Statement on Monetary Policy
AUGUST 2019
Statement on Monetary Policy
AUGUST 2019
Contents
Overview 1
1. The International Environment 5 Box A: Small Banks in China 21 2. Domestic Economic Conditions 25 Box B: The Recent Increase in Iron Ore Prices and Implications for the Australian Economy 37 3. Domestic Financial Conditions 41 4. Inflation 51 5. Economic Outlook 59 The material in this Statement on Monetary Policy was finalised on 8 August 2019. The next Statement is due for release on 8 November 2019.
The Statement is published quarterly in February, May, August and November each year. All the Statements are available at www.rba.gov.au when released. Expected release dates are advised ahead of time on the website. For copyright and disclaimer notices relating to data in the Statement, see the Bank's website.
The graphs in this publication were generated using Mathematica.
Statement on Monetary Policy enquiries:
Secretary's Department Tel: +61 2 9551 8111 Email: [email protected]
ISSN 1448–5133 (Print) ISSN 1448–5141 (Online) Overview
The Australian economy has been navigating a growth is therefore likely to remain low and to period of slow growth, with subdued growth in increase more gradually than earlier expected. household income weighing on consumption As a result, inflation is likely to take longer to rise spending. In contrast, employment growth has to 2 per cent. Trimmed mean inflation is forecast been strong. The response of labour supply has to remain around 1½ per cent for the rest of this been even stronger, taking the participation rate year, before increasing to be a little under to a record level. Despite the strong 2 per cent over 2020 and a little above employment growth, the unemployment rate 2 per cent over 2021. Headline inflation is has increased to 5.2 per cent, where it has expected to follow a similar trajectory. remained for three months. Domestic inflation Global growth remains reasonable, but the risks pressures remain subdued. Housing-related have become more clearly tilted to the inflation has been particularly soft lately, downside. Global trade has declined noticeably compounding the ongoing effects of spare in the context of continuing trade and capacity in the labour market and the resulting technology disputes. There is considerable slow growth in labour costs. uncertainty about possible future tariff measures GDP growth is likely to have troughed around and the potential for global technological the middle of this year and is expected to reach standards to become fragmented. This about 2½ per cent over 2019. It is expected to uncertainty has weighed on investment and pick up gradually to 2¾ per cent over 2020, and investment intentions in a number of around 3 per cent over 2021, which is a little economies, and poses a significant risk to the higher than previously forecast. Growth is global outlook. expected to be supported by a number of In China, growth slowed further in the June factors, including lower interest rates and recent quarter. Additional policy measures have been tax measures. The established housing markets announced to support growth in the face of the in some cities are showing signs of a turnaround, negative effects of tariff measures. Some of which should support spending. The mining these policy measures have been focused on sector is also likely to support output growth; in enabling infrastructure spending, which has the near term, resource exports are recovering been a positive for steel production – and thus from recent supply disruptions, while a pick-up demand for some bulk commodities – even as in mining investment will boost growth further conditions in the industrial sector more broadly out. have remained weak. This has benefited the Given the slower output growth over recent Australian economy. quarters, the unemployment rate is expected to These trade-related developments have remain around its current level for a time, before particularly affected the economies in east Asia declining to around 5 per cent in 2021. Wages
STATEMENT ON MONETARY POLICY – AUGUST 2019 1 that are most exposed to Chinese domestic the global trade tensions, but are still noticeably demand and are most integrated into global higher over the year to date. Credit growth has manufacturing supply chains. Growth in continued to slow, but there was an increase in investment has also turned down in some of housing loan approvals in the month of June, in these economies. By contrast, growth has been line with better conditions in housing markets more resilient in economies such as Indonesia, more generally. Some lenders have announced where manufacturing for export is a smaller changes to their lending criteria in response to share of activity. the Australian Prudential Regulation Authority Growth in the major advanced economies has revising its guidelines, which have boosted slowed over the past year, driven by slower borrowing capacity for some customers. external demand and business investment. The Australian dollar has depreciated over Consumption growth is still reasonable, recent months and is at its lowest level of recent however, and labour markets in these times. The depreciation over the past year is economies remain tight. Faster wages growth is consistent with the decline in Australian bond supporting consumption, but is yet to translate yields relative to those in other major markets into materially higher inflation in these over that period. economies. Inflation generally remains below There have been some large movements in central bank targets, though it is around target commodity prices in recent months. Iron ore in several advanced economies. prices had increased in response to restricted In response to the weaker growth outlook and seaborne supply and strong Chinese demand, ongoing low inflation, a number of central banks but have fallen more recently, along with oil have lowered policy interest rates in recent prices, following the recent escalation in trade months. This has added to already tensions. Coal prices have also declined because accommodative financial conditions. Sovereign demand has weakened somewhat at a time bond yields have declined further – in many when seaborne supply has been ample. Taken cases to historical lows – and credit spreads together, though, prices of Australia's remain narrower than a year ago. Equity market commodity exports remain at high levels. The valuations have generally been supported by terms of trade are therefore higher than the effect of accommodative monetary policies previously expected. This represents a boost to on risk-free yields and positive expectations for Australia's national income, as a portion of the earnings growth, though prices have declined higher profits of mining companies are recently in response to heightened concern distributed to domestic shareholders and via about the trade and technology disputes. These government revenues. expansionary financial conditions have also GDP growth was a touch slower in the March benefited emerging markets, although risks quarter than expected at the time of the May surrounding global trade developments remain. Statement on Monetary Policy. Early indications Domestic financial conditions have also eased. for the June quarter are for reasonable growth. The reductions to the cash rate in June and July Some of the temporary factors that weighed on have largely been passed through to deposit growth in recent quarters, including supply and lending rates. Australian government bond disruptions to resource exports, have been yields have reached a new historical low. Bank resolved. However, consumption growth funding costs have also declined to historically remains slow, consistent with ongoing weakness low levels. Equity prices declined in response to in household incomes and the effects of recent
2 RESERVE BANK OF AUSTRALIA falls in housing prices. The adjustment in from the low- and middle-income tax offset. The housing markets is also evident in declining outlook for consumption more broadly dwelling investment and low turnover rates for continues to be the main uncertainty facing the existing homes. domestic economy, especially in the context of Following a period where labour market data ongoing high levels of household debt. were stronger than other data on economic A more positive signal for future consumption is activity implied, labour market conditions were that established housing markets appear to have more mixed in the June quarter. Employment stabilised. Prices in Sydney and Melbourne have growth continues to run well above growth in stopped falling and, although prices are still the working-age population, taking the falling in some other markets, the pace of employment-to-population ratio close to its decline has eased. The rate of sales turnover also historical peak. The participation rate reached its appears to have troughed and auction clearance highest level on record, driven by strong rises in rates have risen. Rental vacancies remain low in participation by older workers and women aged most cities, except in Sydney, where the vacancy between 25 and 54. However, the rate has increased as new apartments continue unemployment rate also picked up a little and to be added to the rental stock. has remained at 5.2 per cent for a few months. Similarly, the mining sector is also expected to Leading indicators point to a moderation in support growth over the next few years, after a employment growth in the period ahead. long period during which declining mining With increasing demand for labour being met by investment was a drag on growth. Mining an expansion in labour supply, spare capacity investment is forecast to increase moderately in remains in the labour market. This has weighed coming years as firms invest to sustain and on wages growth. Wages growth has picked up expand production. Resource exports had a little in the private sector over the past year, experienced some weakness earlier in the year, but remains stable in the public sector, related to supply disruptions, but have increased consistent with government wages policies. in recent months because these disruptions Labour income growth has therefore been have been resolved and production at recently underpinned more by the strong employment completed liquefied natural gas facilities growth of recent times than by rising wages. continues to ramp up. Growth in non-labour income has been weak, The investment outlook in Australia more partly because unincorporated business income generally is broadly positive. Non-mining has been held down by declining housing business investment continues to expand at a construction and sales turnover, as well as moderate pace, supported by a solid pipeline of drought-related weakness in farm incomes. non-residential building work and infrastructure Household disposable income growth has also projects (particularly transport and renewable been lowered by the unusually fast growth in energy). Infrastructure projects have also been household tax payments over 2018. an important element of public demand's Slow growth in household incomes has ongoing support to growth. dampened consumption spending for some Inflation remains low. Trimmed mean inflation time. This is likely to have continued into the increased a little to 0.4 per cent in the June June quarter; the volume of retail sales increased quarter, but remained at 1.6 per cent over the only a little in the quarter. Household incomes year. Measures of underlying inflation have now will receive a boost in the second half of 2019 been below 2 per cent for around three years.
STATEMENT ON MONETARY POLICY – AUGUST 2019 3 Housing-related inflation, including both rents monetary policy further if needed to support and prices of newly built dwellings, has been a sustainable growth in the economy and the significant contributor to the low inflation achievement of the inflation target over time. outcomes. The prices of some administered items have also risen at a below-average pace lately. This has been only partly offset by higher prices for some retail goods affected by the drought or the pass-through of exchange rate depreciation. Headline inflation was affected by higher petrol prices and increased to 0.7 per cent in the June quarter and 1.6 per cent over the year. Oil prices have fallen more recently, suggesting that some of this effect will reverse in the September quarter. Further out, inflation is still expected to drift up gradually. However, this is now forecast to take place over a more extended period than previously envisaged, because there appears to be more spare capacity remaining in the labour market than had been thought. Together, the recent data on wages, prices, output and unemployment suggest that there was more spare capacity in the economy than had previously been recognised. They also suggest that, like a number of other countries, Australia can sustain lower rates of unemployment and underemployment without running inflation risks. In response to this accumulation of evidence, the Reserve Bank Board lowered the cash rate at both its June and July meetings, to a new low of 1 per cent. While the stance of policy had already been accommodative for some time, the Board judged that additional monetary stimulus would assist with faster progress in reducing unemployment, and help create the conditions for more assured progress towards the inflation target. Given the current environment, it is reasonable to expect that an extended period of low rates will be needed to achieve the Board's employment and inflation objectives. The Board will continue to monitor developments in the labour market closely and is prepared to ease
4 RESERVE BANK OF AUSTRALIA 1. The International Environment
Growth in Australia's major trading partners growth. The more accommodative outlook for remains reasonable. The growth outlook is a policy in major economies, as well as subdued little lower than was expected three months ago domestic inflation outcomes, has also provided because there have been further signs of space for a growing number of emerging slowing in activity indicators that are related to market central banks to ease monetary policy in trade, such as exports, manufacturing and support of growth. investment, and the US–China trade and The shift in the expected path for policy rates technology disputes have escalated further has contributed to sharp declines in (Graph 1.1). In contrast, consumption growth government and corporate bond yields and has been relatively resilient. Labour markets are provided some support to equity prices. This tight but global inflation continues to be constellation of lower interest rates and elevated subdued. Downside risks to the outlook have prices for riskier assets over much of this year increased: policy uncertainty remains high and suggest that market participants believe that the potential for the US–China dispute to central banks will respond to downside risks and escalate further has risen, which would adversely thereby sustain the economic expansion. affect business investment. However, risky asset prices fell sharply following Financial market conditions remain the recent escalation in the US–China dispute, accommodative. Several major central banks highlighting the potential for financial market have either eased policy or signalled a greater conditions to tighten quickly if market willingness to do so in response to subdued participants become more concerned about the inflation and persistent downside risks to outlook for global growth.
