 30 per cent from an average of roughly $1.60 per litre in mid 2008 to around $1.15 per litre, which is equivalent to a boost of around 1 per cent of real household income. The Government's one-off payments to pensioners, carers and low-to-middle-income families in December are estimated to have boosted disposable income by around 4½ per cent in the quarter. While some of the extra disposable income has been saved, a sizeable portion appears to have been spent by households. Retail trade and car sales to households both increased strongly in December, with retail sales up by nearly 4 per cent in the month and motor vehicle sales rising by 9 per cent. Recent liaison with retailers suggests that some of this activity was sustained in early January, broadly consistent with the recent readings on consumer sentiment. However, motor vehicle sales to households fell by 3 per cent in January.

Household net worth is estimated to have fallen by around 10 per cent over 2008, which together with increased uncertainty about the future, as reflected in consumer sentiment surveys, has seen significant shifts in the household sector's behaviour. In particular, households have begun to direct more income to saving and reducing their debt. Household deposit growth increased to an annualised pace of around 30 per cent in the three months to December, up from around 15 per cent a year earlier (Graph 38). At the same time, household credit growth has slowed to an annualised rate of 3 per cent, down from 12 per cent a year earlier, reflecting weaker growth in housing credit and a fall in personal lending associated with declining margin lending. With consumption growing only modestly and a significant slowing in the growth of housing credit, households have been injecting equity into housing, after a sustained period of net equity withdrawal (Graph 39).

The difficult environment facing the household sector has also been evident in some easing in residential property markets across the country, with house prices declining modestly through much of 2008. In the December quarter, house prices fell by around ¾ of a per cent, to be 2–3 per cent lower over the year depending on the measure (Table 9; Graph 40).

The softness in housing markets is currently most pronounced in the more expensive suburbs across the larger capital cities (Graph 41). Between 2004 and 2007, house prices in the most expensive 20 per cent of suburbs rose considerably more rapidly than in lower-priced suburbs but over the past year or so house prices in the higher-priced suburbs have fallen by around 10 per cent, while prices elsewhere in the larger capital cities have fallen by around 2 per cent. This pattern may reflect that wealthier households to date have been most affected by the problems in financial markets.

Housing construction activity continued to soften in late 2008, with forward-looking indicators pointing to a significant downturn in dwelling investment into the early part of the new year. The number of private building approvals fell by 16 per cent in the December quarter, driven by falls in both the house and medium-density components (Graph 42). Approvals have now fallen by 35 per cent since their peak in late 2007 to an annualised rate of about 110,000, which is well below estimates of underlying demand and near the troughs of the previous three dwelling investment cycles of the past two decades. While the decline in building approvals over recent months has been much larger than in other indicators – such as housing loan approvals and the HIA measure of new home sales – it is consistent with survey-based measures of residential construction activity, such as the HIA-AIG Performance of Construction Index and the MBA Survey of Building and Construction. Approvals for high-rise developments have been particularly weak, consistent with indications from the Bank's liaison program that developers are having difficulty accessing finance for large projects.

Looking forward, recent falls in interest rates and the increase in the First Home Owner Grant (FHOG) that is part of the government's fiscal stimulus package are expected to lead to some recovery in the residential building industry in 2009. The number of payments for the FHOG increased sharply in December and January. The pick-up in first-home buyer activity, to the extent that it relates to the purchase of new housing, would be expected to flow through to a recovery in building approvals over coming months, and boost dwelling investment in the second half of 2009. Consistent with this, surveys indicate an increase in the proportion of households reporting that it is a good time to buy a dwelling, and the Bank's liaison with the housing industry also indicates a significant pick-up in interest from first-home buyers. Overall, standard measures of housing affordability are estimated to have risen to their highest level in a decade largely as a result of lower mortgage rates (Graph 43).

