reserve bank december board meeting minutes p1, page-2

Part 2:

Domestic Economic Conditions
Members were briefed that, with the national accounts for the
September quarter scheduled for release the day after the meeting, the
staff estimate was for a flat GDP outcome in the quarter, based on the
partial data released to date.
Recent indicators suggested that economic activity had remained
subdued in the early part of the December quarter.
Members then considered in detail the information provided by the
run of regular data releases, covering the household, housing and
business sectors, commodity prices, the labour market, and prices and
wages.
The slowing in domestic demand to date had been led by household
spending.
The volume of retail sales increased only slightly in the
September quarter, following two quarters of small declines.
According to data that were released during the meeting, retail
sales rose by 0.7 per cent in October.
However, the more reliably measured sales of large retailers
increased only slightly in October and the staff's liaison with retailers
suggested that conditions may have weakened further in the past month or
so.
Members observed that retail sales were considerably weaker in
New South Wales than in the rest of Australia, and this was seen in other
economic indicators also.
Another indicator of household consumption was motor vehicle
sales.
These had fallen considerably over the past year.
Consumer sentiment had remained relatively low in November.
Members were updated on developments in household net worth,
which had fallen by 11 per cent over the past year.
Turning to the housing sector, the data on housing loan approvals
and housing credit growth had picked up a little in the past two months
after slowing sharply in the first half of the year.
But activity in the sector remained subdued.
Building approvals data suggested that residential construction
was trending down, though the current level of activity was already
running well below estimates of underlying demand for housing.
In the established housing market, conditions were also subdued.
However, there were some indications that house prices
were levelling out after falling in the September quarter.
Members were informed that business investment was estimated to
have been broadly flat in the September quarter, but had expanded by
about 10 per cent over the past year.
Looking forward, year-ahead investment intentions of businesses
for 2008/09, reported in the ABS capital expenditure survey, were about
20 per cent higher in nominal terms than they had been this time last
year for 2007/08, though there had been some scaling back of investment
plans recently.
Members thought the surprising strength of investment
expectations partly reflected the very long-term nature of many large
investment projects.
However, they noted that private-sector surveys had suggested a
more pronounced scaling back of investment intentions in the past few
months.
Business debt funding had picked up a little over recent months
after slowing in the first half of the year.
It was now running at just under 10 per cent on an annualised
basis, compared with the unusually high rate of 20 per cent at the end of
last year.
Members noted that the slowing since last year was significantly
less than that in the early 1990s episode.
At present, current borrowing was mainly intermediated finance.
Broadly consistent with the credit data, commercial loan
approvals now appeared to be levelling out, after having fallen earlier
in the year.
Indications from business surveys were that business conditions
had continued to soften over recent months, and business confidence had
fallen to a very low level, which was not surprising given the financial
market disruption in recent months.
Members then turned to an assessment of recent developments in
commodity prices.
Oil prices had been falling since July and were now below $US50
per barrel for Tapis crude; they had fallen by 20 per cent over the past
month.
The oil price had also fallen markedly in Australian dollar
terms.
Spot prices for bulk commodity exports were trading well below
the latest contract prices, though members noted there had been little
sales activity in the spot markets.
From a longer-run perspective, bulk commodity prices were still
running ahead of levels of a few years earlier.
Weaker commodities demand, particularly from China, was also
starting to affect resource export volumes, particularly for iron ore.
In this environment, freight rates had fallen very rapidly, more
than unwinding the rise over the past two years.
In reviewing conditions in the labour market, members noted that
employment had held up well in the past few months, and the unemployment
rate had been relatively steady.
However, the trend in employment growth was slowing.
Indicators of future growth in employment were weakening more
sharply; the number of jobs advertised on the internet and in newspapers
was falling and business surveys indicated lower hiring intentions.
Members acknowledged that these data suggested unemployment was
likely to rise in the period ahead.
Turning to developments in wages and prices, wage growth appeared
to have been firm but stable during the September quarter.
The wage price index had increased by 0.9 per cent in the
September quarter, keeping the year-ended rate of growth steady at a
little over 4 per cent.
Liaison with firms suggested that more moderate growth in wages
was likely in the year ahead, in line with the easing in labour demand
that was in prospect.
Members noted that inflation expectations had moved up
significantly around the middle of the year, but had since fallen back to
be at the lower end of the range of the past few years.
This movement, which was reflected in a similar pattern in the
measure of inflation expectations derived from the bond market, was
likely to have been influenced by movements in oil and other commodity
prices.