Graph 1.1 Trade and technology disputes have Economic Activity and Risks escalated … std bps Activity and uncertainty* Federal Reserve dev The US–China trade dispute has escalated over policy expectations** New export orders recent months after negotiations between the 2 75 two countries stalled. In June, the United States increased tariffs from 10 to 25 per cent on 0 0 US$200 billion of imports from China and China retaliated with higher tariffs on US$60 billion of -2 -75 imports from the United States. About half of US Economic policy uncertainty (inverted) imports from China are now covered by a -4 -150 2015 2019 2015 2019 25 per cent tariff rate and most Chinese imports * Average between 2014 and 2018 ** Cumulative expected change in the Federal Reserve policy rate target from the United States are covered by over the proceeding 12 months implied by futures Sources: Bloomberg; Economic Policy Uncertainty; Markit; RBA 5–25 per cent tariffs (Graph 1.2); average US tariff
STATEMENT ON MONETARY POLICY – AUGUST 2019 5 rates on Chinese imports are now 12 per cent, Vietnam, appear to be benefiting from trade which is substantially above those on other US diversion due to the trade dispute. trading partners at around 1 per cent. More The US–China technology dispute has also recently, the US administration announced it will escalated in recent months. The United States impose a 10 per cent tariff on almost all imposed export and transfer controls that remaining imports from China from restricted access to key US technologies for 1 September and further tariff increases have certain Chinese entities, particularly targeting been threatened. A decision by the US advanced semiconductor integrated circuits; the administration on increasing tariffs on United States is the dominant global producer automotive imports from a number of countries of advanced circuits (Graph 1.3). The Chinese has been delayed to November. Trade tensions Government is reportedly considering have broadened in recent months, with some controlling exports of rare earth minerals; China countries using them to address political is the largest global producer of these minerals, disputes. For example, the United States which have various uses in high-technology threatened, but then suspended, higher tariffs processes. The economic effects of the on imports from Mexico in response to a dispute technology disputes are uncertain and are likely over immigration flows. to play out over a long period. The escalation in the trade dispute is weighing on global economic activity. The direct impact … creating downside risks to the of the measures currently in place is relatively outlook for trading partner growth small, but the indirect effects of uncertainty on Major trading partner growth is expected to be investment have been more significant. The risk around 3.7 per cent in 2019 and 2020 and pick of further escalation also poses a major up a little to 3.8 per cent in 2021 (Graph 1.4). This downside risk to global growth, particularly is a little lower than forecast in the May through adverse effects on business investment Statement on Monetary Policy because of the and confidence more generally, and the escalation in the US–China disputes and weak potential for amplification through highly investment indicators. While this outlook is still integrated global supply chains. Nonetheless, reasonable, the downside risks have increased some economies that provide a competitive substantially, given the potential for further production alternative to China, such as
Graph 1.3 Graph 1.2 Inputs to High-tech Products US Tariff Rates on China* Share of global production, 2018 % % Weighted average bilateral tariff rate Semiconductors % % Rare earths
Threatened 60 60
20 20 40 40 Sep 2019
June 2019 10 10 20 20 2018 Pre-trade dispute 0 0 United States China* Other 0 0 Escalation of tariffs * Rare earths production based on production quotas; estimate of actual production (including illegal and undocumented) based on magnet * Excludes steel and aluminium tariffs introduced in 2018 production indicates a share closer to 80 per cent Sources: RBA; World Integrated Trade Solution Sources: SIA; USGS
6 RESERVE BANK OF AUSTRALIA escalation in US disputes with China and other effective from early July. Fixed asset investment economies. At the same time, however, has been supported by continued growth in real monetary policy is expected to become more estate investment, as well as policy measures to accommodative across a range of economies, in facilitate public spending on infrastructure, part because of the easing in global growth, but although the pace of growth in both sectors also in response to the rise in downside risks and eased in the June quarter. Falling exports subdued inflation. subtracted a little from GDP growth in the quarter. In China, activity indicators have Many industrial sector indicators remain weak: moderated growth in the output of industrial products In China, economic conditions have softened remains subdued, manufacturing purchasing since last year and GDP growth is expected to managers indices (PMIs) have trended lower and slow over the next two years. The direct effect of industrial sector profits have been weak. the US–China trade and technology disputes on Nonetheless, the production of some items, Chinese activity has been limited to date; such as steel and plate glass, have continued to however, the impact of the associated rise, supported by high construction-related uncertainty on investment decisions is expected demand (Graph 1.6). This demand has also to add to medium-term downward pressures on underpinned high margins for steel production, growth, which had already been slowing as a although increases in bulk commodity prices result of tighter financial regulations and longer- over the past year have eaten into these term structural factors. Various government margins. measures have been introduced to support the Conditions in Chinese property markets were domestic economy. mixed in the June quarter (Graph 1.7). While In the June quarter, growth moderated for a construction investment continued to grow range of official activity indicators despite some relatively strongly, residential property sales supportive temporary factors (Graph 1.5). declined. Property prices have continued to rise Growth in real retail sales eased despite a but, over the past year, growth in non-official temporary boost from retailers attempting to measures of property prices compiled by the reduce stocks of vehicles that were not private sector firm China Index Academy have compliant with tighter emission standards
Graph 1.5 Graph 1.4 China – Activity Indicators* Australia’s Trading Partner Growth Growth Year-average % % Real fixed asset investment Real retail sales % % Forecast 40 20 6 6 Year-ended 30 15
4 4 20 10
2 2 10 5
0 0 0 0 Quarterly
-10 -5 -2 -2 2009 2014 2019 2009 2014 2019 1991 1997 2003 2009 2015 2021 * Seasonally adjusted by the RBA Sources: ABS; CEIC Data; RBA; Refinitiv Sources: CEIC Data; RBA
STATEMENT ON MONETARY POLICY – AUGUST 2019 7 been notably weaker than official price range of policies designed to support growth. indicators. The People's Bank of China (PBC) has lowered Core consumer price inflation in China has been reserve requirements for some county-level little changed in recent months, after easing banks over the past few months. PBC officials over the past two years, while headline inflation have reiterated that the central bank has has risen further because of higher food price significant room to adjust policies if further inflation stemming from supply disruptions in downside risks were to materialise, and market the rural sector (Graph 1.8). Producer price participants expect that it will do so. inflation has moderated further, partly driven by Authorities have also taken further measures to sharp falls in international oil prices in June. ease fiscal policy. The general government fiscal deficit has continued to widen in recent months Chinese authorities have eased policy (Graph 1.9). Moreover, central authorities have further to support growth authorised local governments to use proceeds Authorities have responded to slowing from special bonds as project capital for some economic activity by announcing a further infrastructure projects, including large railway, highway, power supply and gas supply projects. Measures to support consumption have also Graph 1.6 been announced. China – Industrial Production Growth Year-ended % % Economic activity overall has slowed in the major advanced economies
Plate glass Year-ended growth has slowed in the major 20 20 Crude steel advanced economies. Policy uncertainty and weaker external demand, particularly from
0 0 China, has weighed on investment. Conditions in manufacturing have eased, as have new Steel products export orders; the deterioration has been -20 -20 especially sharp in the United States after the 2011 2013 2015 2017 2019 Sources: CEIC Data; RBA escalation in US–China trade and technology disputes in recent months (Graph 1.10). Surveys
Graph 1.7 China – Residential Property Indicators Graph 1.8 Year-ended growth China – Inflation* % New property prices Investment** % Year-ended Alternative* Land purchases % % 15 20 Consumer prices Producer prices
0 0 8 10 Official Headline Other investment*** % Floor space sold Inventory % 4 5
50 25 0 0 Core 0 0 -4 -5 -50 -25 2013 2016 2019 2013 2016 2019 * China Index Academy -8 -10 ** Contributions of residential and non-residential investment 2009 2014 2019 2009 2014 2019 *** Construction, installation, equipment purchases and other * Seasonally adjusted by the RBA Sources: CEIC Data; CIA; CRIC; RBA Sources: CEIC Data; RBA
8 RESERVE BANK OF AUSTRALIA of conditions in the services sector have been the near term, given that investment intentions, relatively resilient in Japan and the euro area, but capital goods orders growth and business have deteriorated in the United States since May. conditions have declined sharply over the past In marked contrast, consumption growth has six months (Graph 1.12). This is, at least in part, been robust in the major advanced economies, due to the sharp rise in uncertainty associated supported by strong labour markets and rising with US trade and technology policies. Together wages growth. with the effect of higher import tariffs on trade In the United States, consumption growth has and the diminishing boost from earlier fiscal recovered in recent months from its temporary stimulus, the weaker outlook for investment is weakness at the start of the year, supported by expected to lead to slightly slower growth in the strong labour market (Graph 1.11). However, 2019 and 2020 than was previously thought. GDP growth overall slowed in the June quarter In the euro area, GDP growth eased in the June because business investment growth slowed; quarter, which is likely to have been driven by a net exports and inventories also subtracted from fall in exports. Indicators of investment growth. A recovery in investment is unlikely in
Graph 1.11 Major Advanced Economies – Graph 1.9 Consumption Indicators % std United States Euro area Japan China – Fiscal Policy dev Share of GDP, four-quarter rolling sum Retail sales* % % (LHS) 4 2 Expenditure
20 20 Revenue 0 0
10 10 -4 -2 Consumer sentiment** 0 0 (RHS) Balance -8 -4 2014 2019 2014 2019 2014 2019 * Year-ended growth; smoothed; consumption index for Japan -10 -10 ** Deviation from long-run average 2009 2011 2013 2015 2017 2019 Sources: CEIC Data; RBA; Refinitiv Sources: CEIC Data; RBA
Graph 1.12 Graph 1.10 Major Advanced Economies – Major Advanced Economies – Investment Indicators Business Conditions* Smoothed Deviation from post-GFC average % std United States Euro area Japan std United States Euro area Japan std dev dev dev 2 2 12.5 2 0 0 Export orders -2 -2 0.0 0 std United States Euro area Japan std dev dev 2 2 -12.5 -2 Investment 0 0 Capital goods orders* intentions** Services (LHS) (RHS) -2 -2 Manufacturing -25.0 -4 -4 -4 2014 2019 2014 2019 2014 2019 2015 2019 2015 2019 2015 2019 * Year-ended growth; machinery orders for Japan * PMIs; smoothed ** Deviation from post-2000 average Sources: Markit; RBA Sources: Bank of Japan; RBA; Refinitiv
STATEMENT ON MONETARY POLICY – AUGUST 2019 9 intentions and manufacturing conditions have Wages growth increased notably over 2018 in remained weak while, in contrast, growth in the major advanced economies and remains household consumption has been strong, around the highest levels since 2010. Wages supported by strong labour markets. Growth has growth has slowed a little in the United States slowed because of the slowdown in global and the euro area this year. In Japan, full-time trade, moderating growth in China, and country- wages growth has stepped up to around the specific factors in some of its important trading highest rate since late 2000 and wages growth partners (including in the United Kingdom and in the more cyclically sensitive part-time sector Turkey). Subdued external demand is expected has also been high and continues to increase. to continue to weigh on growth in the near Wages are also growing at around their fastest term. The potential for a disorderly exit of the pace since the global financial crisis in the United Kingdom from the European Union is an United Kingdom and New Zealand, where additional source of uncertainty for the euro labour markets are also tight. area outlook. In Japan, growth in domestic demand and Inflation remains subdued in the major exports slowed sharply early in 2019. External advanced economies demand, particularly from China and the rest of Inflation is below target in each of the major Asia, has weakened since late 2018 and is advanced economies, despite tight labour weighing on the manufacturing sector. market conditions (Graph 1.14). Core inflation However, investment intentions remain eased in the United States early this year after relatively strong and have been supported by being close to the 2 per cent inflation target, the need to address severe labour shortages. although other underlying inflation measures, While consumer sentiment has eased, partial such as trimmed mean inflation, have remained indicators suggest that consumption growth close to the inflation target. Inflation is around picked up strongly in the June quarter ahead of target in several other advanced economies the consumption tax increase in October. including the United Kingdom, Canada, Sweden Growth is expected to slow in late 2019 and and Norway. Oil prices have been volatile over early 2020 because fiscal policy will tighten the past few months after declining in late 2018; following the consumption tax increase.
Labour market conditions in advanced Graph 1.13 economies remain tight Major Advanced Economies – Labour Market and Wages Employment growth in many advanced Year-ended growth % % economies has slowed, but remains well above Employment Wages*
working-age population growth and, thus, Japan 3 4 strong enough to continue absorbing spare Japan part-time capacity in the labour market. The slowing in 0 2 employment growth has been most Euro area pronounced in Japan and in the global -3 0 manufacturing sector (Graph 1.13). Nevertheless US Japan full-time labour markets remain tight, unemployment -6 -2 rates are at multi-decade lows and firms 2009 2014 2019 2009 2014 2019 * Average hourly earnings for the US; compensation per employee for continue to report widespread difficulties in the euro area; smoothed matched-sample average full-time scheduled wages and part-time hourly wages for Japan filling jobs. Sources: CEIC Data; ECB; Eurostat; RBA; Refinitiv
10 RESERVE BANK OF AUSTRALIA at current levels, oil prices will not exert upward in July. The Fed noted that the US economy pressure on headline inflation. remains strong but there was room for some Persistently low inflation and slowing GDP easing of monetary policy given the implications growth have lowered some measures of of global developments for the US economic inflation expectations. Market-implied measures outlook and subdued inflation pressures. This of long-term inflation expectations have stands in contrast to Federal Open Market declined this year across all major advanced Committee (FOMC) projections earlier in the economies. The decline has been especially year, where most members envisaged one large in the euro area where market-implied increase of 25 basis points in the policy rate over measures are around their lowest levels in more 2019. Market pricing implies that the Fed is than a decade (Graph 1.15). Economists' long- expected to lower its policy rate by a further term inflation expectations have also eased but 100 basis points over the next 12 months. The by much less. In contrast, in Japan, consumer Fed also announced that it would cease winding inflation expectations have increased ahead of down its balance sheet in August, two months the consumption tax increase in October. earlier than previously indicated.