Business sector

Conditions in the business sector have deteriorated sharply in recent months as a result of the continuing crisis in global financial markets and deepening recession in the world economy. While this is yet to be reflected in the available macroeconomic data on investment and profits, business surveys and the Bank's liaison program indicate that firms are responding by significantly scaling back their investment plans. Nevertheless, while the health of the business sector will come under some stress, it entered the downturn in good shape and the decline in average business interest rates in recent months should provide some relief to the business sector's net cash flow (see also the ‘Domestic Financial Markets’ chapter).

As a result of the problems in global financial markets, it has become increasingly difficult for many firms to access finance. The ACCI-Westpac Survey of Industrial Trends shows that the proportion of firms in the manufacturing sector reporting difficulties obtaining finance in the December quarter rose to its highest level in more than 30 years (Graph 44). The NAB survey also indicates credit conditions tightened significantly in the December quarter, but suggests some improvement late in the quarter. The Bank's business liaison has indicated that financing conditions were becoming more difficult through 2008 for firms across a wide range of industries, with a noticeable tightening in credit availability over recent months. Growth in total business debt – that is, intermediated business credit plus borrowing on the capital market – is estimated to have slowed to an annualised rate of around 1 per cent over the December quarter, down from an annualised rate of 9 per cent over the September quarter.

Private-sector surveys report that overall business conditions fell noticeably below average levels in the December quarter and measures of confidence are now weaker than in the early 1990s recession (Graph 35). Consistent with this, the capacity constraints firms were facing over recent years appear to be easing rapidly, with the NAB survey's capacity utilisation measure close to its long-run average level, and the fall over the past three quarters reversing the tightening in capacity that occurred over the previous six years (Graph 45). In contrast to recent years, firms are also reporting that a lack of demand has become more important as a constraint on output than difficulty finding suitable labour.

In line with these developments, a range of business surveys and the Bank's liaison suggest that the proportion of firms planning to increase investment over the coming period has fallen sharply (Graph 46). This follows a long period of strong growth in business investment, which grew by 13 per cent over the year to the September quarter 2008, a similar rate to its average since 2002. The mining sector has been particularly affected by the rapid shift in conditions, and a number of large mining firms have recently announced significant reductions to their capital expenditure plans for 2009.

In recent months there has been a pronounced downturn in the non-residential building sector. The value of approvals for private non-residential buildings fell by around 40 per cent in the December quarter (Graph 47). The falls have been particularly sharp for large-scale projects such as offices and warehouses, with approvals for offices having fallen by almost two-thirds since early 2008. While these data are particularly volatile from month to month, the recent trend seems consistent with the business surveys and the Bank's liaison, which suggest that the marked step-down in approvals for large-scale projects over recent months appears to at least partly reflect restricted access to external financing.

There has been a significant turnaround in conditions in the office property market. While there is considerable uncertainty around recent trends in capital values, as there has been little sales activity, estimates based on Jones Lang LaSalle data suggest national capital values fell by 5½ per cent in the December quarter, to be 12 per cent lower over the year (Graph 48). The nationwide office vacancy rate has risen by nearly 2 percentage points during 2008, although at 5½ per cent it is still well below its long-term average of around 10 per cent.


In response to the slowing in the global and domestic economies, the Australian Government has recently announced a number of planned stimulus measures. The total cost of new policies announced since early October amounts to around $27 billion in 2008/09 (or 2¼ per cent of GDP) and $22 billion in 2009/10 (1¾ per cent of GDP). The stimulus measures include a combination of direct transfers to households, support for businesses and increased public investment (Graph 49). In addition to the payments in late 2008, a second round of payments to households is planned for early 2009. The measures to support the business sector and boost public investment will have their largest effect in 2009/10.

As a result of the fiscal measures and the slowing in growth, the Federal Budget will shift into deficit in 2008/09. Budget estimates in the Updated Economic and Fiscal Outlook are for an underlying cash deficit for 2008/09 of $22.5 billion, or 1.9 per cent of GDP. The Budget balance has also been revised down for subsequent years compared with the November Mid-Year Economic and Fiscal Outlook.