The December quarter CPI outcome was expected to be held down
noticeably by the fall in global oil prices, with retail petrol prices
expected to subtract around 3/4 percentage point; the March quarter CPI
would also be reduced if current petrol prices were sustained.
The staff forecast was that underlying inflation had peaked, and
it was expected to return to near the centre of the target band by mid
2011.
CPI inflation was likely to fall more quickly in the short term
as a result of the recent falls in petrol prices, with this measure of
inflation likely to fall below 2.5 per cent by the middle of next year.
Financial Markets
Financial markets had remained unsettled in November.
Board members discussed the main developments in the United
States during the past month, which included support programs for a
number of major financial institutions and a shift on the part of the
Federal Reserve to provide more direct financial assistance to the
housing sector.
These measures were aimed at reducing mortgage rates, which had
remained high since the onset of the financial crisis despite the
significant reduction in the federal funds rate.
In response to the various assistance measures, US mortgage rates
had shown some signs of falling recently.
There had been a significant easing in monetary policy in several
industrial economies over the past month.
The European Central Bank reduced its policy rate by 50 basis
points to 3.25 per cent and the Bank of England had lowered rates by 150
basis points to 3 per cent.
Notwithstanding these policy moves, markets expected substantial
easing in monetary policy by both the European Central Bank and the Bank
of England at their next policy meetings.
The Swiss National Bank had reduced rates by 150 basis points at
its past two meetings.
Looking forward, the Federal Reserve was expected to reduce the
federal funds rate by 50 basis points at its meeting in December, which
would take the rate to 50 basis points.
The Reserve Bank of New Zealand was expected to lower rates by
about 100 basis points at its next meeting.
Members were briefed that in many countries the reductions in
official interest rates had had only a relatively small impact on the
interest rates charged by lenders.
In contrast, recent reductions in the official cash rate in
Australia had resulted in substantial reductions in bank lending rates,
particularly for housing.
There had also been a large monetary policy easing in China
during the past month, as part of measures adopted by the Chinese
Government to stimulate the economy.
Money market spreads in major markets had narrowed over the past
month, but activity in interbank markets had been limited.
Year-end pressures were emerging, which meant that spreads had
begun to widen somewhat in the days preceding the meeting.
However, the level of money market yields had fallen sharply
given the reductions in benchmark short-term policy rates.
Government bond yields had also fallen.
These yields were now at post-War lows in many countries and were
allowing governments to borrow at low cost.
US corporate spreads had narrowed somewhat at the high-quality
end of the spectrum, but had continued to widen for lower-quality bonds,
which meant that borrowing costs for lower-rated corporations were very
high.
Spreads in emerging markets had widened.
Debt issuance had gradually increased, but remained at very low
levels.
Issuance by banks using government guarantees had commenced in a
number of countries.
UK banks had issued the most paper to date.
Members noted that the details of the Australian scheme had been
made public during the month, and the first issue under the guarantee was
expected to occur shortly.
Global equity markets had continued to be volatile over the
month.
In net terms, most markets had fallen further, including a
significant fall on US markets on 1 December.
US and European markets generally were now back at the levels of
the mid to late 1990s.
Volatility in the Australian equity market remained high, though
less so than that in the US over the past month.
The Australian market was back at the levels prevailing in 2004.
Turning to foreign exchange markets, members observed that
exchange rates had also remained volatile over the past month, though
less so than in the previous two months.
The US dollar had been mostly unchanged, but was about 20 per
cent above its low point in trade-weighted terms.
The Chinese currency had appreciated in effective terms.
Although it was flat against the US dollar, euro and yen in net
terms, the exchange rate had appreciated strongly against the currencies
of China's Asian trading partners.
Members noted that the 1 per cent depreciation of the renminbi
against the US dollar on 1 December was the largest daily move under the
current framework.
Over the month, the Australian dollar had been volatile but
little changed in net trade-weighted terms.
The exchange rate had fallen by about 20 per cent over the past
year.
Members discussed the volatility of the Australian dollar
exchange rate and its correlation with the US equity market during the
last two hours of trading in New York.
When conditions in the foreign exchange market had been
especially thin on some occasions over the month, the Bank had again
intervened to provide liquidity by buying Australian dollars, though the
scale of the intervention had been less than in the previous month.
Members noted that Australian money market yields had fallen
considerably over the past month, following the reduction in the cash
rate, and further falls in short-term rates were expected.
Longer-term Australian government bond yields had also fallen
sharply over that period, in line with movements in yields globally.
Although the spreads between semi-government securities to
Commonwealth Government securities had risen somewhat, the overall
borrowing costs for the States had nonetheless fallen noticeably.
Members noted that expectations were for a major easing in the
official cash rate at this meeting.