Major central banks have eased policy Graph 1.15 or are prepared to do so in coming Major Advanced Economies – months Inflation Expectations % % Major central banks have eased monetary policy United States Euro area Japan pre-emptively or indicated a willingness to do so Consumer* 4 4 in response to downside risks to growth and Market** subdued inflation outcomes and expectations. 2 2 Consistent with this shift, market participants Consensus*** now expect most major central banks to ease 0 0 policy by more than was the case a few months ago (Graph 1.16). -2 -2 2009 2019 2009 2019 2009 2019 In the United States, the Federal Reserve (Fed) * One-year-ahead ** Monthly average of five-years-ahead inflation expectations implied lowered its policy rate target by 25 basis points from inflation swaps; US adjusted for PCE *** Long-run consensus; average of six-to-ten-years-ahead inflation expectations Sources: Bloomberg; Consensus Economics; ECB; RBA; Refinitiv Graph 1.14 Major Advanced Economies – Inflation Year-ended Graph 1.16 % % United States* Euro area Japan** Policy Rate Expectations Trimmed mean % US % 4 4 3 3 May SMP NZ Headline 2 2 2 2 1 1 Current Core Japan 0 0 0 0 Euro area % % 3 3 Canada -2 -2 2 2 1 1 -4 -4 UK Australia 2009 2019 2009 2019 2009 2019 0 0 * Personal consumption expenditure inflation -1 -1 ** Excludes effect of the consumption tax increase in April 2014 2017 2019 2021 2017 2019 2021 Sources: RBA; Refinitiv Source: Bloomberg
STATEMENT ON MONETARY POLICY – AUGUST 2019 11 The European Central Bank (ECB) has Market pricing suggests that policy rates are emphasised that it will provide additional expected to be lowered in a number of other stimulus in the absence of a further advanced economies, or otherwise remain improvement in the outlook for inflation. In accommodative for an extended period. The particular, it has noted that this could involve a Bank of Canada continues to assess that its combination of lowering the policy rate, current accommodative stance for monetary strengthening its guidance on the future path of policy remains appropriate and future policy the policy rate, and resuming the expansion of decisions will be data dependent; inflation has its balance sheet through the purchase of remained around the 2 per cent target and the government and private-sector securities. Bank of Canada judges GDP growth to be Analysts expect a package of measures to be nearing its potential rate. The Bank of England announced in September, with market pricing continues to point to the outcome of Brexit as a now implying that the ECB is expected to lower significant source of uncertainty, and notes that its policy rate by 30 basis points to −0.7 per cent the next move in its policy rate could be up or over the next 12 months. The ECB has also down. The Reserve Bank of New Zealand (RBNZ) provided more details on its upcoming lowered its policy rate by 50 basis points at its ‘Targeted Longer-term Refinancing Operations’ August meeting to 1.0 per cent. The RBNZ noted (TLTRO-III), which are designed to provide that while employment is strong, inflation continued support for bank lending to the real remains below the 2 per cent mid-point of the economy (Graph 1.17). target range, growth in domestic and global The Bank of Japan (BoJ) has continued to activity has slowed, and risks remain titled to the provide monetary stimulus by maintaining very downside. In contrast, some central banks, such low interest rates and expanding its balance as those in Sweden and Norway, expect to sheet. The BoJ expects to maintain its current increase their policy rates in the coming year, policy settings until at least the second quarter reflecting solid domestic growth and inflation of 2020, although the BoJ has noted that policy around target. could be eased further if necessary. Market pricing implies that the BoJ is expected to lower Government bond yields have fallen, in its policy rate by 10 basis points to −0.2 per cent many cases to historical lows by the end of the year. Yields on long-term government bonds have fallen further to around record lows in some cases (Graph 1.18). Ten-year yields are at or Graph 1.17 below central bank policy rates in most major Central Bank Balance Sheets Share of GDP markets. In Japan, Germany, France, the % % Federal Reserve European Bank of Japan Netherlands, Sweden and Switzerland, both 2- Central Bank 100 100 and 10-year yields are negative and around their lowest levels on record. 75 75 Part of the decline reflects lower real short-term 50 50 interest rates, which is consistent with expectations that central banks will ease 25 25 monetary policy and/or keep policy settings
0 0 accommodative for an extended period. The 2010 2018 2010 2018 2010 2018 declines also reflect a fall in inflation Lending to banks Government bond purchases Other asset purchases Source: Refinitiv compensation, which suggests that market
12 RESERVE BANK OF AUSTRALIA participants have lowered their expectations for The US dollar and the Japanese yen future inflation, and/or that they believe that have appreciated, while the Chinese there is little if any risk that inflation will increase renminbi has depreciated in the future. In addition, term premiums – the The US dollar has appreciated recently, but compensation that investors demand for remains within its relatively narrow range holding long-term rather than short-term bonds following a sustained appreciation over 2018 – have declined to be around record low levels (Graph 1.20). The Japanese yen has appreciated and, by some measures, are negative sharply, as it often does during periods of (Graph 1.19). This reflects unusually low heightened uncertainty, and is around its perceived uncertainty about future interest rates highest level in several years on a trade- and inflation outcomes, and demand for weighted (TWI) basis. The appreciation of the government securities from less price-sensitive yen over the past few months is consistent with buyers such as central banks, insurers and market participants expecting future monetary [1] pension funds. easing in Japan to be more modest than for other major markets. Japanese Ministry of Finance officials have signalled that they are closely monitoring for ‘excessive movements’ in foreign exchange markets. The euro is in the middle of its narrow range of recent years. Graph 1.18 Following the recent escalation of US–China 10-year Government Bonds % % Nominal yield Real yield Inflation disputes, the Chinese renminbi has depreciated compensation* 3 3 on a TWI basis and against the US dollar (Graph 1.21). The renminbi depreciated in early 2 2 August, moving above 7 yuan per US dollar. US 1 1 Market participants had been widely of the view
0 0 that the Chinese authorities would not want to Japan see the exchange rate move through this level -1 -1 Germany while trade negotiations were ongoing. The -2 -2 2015 2019 2015 2019 2015 2019 Chinese authorities attributed the depreciation * Difference between nominal yield and real yield to market forces, while the US government Sources: Bloomberg; RBA
Graph 1.20 Graph 1.19 Nominal Trade-weighted Exchange Rates US 10-year Term Premium 1 January 2014 = 100 % % index index
US dollar 120 120 4 4
110 110
2 2 Japanese yen 100 100
Euro 0 0 90 90
-2 -2 80 80 1971 1983 1995 2007 2019 2014 2015 2016 2017 2018 2019 Source: Refinitiv Sources: BIS; Bloomberg; Board of Governors of the Federal Reserve System
STATEMENT ON MONETARY POLICY – AUGUST 2019 13 formally labelled China a ‘currency manipulator’ In China, money market rates have generally and stated that it will engage with the remained low alongside efforts by the PBC to International Monetary Fund over China's ensure there is ample liquidity in the banking approach to exchange rate determination. system. However, there has been some tightening in funding conditions for small banks The cost of financing for corporations following the takeover of a small bank by remains low regulators due to concerns about its solvency The cost of financing for corporations in bond and reported misappropriation of funds (see markets has declined since the start of this year, ‘Box A: Small Banks in China’). reflecting both lower government bond yields Despite the sharp declines seen since the and narrower credit spreads. This improvement beginning of August, global equity prices have in conditions has encouraged non-financial risen strongly this year (Graph 1.24). Through firms to issue more bonds, particularly firms with much of this year, equity prices had been lower credit ratings (Graph 1.22). In China, the supported by lower sovereign bond yields, cost of financing for highly rated corporations which increase the discounted value of future has been stable in recent months, but it is lower corporate earnings (equity risk premiums appear than in the first half of 2018. In part, this reflects the effect of policy measures aimed at Graph 1.22 improving financing conditions for private Corporate Bond Markets enterprises. % US dollar Euro China % 12 Yield Yield Yield 12 Non-investment Low-rated* The cost of funding in short-term US dollar 9 9 grade money markets has declined since earlier this 6 6 3 3 year (Graph 1.23). Continued inflows into Investment grade High-rated** US dollar prime money market funds, a key US$b Gross issuance*** Gross issuance*** Gross issuance*** US$b 300 300 source of US dollar supply in the market, have 200 200 contributed to the easing in conditions. These 100 100 favourable conditions have contributed to a 0 0 pick-up in issuance of commercial paper by 2014 2019 2014 2019 2014 2019 * Based on five-year AA- domestically rated bond both US and non-US financial institutions. ** Based on five-year AAA domestically rated bond *** Non-financial corporations; September quarter-to-date Sources: CEIC Data; Dealogic; ICE Data is used with permission
Graph 1.21 Graph 1.23 US Dollar Money Markets Chinese Exchange Rates % Rates (three-month) % yuan index 3 3 Yuan per US$ 2 2 (LHS, inverted scale) LIBOR* OIS** 1 1 6.2 110 bps LIBOR-OIS spread (three-month) bps 60 60 40 40 6.6 105 20 20
US$tr Commercial paper outstanding US$tr 1.15 1.15 7.0 100 Trade-weighted index* 1.05 1.05 (RHS) 0.95 0.95 0.85 0.85 7.4 95 2015 2016 2017 2018 2019 2014 2015 2016 2017 2018 2019 * London interbank offered rate * Indexed to 1 January 2014=100 ** Overnight index swap Sources: Bloomberg; China Foreign Exchange Trade System; RBA Sources: Bloomberg; Refinitiv
14 RESERVE BANK OF AUSTRALIA little changed). At the same time, market outlook for growth in east Asia. For most analysts have maintained their forecasts for economies in the region, export growth has strong growth in earnings next year, despite remained negative, new export orders are below some slowing in earnings growth this year average and industrial production has (Graph 1.25). This suggests that participants contracted (Graph 1.26). The ongoing weakness have judged that downside risks to growth are in global trade and the escalation in the either unlikely to affect corporate earnings US–China trade and technology disputes are materially, or that such risks will be offset by likely to have a relatively more severe impact on central bank policy accommodation if needed. these economies because of their integration in global supply chains. In east Asia, the decline in global trade Overall, exports from east Asia to China have has weighed on growth declined sharply since late 2018, partly as a Persistent weakness in external demand, result of weaker Chinese exports to the United especially from China, and intensification of the States, which use significant inputs from the US–China trade dispute have weighed on the region's economies (Graph 1.27). An easing in Chinese domestic demand has also had an effect; for most economies in east Asia, their Graph 1.24 exposure to domestic Chinese demand is Equity Prices 2 January 2017 = 100 significantly larger than their exposure to index index Chinese exports to the United States.
US Intraregional trade has also declined because of 130 130 the region's highly integrated production chains. China However, in Vietnam and some of the high- 115 115 income economies in the region, export growth to the United States has picked up, supported 100 100 Europe by the relocation from China of production of exports to the United States. 85 85 M J S D M J S D M J S 2017 2018 2019 Weaker external demand is affecting domestic Source: Bloomberg conditions in the region and growth has slowed
Graph 1.25 Graph 1.26 Corporate Earnings Growth* Annual growth East Asia – Economic Indicators % % Smoothed United States Forecast index % 20 20 Manufacturing PMI* Production and trade** 10 10 0 0 53 10 % Europe % Aggregate Merchandise 20 20 exports 10 10 50 5 0 0
% China % 15 15 47 0 0 0 Industrial production -15 -15 New export orders -30 -30 2012 2014 2016 2018 2020 44 -5 2015 2019 2015 2019 * Net income of financial and non-financial corporations adjusted for * one-off items; earnings are for companies included in benchmark Purchasing Managers’ Index indices ** Year-ended growth Source: Refinitiv Sources: CEIC Data; IHS Markit; RBA
STATEMENT ON MONETARY POLICY – AUGUST 2019 15 over the past year (Graph 1.28; Graph 1.29). housing services inflation, but headline inflation Policy actions have muted some of the effects of remains in the bottom half of the inflation target weaker external demand more recently, band. Inflation in the Philippines has eased back including in South Korea, where GDP growth to its target range, following tighter monetary picked up in the June quarter, boosted by policy in 2018. In Malaysia, inflation rose in June government spending. In most of the more because of base effects from changes in trade-exposed east Asian economies, business consumption taxes a year ago. investment has fallen sharply over the past year and consumption growth has slowed. In the Accommodative global financial less-trade-exposed economies, investment conditions have supported emerging growth has also slowed but remains relatively financial markets high and consumption growth has remained Expectations that major central banks will ease resilient. policy have supported financial market Inflation remains subdued in east Asia conditions in emerging market economies (Graph 1.30). Indonesian core inflation has (Graph 1.31). Easier external financing conditions increased, driven by higher durable goods and have provided space for many emerging market
Graph 1.27 Graph 1.29 East Asia – Merchandise Export Values East Asia – GDP Growth By destination, smoothed, year-ended growth with contributions Year-ended % % % %
15 15 Other ESEA* 9 9 10 10 Intraregional Total Indonesia 5 5 6 6 US 0 0 China 3 3 -5 -5 South Korea EU, Japan & other 0 0 -10 -10
-15 -15 -3 -3 2014 2015 2016 2017 2018 2019 2007 2010 2013 2016 2019 Sources: CEIC Data; RBA * Emerging South-East Asia; includes Thailand, Malaysia, Philippines and Vietnam Sources: CEIC Data; IMF; RBA
Graph 1.28 East Asia – Investment and Consumption Graph 1.30 Year-ended growth % % East Asia – Inflation South Korea Other more- Less-trade-exposed Year-ended trade-exposed economies** % % economies* Headline Core
8 8 10 10 Philippines 6 6 Indonesia Consumption 4 4 0 0
2 2
Investment 0 0 -10 -10 Malaysia 2014 2019 2014 2019 2014 2019 South Korea * Hong Kong, Singapore, Taiwan, Thailand and Malaysia -2 -2 ** Indonesia and Philippines 2015 2019 2015 2019 Sources: CEIC Data; RBA Sources: CEIC Data; RBA
16 RESERVE BANK OF AUSTRALIA central banks to ease monetary policy in Growth in India has slowed, and the response to downward revisions to domestic central bank has responded growth forecasts, subdued domestic inflationary In India, GDP growth slowed in the March pressures and downside risks to growth. This has quarter, driven by a fall in the level of investment contributed to a sharp decline in yields on (Graph 1.33). More recent monthly activity government bonds denominated in local indicators have been mixed. Steel output and currencies. Spreads for bonds denominated in industrial production have begun to pick up, but US dollars have also tightened for sovereign and remain weak. A range of service sector indicators corporate issuers in emerging markets. have also eased in recent quarters, after being Since the start of the year, emerging markets elevated last year (Graph 1.34). have experienced steady inflows of foreign Future growth is expected to be weaker than capital into their bond markets, while foreign previously forecast, partly because of slower flows to their equity markets have been more growth in the industrial sector, lower-than- mixed. There were some capital outflows from expected fiscal expenditure in 2019/20, weaker mutual and exchange-traded funds that invest external demand and emerging trade tensions. in equities in emerging markets, following the In the recent budget, the Indian Government escalation of the US–China trade and technology disputes in early May (Graph 1.32). The economies that are most integrated into Graph 1.32 Chinese supply chains were the most affected. Flows to Emerging Market Funds* Excluding China; 13-week rolling sum % % Meanwhile, inflows into emerging market bond Total funds have persisted in response to relatively 4 4 higher yields (vis-à-vis advanced economies) Equities 2 2 and further expected policy easing by emerging 0 0 market central banks. The recent escalation in Bonds trade and technology disputes presents a -2 -2 downside risk to capital flows into emerging -4 -4 markets. -6 -6 2013 2015 2017 2019 * Per cent of assets under management; includes bonds denominated in US dollars and local currencies Source: EPFR Global Graph 1.31 Emerging Financial Markets Excluding China Graph 1.33 % index Government bond yields* 8 140 India – GDP and Investment Growth Equity prices** % GDP Investment % 7 120
6 100 Year-ended 12 24 5 80 index Exchange rates** % (against the US dollar) 100 30 6 12 90 20 80 10 0 0 70 0 Quarterly* Cumulative flows to funds*** 60 -10 2015 2019 2015 2019 * Local currency bonds, weighted by market value -6 -12 ** 1 January 2012 = 100 2009 2014 2019 2009 2014 2019 *** Includes flows to exchange-traded funds and mutual funds * Seasonally adjusted by the RBA Sources: Bloomberg; EPFR Global; IMF; JP Morgan; RBA Sources: CEIC Data; RBA
STATEMENT ON MONETARY POLICY – AUGUST 2019 17 announced a slightly smaller fiscal deficit for production has increased strongly over recent 2019/20 than in 2018/19 . The budget included months (see ‘Box B: The Recent Increase in Iron an INR 700 billion recapitalisation of state- Ore Prices and Implications for the Australian owned banks, which should support these Economy’). However, in recent weeks, reports institutions' lending activity. In May, the United have been suggesting Chinese iron ore demand States announced that India would no longer has moderated because of production curbs qualify as a ‘beneficiary developing country’, that are in place in some cities. The escalation in which had given India preferential access to the trade tensions has led to sharp falls in iron ore US market, prompting retaliatory tariffs from prices since the start of August. The outlook for India. iron ore seaborne supply and prices remains Meanwhile, rebounding food and fuel prices highly uncertain; although Chinese steel have boosted headline inflation but core demand is expected to remain elevated in the inflation has continued to moderate; even so, near term, supply constraints should continue to headline inflation remains below the Reserve ease following approval for some Brazilian Bank of India's 4 per cent target (Graph 1.35). In production to resume. response to slower growth and subdued inflation, the Reserve Bank of India lowered its policy rate by 35 basis points in August, Graph 1.35 following earlier cuts in February, April and June. India – Inflation Year-ended % % Iron ore prices have moved in a wide range in recent months … 16 16 Headline The benchmark iron ore spot price has been 12 12
volatile in recent months. For most of the period Excluding food and fuel* since the previous Statement on Monetary Policy, 8 8 prices continued to strengthen and reached 4 4 their highest level since early 2014 (Graph 1.36).