Farm sector

Farm production is expected to increase by roughly 10 per cent in 2008/09, mainly reflecting an increase in wheat and other cereals crops. Conditions in the rural sector have generally improved over the past few months, as a large number of farming regions experienced average to above-average rainfall in November and December. However, hot and dry conditions through January have stressed summer crops, with yields likely to suffer. Despite above-average rainfall in November and December, flows into the Murray-Darling river system have remained low, suggesting that water availability for irrigation is likely to remain constrained.

External sector

Export volumes are estimated to have fallen in the December quarter, following a broadly flat outcome in the September quarter, to be around 4 per cent higher over the year. Resource export volumes are estimated to have dropped sharply in the December quarter, as reductions in global steel production affected demand for raw materials (Graph 50). Iron ore export volumes appear to have fallen by roughly 25 per cent in the quarter as major Australian producers responded to the change in global demand conditions. Metallurgical coal export volumes also fell in the quarter, and miners plan to cut production further in 2009. In contrast, with processing at the North West Shelf's fifth compression plant commencing, LNG export volumes rose in the December quarter; oil export volumes have also picked up.

Manufactured export volumes are estimated to have weakened significantly in the December quarter, in line with the sharp slowdown in trading partner growth. However, the large depreciation of the exchange rate would be expected to provide some support to export volumes over the period ahead in the face of weakness in Australia's trading partners (Graph 51).

Import volumes appear to have fallen by around 7 per cent in the December quarter, with particularly sharp falls in the volume of imported consumption and capital goods (Graph 52). While this partly reflects the recent depreciation of the Australian dollar, the fall in imports is consistent with other data indicating weakness in domestic spending in the December quarter. The large decline in capital imports, in particular, is consistent with the sharp falls seen in investment intentions and suggests that investment in machinery & equipment may have fallen in the December quarter. Given that retail sales volumes increased in the quarter, the large decline in imported consumption goods suggests that inventories may have been run down in the December quarter. In year-ended terms, growth of import volumes has slowed to around 2 per cent.

Reflecting large increases in 2008/09 contract prices for iron ore and coal exports, the balance on goods and services moved into surplus in the September quarter, and the current account deficit narrowed to 3.2 per cent of GDP (Graph 53). The balance on goods and services remained in surplus in the December quarter, suggesting the current account deficit was around 2½ per cent in the quarter.

Labour market

Conditions in the labour market softened in the December quarter. Employment grew by 0.2 per cent in the quarter to be 1.6 per cent higher over the year, with the trend monthly figures for December showing no growth. Part-time employment accounted for all the growth in the quarter, with full-time employment estimated to have fallen. This could be consistent with the pattern of previous downturns – the large swings in employment in previous slowdowns and recessions have been driven by the full-time component, with part-time employment showing less clear cyclical movements. However, these components can be volatile, and the pattern in December was the reverse of that in the September quarter. The unemployment rate has drifted up from a little more than 4 per cent in the March quarter last year to around 4½ per cent at the end of 2008 (Graph 54).

At the state level, the labour market continues to be weakest in New South Wales, where employment fell over the second half of last year (Graph 55). Labour markets in Western Australia and Queensland remained relatively strong up to the end of 2008, with the unemployment rate in Western Australia actually falling to 2.7 per cent in trend terms in December.

While conditions in the labour market softened towards the end of 2008, so far the labour market has held up a little better than might have been expected given the recorded slowing in domestic activity. This may have been a result of labour hoarding, with employers initially less willing to shed labour following the high degree of tightness in the labour market in recent years.

Forward-looking indicators of labour demand are pointing towards further softening in labour market conditions in the early part of 2009. The number of job advertisements fell sharply towards the end of 2008, business surveys report that firms' hiring plans have been scaled back significantly, and the Bank's liaison with firms also indicates weaker hiring intentions (Graph 56).