Disruptions in Australia and Brazil have limited 0 0 2007 2010 2013 2016 2019 available supply in the seaborne market while, at * RBA calculations the same time, Chinese demand for iron ore had Sources: CEIC Data; RBA been relatively resilient because steel Graph 1.36 Graph 1.34 Chinese Steel and Iron Ore Spot Prices US$/t US$/t India – Services Sector index PMI Credit Exports % (LHS) Year-ended growth Year-ended growth 150 600 (RHS) (RHS) Chinese steel* 55 30 (RHS)
100 400 Iron ore** 50 15 (LHS)
50 200
45 0
0 0 2011 2013 2015 2017 2019 40 -15 * Average of hot rolled steel sheet and steel rebar prices 2014 2019 2014 2019 2014 2019 ** 62% Fe Fines index; free on board basis Sources: CEIC Data; IHS Markit; RBA Sources: Bloomberg; RBA
18 RESERVE BANK OF AUSTRALIA … while most other commodity prices particularly from China, while lead prices have have declined increased following supply disruptions in Australian thermal coal prices have steadily Australia and declining global inventories. declined over the past year (Graph 1.37; Prices for Australian rural exports have been Table 1.1). Price declines in recent months have mixed since the previous Statement. Lamb prices reflected ample supply from exporting have increased, supported by strong demand countries, while Asian demand has declined from China and the United States. In contrast, because of a combination of elevated stockpiles, wool prices have declined alongside subdued an increase in renewable generation and some northern hemisphere demand, and wheat prices substitution towards lower-cost LNG and have declined recently as the outlook for global cheaper Russian thermal coal. Coking coal prices supply from some key producing regions has have also declined since the previous Statement picked up. alongside an increase in global supply, notably Australian export prices (including the prices of from Australia, and because demand from some non-commodity exports) are expected to have key steel-producing economies has eased. increased in the June quarter, largely reflecting Oil prices have declined since their peak in mid higher iron ore prices, supporting an increase in May because renewed trade disputes have Australia's terms of trade. Export prices are still raised concerns about the outlook for global oil demand (Graph 1.38). Some partially offsetting support for prices has come from OPEC Graph 1.38 members and a number of other oil-exporting Oil Market US$/b Brent oil price US$/b countries agreeing to extend production cuts 120 120 through to March 2020, as well as rising 80 80 geopolitical tensions between major producers 40 40 which have raised concerns around the outlook mb/d Production Rest of world mb/d (RHS) for global supply. 12 60 US (LHS) Base metal prices have generally declined in 8 40 OPEC (RHS) recent months as trade tensions escalated 4 20 0 0 (Graph 1.39). Zinc prices have declined 2013 2014 2015 2016 2017 2018 2019 considerably alongside rising global supply, Sources: Bloomberg; EIA
Graph 1.37 Graph 1.39 Coal Prices Base Metal and Rural Prices Free on board basis January 2014 = 100 US$/t US$/t index index Thermal coal Hard coking coal Base metals Zinc 150 150 Aluminium 150 300 100 100 Contract Copper Lead 100 200 index Rural commodities index Lamb Spot 150 150 50 100 Beef 100 100 Wool Wheat 0 0 50 50 2011 2015 2019 2011 2015 2019 2014 2015 2016 2017 2018 2019 Sources: Department of Industry, Innovation and Science; IHS Markit; RBA Sources: Bloomberg; Landmark; MLA; RBA
STATEMENT ON MONETARY POLICY – AUGUST 2019 19 Table 1.1: Commodity Price Growth(a)
Since previous Statement Over the past year Bulk commodities 12 7 – Iron ore −5 40 – Coking coal −23 −11 – Thermal coal −23 −43 Rural −1 −11 Base metals −4 −10 Gold 18 26 Brent crude oil(b) −19 −22 RBA ICP 5 14 – Using spot prices for bulk commodities −6 1 (a) Prices from the RBA Index of Commodity Prices (ICP); bulk commodity prices are spot prices (b) In US dollars Sources: Bloomberg; IHS Markit; RBA
likely to decline over the next few years as the terms of trade over the next year or so has Chinese demand for bulk commodities been revised higher compared to the May moderates and low-cost global supply of these Statement (see ‘Economic Outlook’ chapter). commodities increases. Even so, the outlook for
Endnotes [1] RBA (2019), ‘Box B: Why Are Bond Yields So Low?’, Statement on Monetary Policy, May, pp 27–31. Available at
20 RESERVE BANK OF AUSTRALIA Box A Small Banks in China
In recent months, vulnerabilities of small Vulnerabilities of small banks have banks in China have been in focus following been building a tightening in liquidity conditions, which has Concerns about the balance sheets of small prompted a concerted response by the banks have been building for some time.[2] authorities. Small banks in China have The rapid expansion of their assets has been expanded rapidly over recent years and play driven by an increase in opaque forms of an increasingly significant role in China’s credit. In particular, small banks have lent to, [1] financial system. In particular, small banks and purchased securities issued by, non-bank are important providers of financing to financial institutions (NBFIs), which in turn private enterprises, including micro- and extend credit to firms, including MSEs. This small-sized enterprises (MSEs), which has enabled small banks to circumvent struggle to compete with larger firms for restrictions on lending to certain sectors and credit from large banks. However, the rapid other prudential requirements, including growth of small banks has also increased holding lower capital than otherwise. In some risks, in part because the small banks addition, lending by small banks has tended have become increasingly reliant on to be concentrated in certain industries and/ wholesale (often short-term) funding and or regions. Almost all are unlisted, limiting much of their credit has been extended via their scope to access fresh capital quickly. opaque channels where questions of credit Some small banks also have weak corporate quality have surfaced. governance and/or underdeveloped risk- There are around 4,000 small banks in China management systems. In recent years, for – defined as those outside of the 20 largest example, a number of small banks have failed domestic banks by asset size. Together, these to publish financial accounts and provide banks now account for around a quarter of data to independent auditors. These factors banking system assets (up from 10 per cent a decade ago), equivalent to around Graph A1 70 per cent of China’s GDP (Graph A1). While Chinese Banking System Assets By bank size* these banks are individually small relative to % % Per cent of GDP Share of total the big state-owned banks that have Small Medium 300 60 traditionally dominated China’s banking Large system, many of them are still quite large by international standards. For example, the 200 40 largest small bank in China has more than A$200 billion in reported assets, larger than 100 20 the fifth largest bank in Australia. 0 0 2014 2018 2014 2018 * Excluding foreign banks which account for less than two per cent of total assets. Sources: CEIC Data; RBA
STATEMENT ON MONETARY POLICY – AUGUST 2019 21 have contributed to the broader build-up of conventional deposits than for larger state- indebtedness in China and associated owned banks (Graph A3).[3] In addition, small medium-term risks to financial stability. banks have relied heavily on short-term Small banks tend to have weaker asset funding, with around 90 per cent of quality than large banks, and typically report wholesale funding (including wholesale debt lower capital adequacy ratios (Graph A2). and inter-bank deposits) of small banks Small banks have a relatively high share of expected to mature within one year. Many distressed loans despite also having a greater small banks have also accumulated share of loans being written off or disposed significant implicit liabilities through their use of in other ways. Some small banks, especially of off-balance sheet investment vehicles to those based in regions experiencing raise funding. This has increased the potential significant economic slowdowns, have calls on the capital and liquidity of small reported a substantial rise in non-performing banks. loans (NPLs). Moreover, Chinese authorities have strengthened standards for recognising In recent months, investors have NPLs, which has required an increase in been reluctant to lend to small banks provisions at small banks. These develop- In May, Chinese regulators announced that ments have led to a decline in small banks’ they would take over Baoshang Bank – the profitability and capital levels over the past 36th largest bank in China, with around few years. That has prompted several banks A$120 billion in reported assets – due to to raise capital in order to lift their capital concerns about its solvency and reported adequacy ratios. misappropriation of funds. This was the first Small banks are also exposed to considerable reported takeover of a private bank by liquidity risks. The expansion of the balance Chinese regulators since 1998. In addition, sheets of small banks has been mainly while China’s deposit insurance fund took funded by an increase in wholesale debt, as over some debts of Baoshang Bank, the an implicit regulatory ceiling on deposit rates authorities allowed some large creditors to has made it harder for them to attract bear losses (in contrast to the widely held
Graph A3 Graph A2 Chinese Banks’ Funding* Share of assets China’s Banking System* % % By bank size Large banks Small banks % Return on equity CET1 capital ratio % 80 80 20 14 Medium Customer Large deposits 60 60 10 10
40 40 % Distressed loans** Write-offs and disposal % Share of loans Share of loans Wholesale 8 4 20 debt** 20 Small Interbank deposits Other*** 4 2 0 0 2014 2016 2018 2014 2016 2018 0 0 * Includes RBA estimates 2015 2018 2015 2018 ** Includes debt securities, repurchase agreements and central * Includes RBA estimates bank loans ** Includes non-performing loans and special mention loans *** Other financial liabilities and equity Sources: CEIC Data; RBA; S&P Global Market Intelligence Sources: RBA; S&P Global Market Intelligence
22 RESERVE BANK OF AUSTRALIA perception of government guarantees).[4] the bank’s small size relative to China’s More recently, state-owned financial banking system (0.2 per cent of total banking institutions have acquired shares in the Bank assets). In addition, the fact that some large of Jinzhou, the country’s 30th largest lender, creditors will bear losses might help in following the suspension of its Hong Kong reducing perceptions of implicit guarantees listed equity some months earlier. in the Chinese banking system, which could The Baoshang takeover prompted investors improve risk management and credit to reassess the risks of lending to other small allocation over the medium term. However, banks, and liquidity conditions for small in the short term, the associated tightening banks tightened sharply (Graph A4). For in liquidity conditions has increased some example, interest rates on negotiable risks to China’s small banks and the broader certificates of deposit (NCDs), which are financial system. This includes the risk that unsecured funding instruments small banks will be unable to roll over predominantly used by small banks, wholesale funding, which could disrupt increased relative to larger banks.[5] In funding markets more generally. In turn, this addition, net issuance of NCDs by small could tighten financial conditions and banks declined sharply in May, although it undermine the authorities’ efforts to ensure has increased more recently. There have also favourable financing conditions, particularly been reports that small banks have for MSEs. experienced difficulty accessing funding The People’s Bank of China (PBC) has sought markets altogether or have had to provide to maintain favourable financing conditions higher-quality collateral when borrowing on by ensuring a generally high level of liquidity a secured basis. in China’s banking system. It has reduced reserve requirement ratios for banks and The authorities have responded injected liquidity into money markets via The direct implications of the takeover of open market operations and various lending Baoshang Bank appear to be limited, given facilities. However, in light of recent develop- ments, the authorities have implemented additional targeted measures to support Graph A4 funding conditions for small banks, including Chinese Money Market Three-month NCDs by: % Yields %
5 5 • directing state-owned financial Small banks 3 3 institutions to make strategic investments Medium and large banks in the Bank of Jinzhou bps Spread* bps 100 100 • adding NCDs and bank bills to the list of
50 50 eligible collateral in PBC operations
CNYt Net issuance CNYt • increasing the quotas for certain PBC Total 0.6 0.6 lending facilities that are accessible to 0.0 0.0 small banks[6] -0.6 -0.6 2015 2016 2017 2018 2019 • providing additional funding to a * Between small banks and medium and large banks Sources: CEIC Data; RBA; WIND Information prominent issuer of credit risk mitigation
STATEMENT ON MONETARY POLICY – AUGUST 2019 23 instruments. These instruments are a small banks remain elevated relative to larger form of insurance that compensates banks. Small banks are likely to continue to investors if the issuer of the underlying face challenges in the period ahead, asset defaults. To date, these have been including issues with asset quality and thin used by at least one small bank (Bank of capital buffers, particularly those in regions Jinzhou) to facilitate access to the NCD with weaker economic conditions. There is market also ongoing uncertainty around the • instructing financial institutions to authorities’ approach to bank resolution and, continue trading in instruments that are relatedly, the role of government agencies issued by small banks. The PBC has also and state-owned firms in absorbing potential allowed brokerages to raise additional losses. These issues are likely to remain in funds to support their operations in focus as Chinese authorities continue their money markets. efforts to manage risks in China’s financial system, while ensuring favourable financing The recent measures have contributed to a conditions for private enterprises. stabilisation in funding conditions for small banks, although yields on NCDs issued by
Endnotes [1] Small banks include city and rural commercial and local currency up to a maximum of banks, village banks, rural credit unions, and credit CNY500,000. However, in Baoshang Bank’s case, cooperatives. Analysis in this box is based on city the scheme and Chinese authorities guaranteed and rural commercial banks where data for other corporate and interbank deposits valued up to small banks are not available. Medium banks CNY50 million, and personal deposits were fully refers to joint-stock banks and large banks guaranteed. captures large state-owned commercial banks. [5] NCDs and other interbank funding instruments [2] For more details, see RBA (2016) ‘Box A: Recent account for around 10 per cent of small banks’ Growth of Small and Medium-sized Chinese liabilities. Banks’, Financial Stability Review, October, [6] The PBC expanded the size of its rediscount pp 14–16. Available at
24 RESERVE BANK OF AUSTRALIA 2. Domestic Economic Conditions
The Australian economy has been growing at a Victoria and New South Wales continue to below-trend rate over recent times. This largely account for a higher-than-average share of reflects that consumption growth has been employment growth. Employment has weighed down by a period of low growth in outpaced the relatively strong working-age household income and declining housing population growth in both states over the past prices. By contrast, labour market outcomes year, whereas the employment to working-age have been generally strong. In the June quarter, population ratio has declined in Queensland. employment continued to grow faster than the By industry, education and health care & social working-age population and labour force assistance have been a consistent source of participation rose to a record level, but the unemployment rate increased. Economic growth is expected to gradually strengthen. Graph 2.1 Partial indicators suggest economic growth was Labour Force % % firmer in the June quarter partly because of Participation rate stronger growth in resource exports. 65.0 65.0
Employment growth has been strong … 62.5 62.5 Employment growth has remained strong at 2.6 per cent over the year to the June quarter. 60.0 60.0 Employment to working-age population Growth in employment has exceeded population growth and the share of the 57.5 57.5 2003 2007 2011 2015 2019 working-age population employed is close to a Source: ABS record-high level (Graph 2.1). In the June quarter, the bulk of growth was in part-time Graph 2.2 employment, though full-time employment has Participation Rate accounted for most of the growth over the past By age and sex % % year. Strong labour demand has been met 15–24 25–54 55–64 65+ Males recently by an increase in labour supply that has 80 80 seen the participation rate increase further to a 60 60 record-high level. More people are entering the Females workforce as opportunities arise, particularly 40 40 young people and women aged 25–45 years; older workers are also retiring later than in the 20 20 past (Graph 2.2). 0 0 1979 1999 2019 1999 2019 1999 2019 1999 2019
Sources: ABS; RBA
STATEMENT ON MONETARY POLICY – AUGUST 2019 25 employment growth (Graph 2.3). This reflects remains slightly lower than it was a year ago. longer-term trends in demand in the economy, Unemployment rates have increased across especially for health-related jobs as the most states in recent months, with Western population ages and the National Disability Australia a notable exception. Insurance Scheme (NDIS) is rolled out across It remains likely that the labour market can Australia. While employment in professional, absorb additional labour demand before scientific & technical services has picked up in anything more than gradual upward pressure is recent quarters, there has been little generated for wage and price inflation. employment growth elsewhere in the business Estimates of the unemployment rate associated services sector over the past year. Despite the with full employment are subject to recent moderation in residential building considerable uncertainty. However, given that activity, employment in the construction wage and price inflation have been lower than industry has continued to rise, though at a past relationships would have suggested, it is slower pace than a year ago. likely that this rate has trended down recently, to perhaps be around 4½ per cent, although … but the unemployment rate has uncertainty around any estimate of full increased employment is high. The unemployment rate increased to 5.2 per cent in the June quarter (Graph 2.4). This Leading indicators suggest employment followed a period over late 2018 and early 2019 growth will moderate during which the unemployment rate was Forward-looking indicators of labour demand stable at around 5 per cent. The share of have moderated since mid 2018 (Graph 2.5). Job underemployed workers – who want and are vacancies declined slightly in the three months available to work additional hours – also to May, but remain at a high share of the labour increased in the June quarter. As a result, a force. Vacancies in health care continue to broader measure of labour market increase strongly, in line with the strength in the underutilisation, which captures both the hours employment data for this industry. By contrast, sought by the unemployed and the additional vacancies in construction and several other hours that underemployed people would like to industries have declined this year. Measures of work, has increased in recent months but job advertisements have declined further in
Graph 2.3 Graph 2.4 Employment by Sector Labour Market Cumulative change since 2011 % % ’000 ’000 Underutilisation rate* 900 900 Professional, Household scientific & 8 8 services technical services* 600 600 Unemployment rate**
Business services 300 300 5 5 Goods-related Underemployment rate* 0 Education* 0 Health care & Construction* social assistance* 2 2 -300 -300 2007 2011 2015 2019 2014 2019 2014 2019 2014 2019 * Hours-based measure * Select industry within sector ** Trend unemployment in dark blue Source: ABS Sources: ABS; RBA
26 RESERVE BANK OF AUSTRALIA Table 2.1: Demand and Output Growth Per cent March quarter December Year to March Share of GDP 2019 quarter 2018 quarter 2019 2017/18 GDP 0.4 0.2 1.8 100 Domestic final demand 0.1 0.4 1.6 99 – Consumption 0.3 0.4 1.8 56 – Dwelling investment −2.5 −2.9 −3.1 6 – Mining investment(a) −1.8 −7.4 −10.6 3 – Non-mining investment(a) 1.2 2.5 1.4 10 – Public consumption 0.8 2.0 5.1 19 – Public investment(a) 0.4 1.0 7.2 5 Change in inventories(b) −0.1 0.2 0.0 n/a Exports 1.0 −0.5 1.7 22 Imports −0.1 0.4 −0.5 −21 Mining activity(a) 0.9 −2.6 −1.6 13 Non-mining activity(a) 0.3 0.6 2.3 87 Farm GDP −0.2 −5.2 −6.8 2 Non-farm GDP 0.4 0.3 2.0 98 Nominal GDP 1.4 1.2 4.9 n/a Terms of trade 3.1 3.0 6.1 n/a (a) RBA estimates (b) Contribution to GDP growth Sources: ABS; RBA recent months, though the timing of public consumption. There were also further declines in holidays and the federal election can account for dwelling investment. Public demand remained some of the weakness in April and May. strong. Elevated infrastructure spending has Employment intentions in the NAB survey and been a recent feature of both public and private the Bank's liaison program have moderated, but investment; non-mining business investment remain above long-term averages. added modestly to growth in the March quarter though mining investment subtracted from it. Growth in the domestic economy That GDP growth has been subdued despite remained subdued in the March quarter strong employment growth implies very weak Real GDP increased by 0.4 per cent in the March growth in labour productivity: there has been quarter to be 1.8 per cent higher over the year little growth in non-farm labour productivity (Table 2.1; Graph 2.6; Graph 2.7). Subdued over the past three years. growth in income and lower housing prices in recent years continued to weigh on growth in
STATEMENT ON MONETARY POLICY – AUGUST 2019 27 Growth in household discretionary spending slowed further Graph 2.5 Household consumption grew by 0.3 per cent in Labour Market Indicators the March quarter to be 1.8 per cent higher over % ppt Per cent of labour force Employment intentions* NAB survey the year, the slowest rate of growth in several
2.5 15 years (Graph 2.8). In addition to subdued income Advertisements (DoESSFB) growth, weak housing market conditions have 2.0 0 contributed to the slowdown in consumption. Vacancies** (ABS) 3-months-ahead The slowdown in consumption growth in recent 1.5 -15 quarters has been more pronounced for
1.0 -30 Advertisements discretionary items, particularly those typically (ANZ) 12-months-ahead associated with housing turnover and 0.5 -45 2009 2014 2019 2009 2014 2019 household wealth (Graph 2.9). By category, year- * Net balance for the following period; deviation from average; 12-months-ahead measure seasonally adjusted by the RBA ended growth has eased the most since ** Survey was suspended between May 2008 and November 2009 Sources: ABS; ANZ; Department of Employment, Skills, Small and Family mid 2018 for furnishing & household equipment Business (DoESSFB); NAB; RBA and sales of new cars. More recent indicators suggest household Graph 2.6 consumption growth remained soft in the June GDP Growth % % quarter. Retail sales volumes grew by
Year-ended 0.2 per cent over the year to the June quarter,
4 4 the slowest rate of growth since the early 1990s; sales of household goods and at food retailers
2 2 declined over the year. Information from the Bank's business liaison program has indicated
0 0 that strong price rises for meat and vegetables Quarterly during the first few months of 2019, as a result of
-2 -2 supply shortages associated with the drought, 2003 2007 2011 2015 2019 Source: ABS contributed to reduced sales volumes for food. Sales of new cars to households declined in the June quarter and remained much lower than a Graph 2.7 year ago. Households' sentiment about the GDP Growth Year-ended contribution ppt ppt March 2018 March 2019 Graph 2.8 3 3 Household Consumption Growth % % 2 2 Year-ended 1 1 6 6
0 0 4 4
-1 -1 2 2
-2 -2 t t t t s s g n n n n n P t t g n r r n e e e o o g c i i i n D
i 0 0 e i t t o o l n l n m m m c i l i G p p i t t t p p b m l n e t s s s x
i Quarterly u m b m m m s - e e e w I E P u u u M e v v v n D s s v P n n n o i i i n n n i N o o -2 -2 c C 2007 2011 2015 2019 Sources: ABS; RBA Source: ABS
28 RESERVE BANK OF AUSTRALIA economic outlook has declined in recent although these tax payments declined slightly in months but sentiment towards their current the March quarter. Nominal income growth was finances has improved; both measures are close a little faster than growth in household to their long-run average. consumption spending, so the household saving ratio increased for the second Non-labour sources of income consecutive quarter. continued to weigh on household Year-ended growth in disposable income is income growth expected to remain subdued in the June Household disposable income grew by quarter, before picking up over the second half 0.8 per cent in the March quarter and growth of 2019. The reductions in the cash rate in June remained subdued in year-ended terms at and July and application of the low- and middle- 2.3 per cent (Graph 2.10). Growth in labour income tax offset will boost disposable income income supported household disposable in the September quarter. income growth in the March quarter, consistent with strong employment growth. Non-labour income declined by 0.3 per cent in the March quarter, however, and year-ended growth slowed to 1.5 per cent. Income from Graph 2.10 unincorporated businesses declined in the Household Disposable Income Growth quarter and over the year because of lower Nominal, year-ended with contributions % % residential construction activity, lower turnover Total Non-labour income Labour income Income payable* in the housing market and weakness in the 10 10 farming sector (Graph 2.11). Growth in other forms of non-labour income, such as social 5 5 assistance and rental income, also remained low. Strong growth in household tax payments of 0 0 7.6 per cent over the year to the March quarter has weighed on disposable income growth, -5 -5 2011 2013 2015 2017 2019 * Includes tax and interest payments Sources: ABS; RBA Graph 2.9 Household Consumption Growth Year-ended with contributions % % Graph 2.11 Total 4 4 Unincorporated Business Income Year-ended contribution to household disposable income Discretionary* ppt ppt 3 3 Total Farm Non-farm 2 2 2 2
1 1 1 1 0 0 Essential**
-1 -1 0 0 2011 2013 2015 2017 2019 * Includes furnishing & household equipment, clothing & footwear, recreation & culture, motor vehicles, alcohol & tobacco, air & water transport, hotels, cafes & restaurants, and ‘other goods and services’ ** Calculated as a residual; includes categories such as food, housing, -1 -1 health, education and utilities 2011 2013 2015 2017 2019 Sources: ABS; RBA Sources: ABS; RBA
STATEMENT ON MONETARY POLICY – AUGUST 2019 29 Dwelling investment continued to Established housing markets appear to decline have stabilised Private dwelling investment declined by Conditions in a number of housing markets 2.5 per cent in the March quarter and by have stabilised recently, following the removal of 3.1 per cent over the year (Graph 2.12). The uncertainty that preceded the federal election, quarterly decline was broad based across APRA's announcement of proposed changes to dwelling investment types. The pipeline of work mortgage serviceability requirements and the to be done remains at a high level, particularly lowering of the cash rate. After declining for for higher-density projects in New South Wales more than a year, established prices in Sydney and Victoria, though it has declined in most and Melbourne increased slightly over recent states (Graph 2.13). The number of dwellings in months (Table 2.2; Graph 2.14). Auction the pipeline is expected to continue to fall as clearance rates have strengthened further in completions outpace approvals. Residential Sydney and Melbourne on low auction volumes building approvals declined further over May (Graph 2.15). The share of households expecting and June, to be more than 20 per cent lower further price declines has eased in recent over the year. consumer surveys. Conditions in the earlier stages of residential Conditions remain subdued in established property development remain weak. Contacts in housing markets outside Sydney and the Bank's liaison program indicate that demand Melbourne, though they have recovered a little for new houses and apartments has remained in most capital cities and some regional areas around the low levels of late 2018. Given this, more recently. Prices increased in July in the typical lags between the sale and Brisbane, following declines for most of the past construction of new dwellings imply that the year. The size of price declines in some other decline in dwelling investment will continue for areas, including Perth, have moderated in recent some time, despite the recent signs of months. stabilisation in the established housing market. Rental vacancy rates were below their long-run average in the March quarter in most cities (Graph 2.16). The Perth rental market has tightened since mid 2017; vacancy rates have fallen and advertised rent inflation has turned
Graph 2.12 Graph 2.13 Residential Dwelling Pipeline* Dwelling Investment Growth ’000 ’000 Year-ended with contributions By type Mainland states % % NSW Total 10 10 Higher-density 200 80
5 5 Vic Total Qld 0 0 Higher-density Detached 100 40
-5 -5 WA Detached SA -10 -10 Alterations & additions 0 0 2007 2013 2019 2007 2013 2019 -15 -15 * Includes dwellings approved but not yet commenced and private 2009 2011 2013 2015 2017 2019 dwellings under construction Sources: ABS; RBA Sources: ABS; RBA
30 RESERVE BANK OF AUSTRALIA Table 2.2: Growth in Housing Prices Percentage change, seasonally adjusted Growth over previous five July June May April Year-ended years Sydney 0.1 0.0 −0.5 −0.7 −9.0 18 Melbourne 0.2 0.1 −0.5 −0.6 −8.2 24 Brisbane 0.3 −0.4 −0.4 −0.4 −2.4 7 Adelaide −0.3 −0.3 −0.0 −0.3 −0.8 10 Perth −0.4 −0.7 −0.9 −0.6 −8.9 −20 Darwin 0.2 −0.8 −1.1 −1.1 −8.7 −29 Canberra 0.0 −0.4 −0.1 0.1 1.1 22 Hobart 0.3 0.3 −0.1 −1.1 2.8 36 Capital 0.1 −0.1 −0.4 −0.6 −7.3 13 cities Regions 0.0 −0.1 −0.2 −0.4 −3.0 11 National 0.1 −0.1 −0.4 −0.6 −6.4 13 Sources: CoreLogic; RBA positive. Sydney rental vacancy rates remain an of private ownership transfer costs in the March outlier and have risen further, particularly in quarter, which subtracted 0.2 percentage points areas where the supply of new apartments has from quarterly GDP growth. Private ownership increased significantly; advertised rents have transfer costs measure the services associated declined over the past year. with buying housing, including costs such as Despite some stabilisation in established market fees and commissions paid to real estate agents, conditions, housing market turnover remains auctioneers and lawyers and stamp duty. This around its lowest level in recent decades. The component will be less of a drag on GDP growth decline in housing market turnover led to a as turnover in the housing market stabilises. sharp decline in the national accounts measure
Graph 2.14 Graph 2.15 Housing Prices Auction Clearance Rates Seasonally adjusted, December 2013 = 100 % Sydney % index index Sydney 80 80
140 140 60 60 Hobart Weekly 40 40 Melbourne Monthly* 120 120 Canberra % Melbourne % Brisbane Adelaide Regional 80 80 100 100 60 60 Perth Darwin 80 80 40 40
20 20 60 60 2009 2011 2013 2015 2017 2019 2016 2019 2016 2019 * Seasonally adjusted Sources: CoreLogic; RBA Sources: APM; CoreLogic; RBA; REIV
STATEMENT ON MONETARY POLICY – AUGUST 2019 31 Household net wealth was unchanged in the 2019/20 . After this, the reduction in the March quarter because declines in housing consolidated deficit is expected to occur more prices were offset by an increase in financial gradually than the contraction that occurred in wealth. In the June quarter, equity prices 2017/18 . The federal government cash balance increased further and declines in housing prices is projected to be in surplus by 2019/20 , while were smaller, which should have supported the deficit of the states and territories is growth in household net worth. projected to peak this year (Graph 2.18).
Public demand has supported Infrastructure investment has been economic growth strong Strong growth in public demand has continued Investment in infrastructure has picked up over the recent trend of contributing a larger share of recent years (Graph 2.19). This has been led by economic growth as private demand has slowed both public and private investment in transport (Graph 2.17). Public demand increased by infrastructure in metropolitan areas. There has 0.8 per cent in the March quarter to be also been a large increase in electricity-related 5.5 per cent higher over the year. Growth in public consumption was driven by ongoing Graph 2.17 federal government spending on social benefits Domestic Final Demand Growth* to households, reflecting the rollout of the NDIS Year-ended with contributions % % and increased spending on the Pharmaceutical Benefits Scheme. Public investment, which Total 4 4 includes spending on infrastructure and public Private demand buildings across all levels of government, grew 2 2 strongly over the year.
The projections for the underlying cash balance 0 0 Public demand across the latest consolidated government
budgets is mostly unchanged since last year's -2 -2 2009 2011 2013 2015 2017 2019 updates. The underlying cash deficit is expected * Adjusted for second-hand asset transfers between the public and other sectors to be around 1 per cent of GDP in 2018/19 and Sources: ABS; RBA
Graph 2.16 Graph 2.18 Rental Vacancy Rates Consolidated Government Balance Quarterly, seasonally adjusted Underlying cash balance, per cent of GDP % % % Total Federal Forecasts % 6 6 Previous* States and territories Australia* Melbourne** 2 2 4 4
2 2 Sydney 0 0 % %
9 9 -2 -2 Brisbane Perth 6 Canberra 6 -4 -4 3 3
0 0 -6 -6 1993 2006 2019 1993 2006 2019 82 / 83 90 / 91 98 / 99 06 / 07 14 / 15 22 / 23 * Capital cities excluding Adelaide, Darwin and Hobart * Updated 2018/19 budgets; includes federal mid-year economic ** Series break December quarter 2002 and fiscal outlook Sources: RBA; REIA Sources: ABS; Australian Treasury; RBA; State and territory budgets
32 RESERVE BANK OF AUSTRALIA infrastructure spending, particularly private- (Capex) survey suggest capital expenditure on sector renewable energy projects. The pipeline machinery & equipment investment will ease; of infrastructure work yet to be done suggests that said, early estimates of capital expenditure the level of activity will remain elevated in have historically been subject to a large degree coming years, supported by roads and electricity of uncertainty. (particularly renewables) projects. Consistent with the slower growth outlook for non-mining business investment, survey Growth in other non-mining investment measures of expected capital expenditure and has slowed over the past year business conditions have eased since early 2018 Non-mining investment apart from and remain close to average for most industries; infrastructure remains elevated, but has been conditions are more subdued in the retail and growing slowly over the past year. In particular, transport & utilities industries (Graph 2.22). By growth in non-residential building investment contrast, non-mining profits increased strongly has slowed, after a period of strong growth over in the March quarter and should support 2017 and the first half of 2018. However, conditions for firms to invest. building approvals remain around their average since 2016 and the stock of work yet to be done on private non-residential buildings remains Graph 2.20 elevated, reflecting work underway on offices, Non-residential Building Activity warehouses and other commercial buildings $b Building approvals $b
(Graph 2.20). 4 4 Investment in machinery & equipment and 2 2 other assets has also been growing at a subdued % Private building work yet to be done % pace (Graph 2.21). In contrast, firms' investment Per cent of quarterly GDP in computer software has increased steadily in 6 6 recent years. Investment intentions for 2019/20 3 3 reported by non-mining firms in the Australian 0 0 Bureau of Statistics (ABS) Capital Expenditure 2003 2007 2011 2015 2019 Sources: ABS; RBA
Graph 2.19 Infrastructure Work Done* Graph 2.21 Share of nominal GDP % By sector % Non-mining Investment* Chain volume 4 4 $b $b 3 3 Machinery & equipment 2 2 15 15 1 1
% By asset % 4 4 10 10 Non-residential construction 3 3
2 2 Other** 5 5 1 1 0 0 Software 02 / 03 06 / 07 10 / 11 14 / 15 18 / 19 Private Roads & bridges Electricity 0 0 Public Railways Other 2007 2011 2015 2019 * * Excludes explicitly identified resources and other heavy industry RBA estimates of new investment projects, but captures some resource-related work; 2018/19 includes ** Includes cultivated biological resources (mainly livestock, vineyards projections for the June quarter and orchards), research & development and artistic originals Sources: ABS; RBA Sources: ABS; RBA
STATEMENT ON MONETARY POLICY – AUGUST 2019 33 Mining investment and resource to the broader economy from the boost to exports are expected to recover from national income (for more discussion, see Box B: recent soft outcomes The Recent Increase in Iron Ore Prices and Mining investment declined further in the March Implications for the Australian Economy). quarter as construction on the remaining liquefied natural gas (LNG) projects continued to Drought conditions have weighed on wind down. The decline in the quarter, taken the farm sector together with the recent Capex survey for Drought conditions have persisted across south- 2018/19 , suggests that mining investment is eastern Australia, although some regions have around its trough (Graph 2.23). Information from had rainfall in recent months, particularly South the Capex survey for 2019/20 , the Bank's liaison Australia, Victoria and southern New South program and company announcements Wales. Farm GDP has fallen by around 7 per cent continue to suggest that mining investment will since the middle of 2018, driven by lower crop pick up gradually over the next year or so as production. With lower output and elevated mining firms invest to sustain production levels input costs (including higher feed and water and, in some instances, expand productive costs), nominal farm profits declined by capacity. 6 per cent in the March quarter, to be Resource export volumes were unchanged in the March quarter, as a strong rebound in non- Graph 2.23 monetary gold exports offset declines in other Mining Capital Expenditure* resource exports (Graph 2.24). Partial trade data Nominal $b Machinery & equipment Buildings & structures $b suggest that resource exports should increase in
the June quarter. Growth is expected to be led 60 90
by LNG exports, as recently completed projects National accounts ramp up production, and iron ore exports as 40 60 Previous they recover from supply disruptions including
Tropical Cyclone Veronica in late March. The 20 30 strength in iron ore prices over recent months is Estimates
not expected to affect resources sector activity 0 0 09 / 10 14 / 15 19 / 20 09 / 10 14 / 15 19 / 20 directly, although there are likely to be spillovers * Estimates are firms’ expected capital expenditure; adjusted for past average differences between expected and realised spending Sources: ABS; RBA
Graph 2.22 Business Conditions by Industry* Graph 2.24 Net balance, deviation from long-run average ppt ppt Resource Export Volumes $b $b
Retail Metal ores and minerals Other mineral fuels 20 20 (incl LNG) (incl iron ore)
20 8
0 0 Non-monetary gold
-20 -20 10 4 Transport & utilities All other industries Coal, coke and briquettes Metals -40 -40 1999 2003 2007 2011 2015 2019 0 0 * Three-month moving average 2009 2014 2019 2009 2014 2019 Sources: NAB; RBA Sources: ABS; RBA
34 RESERVE BANK OF AUSTRALIA 24 per cent lower than June quarter 2018. The couple of years. The importance of travel most recent climate outlook published by the services to Australia's export base has increased Bureau of Meteorology indicates that drier-than- considerably over the past two decades, from average conditions are expected for large parts around half of total service exports in the early of the country over the next three months, 2000s to around two-thirds more recently, with which suggests further weakness in activity in most of the increase driven by education-related the rural sector in coming quarters. travel exports (Graph 2.26). Rural exports increased solidly in the March Growth in total import volumes has eased over quarter, because strong growth in meat exports the past year or so, alongside slower growth in more than offset continued weakness in cereal both public and private investment, which are exports (Graph 2.25). Dry conditions have kept relatively import-intensive components of slaughter rates elevated over recent months and expenditure. Partial data suggest that import demand for meat products has been supported volumes declined modestly in the June quarter. by strong overseas demand and a lower An increase in Australia's export volumes, higher Australian dollar. Assuming that seasonal export prices, and a modest decline in import conditions gradually return to average over the volumes resulted in a further increase in the next year or so, meat exports should ease from trade surplus in the March quarter, to its highest their elevated levels as producers focus on herd share of nominal GDP since the March quarter rebuilding. 1973 (Graph 2.27). Available data suggest another sizeable trade surplus is expected in the Service and manufactured exports June quarter. The recent increases in the trade continue to grow steadily surplus have offset some widening in the net Australia's service and manufactured exports income deficit, leaving the current account have grown steadily over recent years, deficit at its narrowest as a share of GDP since supported by the continued economic the late 1970s. The widening in the net income expansion in Australia's major trading partners deficit over the past couple of years is consistent and a modest depreciation of the Australian with a pick-up in dividend payments to non- dollar. Increasing enrolments of overseas residents because revenues in the largely students and visitor arrivals should continue to foreign-owned mining sector have increased. support growth in service exports over the next
Graph 2.25 Graph 2.26 Rural Exports Travel Service Exports Growth Chain volume, quarterly Chain volume, year-ended with contributions $b Meat Cereal grains $b % % Total 3.5 3.0 12 12 Other personal* 3.0 2.0 8 8 2.5 1.0 Education
4 4 $b Wool and sheepskins Other rural* $b 1.4 6.0 0 0 1.1 4.5 Business -4 -4 0.8 3.0
0.5 1.5 -8 -8 2005 2012 2019 2005 2012 2019 2007 2010 2013 2016 2019 * Includes horticulture and dairy exports * Includes tourism Sources: ABS; RBA Sources: ABS; RBA
STATEMENT ON MONETARY POLICY – AUGUST 2019 35 Graph 2.27 Current Account Balance Per cent of nominal GDP % % Current account balance
0 0
-4 -4
% % Trade balance 0 0
-4 -4 Income balance
-8 -8 1967 1980 1993 2006 2019 Sources: ABS; RBA
36 RESERVE BANK OF AUSTRALIA Box B The Recent Increase in Iron Ore Prices and Implications for the Australian Economy
Iron ore prices have increased sharply from Western Australian ports by close to in recent months 25 million tonnes (around 3 per cent of Developments in the global iron ore market Australia’s annual export volumes). are important for Australia’s economy. Meanwhile, demand for iron ore has been Australia is the largest global producer and strong in recent months as Chinese steel exporter of iron ore and in 2018 exported production has been increasing, supported around 830 million tonnes of iron ore worth by policy measures targeted at steel- A$63 billion. This accounted for around intensive infrastructure projects. Although 15 per cent of total exports by value, and was trade tensions are creating significant equivalent to 3.3 per cent of nominal GDP. uncertainty for the global economic outlook, Between late January and mid July the benchmark iron ore spot price increased Graph B1 significantly. Although this price has declined Iron Ore Prices sharply in recent days as global trade US$/t US$/t tensions have escalated, it remains around Spot price* 150 150 25 per cent higher than at the start of the Consensus forecast July 2019 year, and well above the levels of recent years 100 100 (Graph B1). A key driver of the recent price increase has been a significant decline in iron 50 50 Consensus forecast ore production in Brazil, following a tailings January 2019 dam collapse earlier this year and the 0 0 2009 2012 2015 2018 2021 subsequent closure of several mines. Brazil is * 62% Fe Fines index; free on board basis; monthly average; actual prices received may vary based on product characteristics the second-largest exporter of iron ore, and Sources: Bloomberg; Consensus Economics these closures sidelined around 6 per cent of global seaborne supply (Graph B2). While Graph B2 some production has come back online Iron Ore and Steel Market recently, market reports suggest that it could Mt Chinese iron ore port inventory Mt 160 160 take two to three years for Brazilian exports to 130 130 return to their former capacity. 100 100 Mt Iron ore exports Mt 75 75 In recent months, shorter-term supply 50 Australia 50 25 25 disruptions to Australian iron ore exports Brazil Mt Chinese steel production Mt have also affected the global iron ore market. 80 80 The most notable of these disruptions was 70 70 60 60 Tropical Cyclone Veronica in late March, 50 50 2015 2016 2017 2018 2019 which reduced large firms’ iron ore exports Sources: ABS; Bloomberg; CEIC Data; RBA
STATEMENT ON MONETARY POLICY – AUGUST 2019 37 Chinese policy measures are expected to However, iron ore mining firms continue to continue to support demand for steel in the invest to sustain production levels, as part of near term. Iron ore prices are therefore their long-term plans.[2] Over recent years expected to remain elevated over the near Australian iron ore capital expenditure has term but to decline gradually over coming averaged around 0.5 per cent of nominal years as global supply increases and demand, GDP. Sustaining investment is expected to particularly from China, slowly eases.[1] increase over the next few years as several large replacement iron ore mines are Higher prices are unlikely to see constructed in Western Australia. But the much lift in export volumes or amount of investment expected over coming investment in additional capacity … years is much lower than a decade ago, when The recent strength in iron ore prices is not iron ore production capacity expanded expected to drive much of a near-term significantly in response to a large increase in increase in iron ore production in Australia, global demand. During that period, beyond what was already in train. Australian investment in other parts of the resource export volumes have recovered over the past sector also increased strongly, and there were few months as disruptions have been large spillovers to the rest of the economy resolved, but production was already near full through employment, wages and non- capacity before the disruptions, so volumes mining activity more broadly. have little scope to increase much further in the near term (Graph B3). Some smaller … and the boost to incomes is likely producers could increase their exports, either to increase GDP growth only a little through shipping stockpiled lower-grade ore While higher iron ore prices are therefore or increasing production rates at existing unlikely to have much direct effect on operations, but available information domestic mining sector activity, mining firms’ suggests this might boost annual iron ore profits could be significantly higher, which export volumes by only around 1 per cent. will have some indirect effects on the broader Because Brazilian production is expected to economy. continue recovering, market participants expect that prices will ease further (Graph B1). The recent strength in prices is Graph B3 therefore not expected to spur additional Iron Ore Investment and Exports % Mt investment in expanding production in
2.0 200 Australia, given that such projects take Iron ore exports several years to plan and build. While there is (RHS) 1.5 150 renewed interest in expansionary projects for very high grade (magnetite) ore, this appears 1.0 100 Capital expenditure to be driven primarily by expectations of (share of nominal GDP, LHS) 0.5 50 strong future demand for such products rather than a response to the recent strength 0.0 0 2009 2011 2013 2015 2017 2019 in prices. Sources: ABS; RBA
38 RESERVE BANK OF AUSTRALIA In the first instance, recent higher prices will profits will increase household income, which boost state and federal government in turn could be used for household revenues, through mining royalties and consumption. A lift in household wealth company income tax payments, although because of higher mining company share these will be received with lags (ranging from prices may further support household a few months to over a year). Iron ore prices consumption. have followed a higher path than was Higher iron ore prices are therefore likely to expected at the time the 2019/20 state and increase nominal incomes in the Australian federal budgets were prepared. The iron ore economy for a period. Given the recent price was around US$90 per tonne in May, strength in prices, and assuming prices and the federal budget assumed prices gradually decrease in line with the path would decline to US$65 per tonne by March suggested by market expectations, nominal quarter 2020. Since then, the iron ore price household disposable income and govern- reached as high as US$120 and, despite ment revenue combined could be around recent declines, is still around levels A$5–10 billion higher each year on average prevailing in early May. A period of higher- over the next few years, relative to a scenario than-expected prices is likely to mean where prices had evolved as was expected in significantly more revenue being realised early 2019. than was factored into the budget Focusing just on this flowthrough of higher outlooks.[3] Should the public sector spend prices to the household and public sectors, some of this higher income on consumption the effect on the economy could be fairly or investment, or if it is distributed to and small.[5] The effect would be a little larger if then spent by other sectors in the economy, households or the public sector spent more this will boost GDP growth. of the extra income or if iron ore prices Stronger mining firm profits will also boost stayed higher for longer than currently household sector incomes via shareholdings. expected, but smaller if the exchange rate Estimates suggest between a fifth and a appreciated in response to higher quarter of the Australian iron ore mining commodity prices. However, the ultimate industry is owned by the Australian effect on the economy is difficult to predict, household sector (either through direct given the uncertain outlook for iron ore holdings or via intermediaries such as prices and that, as other episodes of superannuation funds), with most of the commodity price strength have [4] remainder owned by foreign investors. demonstrated, higher prices and incomes Market expectations and guidance from could affect the economy through other mining firms suggest that much of the channels. increase in profits could be returned to shareholders. The distribution of higher
Endnotes [1] See also RBA (2017), ‘Box A: The Chinese Steel Market and Demand for Bulk Commodities’, Statement on Monetary Policy, November, viewed 7 August 2019. Available at
STATEMENT ON MONETARY POLICY – AUGUST 2019 39
40 RESERVE BANK OF AUSTRALIA 3. Domestic Financial Conditions
Domestic financial conditions are Investors expect a further reduction in accommodative for most households and large the cash rate later this year businesses, and have become increasingly so The cash rate target stands at 1.0 per cent, following the reductions in the cash rate in June following two 25 basis point reductions at the and July. Financial market prices imply that June and July Board meetings. Financial market market participants expect the cash rate to be prices imply that participants expect the cash reduced by a further 25 basis points later this rate to be lowered by a further 25 basis points year. Government and corporate bond yields later in 2019 (Graph 3.1). have continued to decline over 2019 across all maturities to be at historic lows. Banks' funding Government bond yields have costs also declined to historically low levels. continued to decline Notwithstanding recent declines, Australian Yields on Australian Government Securities equity prices have risen across all sectors since (AGS) have declined over 2019 across all the start of the year. The value of the Australian maturities, with 10-year AGS yields reaching a dollar is at its lowest level in some time. historic low of around 1 per cent (Graph 3.2). In Banks have passed through most of the recent months this has reflected expectations reductions in the cash rate to housing interest for an easing of monetary policy, and was rates and to retail deposit rates. Both housing broadly in line with changes in yields on loan and deposit rates are very low by historical government securities in a number of advanced standards, as are rates on business loans. Growth economies; weaker-than-expected domestic in housing credit continued to decline, largely data also contributed. The spread between US reflecting weaker demand for housing over the past year. However, there was a rise in housing loan approvals in the month of June, consistent Graph 3.1 Cash Rate* with improvement in other indicators of housing % % market conditions. Meanwhile, growth in 7 7 business debt remains higher than the average 6 6 of recent years. However, this has been driven 5 5 entirely by lending to large businesses, whereas 4 4 access to funding for small businesses has 3 3 tightened further over the past year or so. 2 2
1 1
0 0 2000 2004 2008 2012 2016 2020 * Data from September onwards are expectations derived from interbank cash rate futures Sources: ASX; Bloomberg
STATEMENT ON MONETARY POLICY – AUGUST 2019 41 Treasury and AGS yields has stabilised, with the Banks' senior bond issuance has AGS 10-year yield around 75 basis points below slowed … the 10-year US Treasury yield. AGS yields for even Australian banks have issued bonds at a slower longer maturities have also declined over 2019. pace than in previous years, with around The yield on the longest AGS (maturing in March $60 billion of bonds issued in the first seven 2047) has declined by around 110 basis points months of 2019 (Graph 3.4). Given that the over 2019, to be below 1.70 per cent. volume of scheduled maturities is higher than gross issuance, this means that net issuance is Short-term money market spreads have negative. The decline in net issuance is narrowed a little further consistent with lower funding needs due to After declining over the first quarter of this year, slower asset growth. In July, the Australian spreads of interest rates to overnight indexed Prudential Regulation Authority (APRA) swaps (OIS) in the markets for bank bills and announced that it would require major banks to foreign exchange (FX) swaps declined a little increase their total capital by 3 percentage further in recent months. The spread of 3-month points by January 2024. It is likely that this bank bills relative to OIS moved lower over the additional capital will be sourced from issuance June quarter, to be around 15 basis points, of Tier 2 hybrid instruments. Hybrid securities which is around its lowest level in the past 5 have both equity and debt features and can be years (Graph 3.3). Similarly, the cost of raising used to fulfil a part of regulatory capital US dollar funding and then converting these requirements. Because this capital represents an funds into Australian dollars for a short term in additional source of bank funding, this the FX swap market declined a little relative to requirement is also likely to reduce the need for OIS over recent months. Repurchase agreement banks to issue senior unsecured debt for a time. (repo) rates were little changed relative to OIS overall in recent months. The cash rate … while RMBS issuance increased in the continued to trade at the Reserve Bank Board's June quarter target. Issuance of residential mortgage-backed securities (RMBS) increased strongly in the June quarter to its highest level since the global
Graph 3.3 Graph 3.2 Australian Dollar Money Market Spreads Spread to OIS Australian Yield Curve bps bps % % 3-month BBSW RBA Repo 3-month AUD/USD Swap* 2.25 2.25 80 80
2.00 2.00 60 60 1.75 1.75 40 40 1.50 1.50 Previous SMP 1.25 1.25 20 20
1.00 1.00 0 0 0.75 0.75 07-Aug-19 -20 -20 0.50 0.50 2017 2019 2017 2019 2017 2019 1 2 3 4 5 6 7 8 9 10 20 30 * Implied cost of offshore issurance in US dollars swapped back to Maturity (years) Australian dollars Sources: RBA; Yieldbroker Sources: ASX; Bloomberg; RBA
42 RESERVE BANK OF AUSTRALIA financial crisis (Graph 3.5). The increase was yields to reference rates also declined over the driven by non-authorised deposit-taking first half of the year (Graph 3.6). institutions (non-ADIs) and non-major banks; this reflects the strong credit growth in 2018 by Banks passed through most of the cash non-ADIs (who are largely funded via rate cuts to retail deposit rates securitisations). Over recent months, banks lowered the interest rates on a large share of the value of their retail Banks' funding costs continued to deposits (which account for one-third of debt decline to new historical lows funding) (Graph 3.7). As is typical, however, the Banks' funding costs are at a very low level, interest rates on transaction accounts (which are reflecting both low wholesale funding costs – close to zero) did not change following the including as a result of decreases in bank bill reductions in the cash rate. Other at-call deposit swap (BBSW) rates – and low deposit rates. Bank rates are estimated to have decreased by 40 to bond yields have declined since the since the 45 basis points. A number of banks also reduced start of 2019, in line with declines in other their interest rates on term deposits by around market rates. The spreads of major bank bond 20 to 60 basis points over recent months.
Graph 3.6 Major Banks' Bond Pricing Graph 3.4 Domestic market; 3-year target tenor % bps Bank Bond Issuance Yields Bank bond spreads $b Gross issuance Net issuance $b
Unsecured 8 200 120 25 Spread 2018 Swap to AGS Average (2012-18) 80 0 4 100 2019 AGS 40 -25 Spread to swap 0 0 Range (2012–18) 2009 2014 2019 2009 2014 2019 0 -50 M J S D M J S D Sources: Bloomberg; RBA Sources: Bloomberg; Private Placement Monitor; RBA
Graph 3.7 Graph 3.5 Major Banks’ Retail Deposit Rates Australian RMBS $10 000 deposits % % $b Issuance Major banks $b Other banks Non-ADIs 20 20 8 8 Term deposit specials* 10 10 6 6 Bonus savers bps Primary market pricing bps 4 4 300 300 Non-conforming deals Non-ADI conforming deals 200 200 2 2 100 100 Online savers** ADI conforming deals 0 0 0 0 2007 2011 2015 2019 2007 2011 2015 2019 * * Face-value weighted monthly average of the primary market spread Average of 1–12, 24-, 36- and 60-month terms to bank bill swap rate for AAA rated notes ** Excludes temporary bonus rates Sources: Bloomberg; KangaNews; RBA Sources: Canstar; major banks' websites; RBA
STATEMENT ON MONETARY POLICY – AUGUST 2019 43 Prior to the most recent reduction in the cash The average outstanding interest rate paid had rate in July, the major banks reported in June already been drifting lower over the eight that they paid no interest on just under months before June, reflecting the fact that 10 per cent of the value of their (retail and interest rates on new loans remain well below wholesale) deposits (Graph 3.8). This share is those on outstanding loans and existing estimated to have increased only marginally customers have been refinancing at these lower since February. The share of deposits that paid rates. In addition, customers have been some interest, but less than 50 basis points, was continuing to switch from interest-only to also a little under 10 per cent in June (up from principal-and-interest loans with lower interest around 5 per cent of deposits in February). rates. Consistent with this, liaison with the major banks, mortgage brokers and non-ADI lenders Lenders passed through most of the indicates that competition for high-quality cash rate cuts to housing interest rates borrowers remains strong. Following the reductions in the cash rate, Interest rates on fixed-rate housing loans also lenders reduced their standard variable rates continued to decline. Advertised fixed rates have (SVRs) on housing loans by an average of fallen substantially over the past year. This is 44 basis points (23 basis points in June and consistent with lower interest rate swap rates, 21 basis points in July). The extent of pass- which are often used as a pricing benchmark. through was similar across different types of banks. Credit growth slowed across all The average interest rate paid on outstanding components variable-rate loans in the Securitisation Dataset Total credit growth slowed to 2¼ per cent on a decreased by 23 basis points in June, the same six-month-ended annualised basis in June as the average reduction in SVRs announced by (Graph 3.11 and Table 3.1). This was driven by a the banks (Graph 3.9 and Graph 3.10). Moreover, slowing in housing and business credit growth, preliminary data suggest that actual rates paid although growth of a broader measure of on new loans decreased by more than the SVR business debt has been stable over the course of decreases in the June quarter for some banks. this year.
Graph 3.8 Graph 3.9 Major Banks' Deposits by Interest Rate* Share of deposits; as at end June 2019 Variable Housing Interest Rates % % % % At-call Term 40 40 5.5 5.5 Standard variable reference rate* 30 30 5.0 5.0
Outstanding loans** 20 20 4.5 4.5
10 10 4.0 4.0 New loans***
0 0 3.5 3.5 s 0 .25 0.5 .75 –1 .25 .25 nt 2015 2016 2017 2018 2019 –0 5– –0 .75 –1 >1 ou 0 .2 .5 0 1 cc * 0 0 t a Average across major banks' rates; data to July fse ** Of Data from the Securitisation Dataset, re-weighted using housing credit shares; data to June * Interest rates were estimated as weighted average rates for various *** Average new variable lending rates based on APRA quarterly data; deposit product types by depositor type data to June; latest observation preliminary Sources: Major banks; RBA Sources: APRA; major banks' websites; RBA; Securitisation System
44 RESERVE BANK OF AUSTRALIA Table 3.1: Financial Aggregates Percentage change(a) Three-month-ended annualised Six-month-ended annualised Mar Jun Dec Jun 2019 2019 2018 2019 Total credit 3.1 1.4 4.3 2.2 – Housing 3.1 2.7 4.1 2.9 – Owner-occupier housing 4.4 4.1 5.6 4.2 – Investor housing 0.3 –0.2 1.0 0.0 – Personal –3.9 –4.4 –2.8 –4.1 – Business 4.4 –0.2 6.1 2.1 Broad money 9.9 1.9 2.2 5.8 (a) Seasonally-adjusted and break-adjusted Sources: ABS; APRA; RBA
From the July 2019 release onwards, the financial occupiers picked up in June but were little aggregates published by the Reserve Bank will changed in the first half of 2019, after declining incorporate an improved conceptual framework from their 2017 peak (Graph 3.13). and a new data collection. The changes are likely Housing credit for investors was unchanged to result in revisions, some of which may be over the past six months. Credit extended by the significant. For further information about the major banks to investors has contracted since upcoming changes and the new data collection, mid 2018. Investor credit extended by other see Updates to Australia's Financial Aggregates. financial institutions has been a little stronger Housing credit extended to owner-occupiers and has offset the reduction of investor lending grew by around 4¼ per cent on a six-month- by the major banks in recent months. Loan ended annualised basis over the first half of approvals to investors have declined for the past 2019, down from its recent peak of 10 per cent two years, to be around 50 per cent below their in 2016 (Graph 3.12). Loan approvals to owner-
Graph 3.10 Graph 3.11 Variable Housing Interest Rates* Credit Growth by Sector* Outstanding loans Six-month-ended annualised % % % Owner-occupier Investor % Housing 5.5 5.5 20 20 Interest-only
5.0 5.0 10 10
4.5 4.5 Total**
Principal-and-interest 0 0 4.0 4.0
Business 3.5 3.5 -10 -10 2017 2019 2017 2019 2003 2007 2011 2015 2019 * * Average of securitised loans, re-weighted using housing credit Seasonally adjusted and break-adjusted; including securitisation shares; data to June ** Includes housing, personal and business credit Sources: RBA; Securitisation System Sources: ABS; APRA; RBA
STATEMENT ON MONETARY POLICY – AUGUST 2019 45 level in early 2017, although they, too, increased However, consistent with the increase in loan slightly in June. approvals in June, in liaison some lenders have reported tentative signs of a pick-up in Demand for housing credit remains applications since May. weak … The soft conditions in the housing market have … and banks' assessment of mortgage contributed to the slowing in housing credit applications continues to evolve growth over the past couple of years. The Housing credit conditions tightened following declines in housing prices and the associated the strengthening of lending policies and reduction in housing turnover have reduced the practices over recent years. These changes demand for credit, particularly from investors, reduced the maximum loan size available to who are especially sensitive to expectations of many households, though only a small share of capital losses. Liaison with mortgage brokers, households borrow close to the maximum banks and non-ADIs suggests that housing loan amount that they are offered. One way in which applications are well down over the past year. banks improved their processes for assessing mortgages has been the more thorough verification of expenses in loan applications. In Graph 3.12 liaison, the banks indicated that they have Housing Credit Growth* % Owner-occupier Investor % recently made this process more efficient,
12 12 Six-month-ended following an increase last year in the time it took annualised 9 9 to approve loans. The banks also noted that the rates of loan applications that are approved 6 6 were little changed at high levels and that over 3 3 the past year, households' maximum borrowing
% % capacity has not changed materially. Monthly 0.5 0.5 Banks are continuing to make a number of 0.0 0.0 changes to the way that they assess -0.5 -0.5 2009 2014 2019 2009 2014 2019 serviceability. Comprehensive credit reporting * Seasonally adjusted and break-adjusted (CCR) is being expanded from consumer credit Sources: APRA; RBA to mortgages. In liaison, the banks indicated that CCR is not expected to have a significant effect Graph 3.13 on the supply of credit. The income and Housing Loan Approvals* expenses verification process should already be Excluding refinancing $b $b picking up existing mortgages through examination of bank statements and the banks 20 20 Total have found little deliberate misreporting so far. 15 15 APRA has amended its guidance to ADIs on the
Owner-occupier interest rates they use in serviceability 10 10 assessments for residential mortgage [1] 5 5 applications. ADIs now use the higher of an Investor interest-rate floor they set themselves and an 0 0 2003 2007 2011 2015 2019 interest rate that is a minimum 2.5 percentage * Seasonally adjusted and break-adjusted Sources: ABS; RBA points over a loan's actual interest rate.
46 RESERVE BANK OF AUSTRALIA Previously, ADIs were required to use the higher are around 40 per cent lower than their peak in of interest rates comfortably above a floor of 2016, reflecting a decrease in approvals for both 7 per cent and a 2 percentage point buffer over the purchase and construction of residential a loan's interest rate (in practice, ADIs were using property. the higher of 7.25 per cent or a 2.25 percentage As noted above, a pick-up in business borrowing point buffer). ADIs have announced interest-rate through bond issuance in 2019 has offset the floors of around 5¼ to 5¾ per cent. These slowing growth in business borrowing from changes will have different effects on different banks. The pace of bond issuance by non- borrowers. They will generally result in an financial corporations continued to increase in increase in borrowing capacity for borrowers the June quarter (Graph 3.16). Issuance by eligible for lower-rate loans, such as owner- companies in the infrastructure sector has occupier principal-and-interest loans. By driven non-resource related bond issuance. contrast, there would be little change, or even a Secondary market yields continued to decline, small tightening, in borrowing capacity for further easing funding conditions for large borrowers that pay higher interest rates, which is corporations. more typical of investors with interest-only loans.
Large businesses' funding conditions Graph 3.14 remain accommodative … Business Debt Six-month annualised growth, seasonally adjusted Growth in business borrowing has been little % % Business credit changed at a relatively strong pace over 2019, Other lending Non-intermediated debt although the composition of this borrowing has 20 20 changed. A pick-up in growth in borrowing Business debt through bond issuance and continued growth 10 10 in borrowing through syndicated lending has offset slower growth in borrowing from ADIs 0 0 (that is, business credit) (Graph 3.14). The slowing in growth in business credit over the -10 -10 2007 2011 2015 2019 past six months was driven by a decline in credit Sources: APRA; Bloomberg; RBA; Refinitiv extended by the major banks and slower growth in credit extended by the foreign banks (Graph 3.15). Lending to large businesses Graph 3.15 Business Credit by Institution Type accounted for all of the growth in business Seasonally adjusted and break-adjusted credit over the past year or so; lending to small $b $b Foreign banks* businesses declined over this period. 600 150
Over the past few months, business loan Majors approvals picked up, retracing much of their 550 100 decrease earlier in the year. This reflects an Non-ADIs increase in loan approvals for commercial 500 50 property and across a range of other industries Other Australian banks including manufacturing, property & business 450 0 services and transportation & storage. By 2009 2014 2019 2009 2014 2019 * Not all foreign banks report to APRA contrast, loan approvals for residential property Sources: APRA; RBA
STATEMENT ON MONETARY POLICY – AUGUST 2019 47 … while small businesses' access to Interest rates on business loans are low funding remains difficult Interest rates on loans to large businesses – Lending to small businesses declined over the which tend to move with BBSW rates – are past year. Small businesses also reported in estimated to have declined over recent months surveys that they are finding it difficult to obtain (Graph 3.17). Large business interest rates are at finance. In July, the Reserve Bank hosted the low levels. 27th Small Business Finance Advisory Panel, Lending rates on outstanding loans to small which provided valuable information on the businesses decreased by around 20 basis points financial conditions facing small businesses following the reduction in the cash rate in June [2] throughout Australia. The panellists indicated (the latest data available). Small business lending that banks' heightened verification of expenses rates are noticeably higher than interest rates for and income has made it more difficult to access large businesses. This partly reflects the higher finance. This is consistent with liaison with banks default rates associated with small business that suggests that the verification process for loans. lending to consumers (including lending for housing) has been extended to many small Australian equity prices have increased businesses. While the Australian Securities and this year Investments Commission does not require The ASX 200 is 20 per cent higher than its consumer responsible lending obligations to be trough at the end of 2018, and has moved applied to business lending, the distinction broadly in line with overseas markets since the between business and personal borrowing for beginning of the year (Graph 3.18). The ASX 200 small businesses is often unclear. Relatedly, the reached a record high at the end of July, before panellists suggested that small businesses find uncertainty related to the US–China dispute led that it has become increasingly difficult to to some price falls. provide the evidence required by banks that they can service a loan. The panellists noted that Share prices across all industry sectors of the non-traditional sources of finance are being ASX 200 are materially higher than they were at increasingly used by small businesses, but these the start of the year (Graph 3.19). Share prices of sources are often expensive. resources companies have been supported by higher iron ore prices. The industrials and
Graph 3.16 Graph 3.17 Australian Corporate Bond Issuance Variable Business Lending Rates* Quarterly; share of GDP Average interest rate on outstanding lending % % % %
4 4 10 10 Small business
3 3 8 8
2 2 6 6
Large business 1 1 4 4
0 0 2013 2015 2017 2019 2 2 2003 2007 2011 2015 2019 Resource-related corporations Other non-financial corporations * RBA estimates Sources: Bloomberg; Private Placement Monitor; RBA Sources: APRA; RBA
48 RESERVE BANK OF AUSTRALIA communications sectors have also performed The Australian dollar is at its lowest level strongly since the start of the year. Banks' share in some years prices have risen this year but have Over the past year, the Australian dollar underperformed the broader market, following depreciated by about 7 per cent on a trade- weakness in global banking stocks and recent weighted (TWI) basis to be at its lowest level in reductions in the official cash rate. some time (Graph 3.21). Over this period, Analysts' forecast earnings for the broader share Australian Government bond yields declined market were little changed overall in recent further relative to those in major markets as months. Earnings expectations for resources market participants revised lower their companies were revised up due to higher expectations for monetary policy in Australia, commodity prices, while earnings forecasts for and notwithstanding expectations of lower most sectors outside of resources declined policy rates also in major economies. The RBA marginally. Consistent with earnings Index of Commodity Prices fell in recent weeks expectations, price-to-earnings ratios for but is little changed over the past year. The net resources ticked down slightly, while those of effect of these developments is consistent with financials edged up (Graph 3.20). Ratios for other the Australian dollar being around its lowest sectors remain elevated. level for some time on a TWI basis. Net capital inflows to Australia declined in Graph 3.18 recent quarters, consistent with the decline in the current account deficit (Graph 3.22) (see Total Return Indices End December 2014 = 100 ‘Domestic Economic Conditions’ chapter). At a index index sectoral level, there were increased flows of S&P 500 145 145 foreign investment to the non-mining corporate sector and a decline in flows to the mining
125 125 sector in the past few years. ASX 200 Australia's net foreign liability position declined 105 105 as a share of GDP over recent years to be around MSCI World excluding US its lowest level since 2002 (Graph 3.23). This 85 85 reflected a decline in net capital inflows at a 2015 2016 2017 2018 2019 Sources: Bloomberg; Refinitiv time when nominal output was growing. The
Graph 3.19 Graph 3.20 Australian Share Prices ASX 200 Price-earnings Ratios End December 2013 = 100 12-month-ahead earnings forecasts index index ratio Resources Other ratio 20 20 140 140 Other sectors 15 15 Average 120 120 since 2003 10 10 Financials 100 100 ratio Financials ASX 200 ratio 20 20 80 80 15 15 Resources 60 60 10 10
40 40 5 5 2014 2015 2016 2017 2018 2019 2007 2013 2019 2007 2013 2019 Source: Bloomberg Sources: RBA; Refinitiv
STATEMENT ON MONETARY POLICY – AUGUST 2019 49 value of the net foreign liability position has been little changed since early 2016, as a Graph 3.22 modest increase in the value of net foreign long- Australian Capital Flows term debt liabilities has been offset by an Net inflows, per cent of GDP % Private non-financial sector* Banks*** % increase in Australia's net foreign equity asset Mining sector* Other financial Public sector** position. This is consistent with the sizeable 10 10 Net capital offshore equity holdings of the Australian flows superannuation sector, and foreign equities 5 5
outperforming Australian equities over the past 0 0 couple of years. -5 -5
-10 -10 2003 2007 2011 2015 2019 * Prior to 2007 the mining sector is included in the private non-financial sector ** Excludes official reserves and other RBA flows *** Adjusted for US dollar swap facility in 2008 and 2009 Sources: ABS; RBA Graph 3.21 Australian Dollar 1 January 2016 = 100 Graph 3.23 index US$ TWI Net Foreign Liabilities (LHS) By type, per cent of GDP 115 1.0 % %
Total 100 0.8 60 60 US$ per A$ (RHS) index ppt 45 45 Two-year interest rate differential** Long-term debt (RHS) 180 2 30 30
RBA index of Short-term debt 130 1 15 15 commodity prices* (LHS) 80 0 0 0 2013 2014 2015 2016 2017 2018 2019 Equity * With spot bulks ** Spread to equally weighted nominal yields in Germany, Japan, the -15 -15 United Kingdom and the United States 2003 2007 2011 2015 2019 Sources: Bloomberg; RBA Source: ABS
Endnotes [1] See APRA (Australian Prudential Regulation Authority) [2] For information about the small business advisory (2019), ‘APRA finalises amendments to guidance on panel see the Reserve Bank website at residential mortgage lending’, Media Release, 5 July.
50 RESERVE BANK OF AUSTRALIA 4. Inflation
Inflation remains low tradable inflation reflects a slowing in inflation in Trimmed mean inflation increased a little to the prices of new dwellings and administered 0.4 per cent in the June quarter but remained at items, including utilities (Graph 4.4). Following 1.6 per cent over the year (Table 4.1; Graph 4.1). several years of deflation, prices of tradable This was in line with the forecast in the May items (excluding volatile items) increased in the Statement on Monetary Policy. There has been June quarter and over the year. This is consistent some pass-through of the earlier exchange rate with some pass-through to retail prices from the depreciation to retail prices, while the ongoing drought has boosted food inflation. However, housing-related inflation was particularly weak Graph 4.1 in the first half of 2019. Headline inflation Measures of Underlying Inflation* increased to 0.7 per cent (seasonally adjusted) in % % 5 5 the June quarter and 1.6 per cent over the year Weighted median (year-ended) (Graph 4.2). Automotive fuel prices rose by 4 4 Trimmed mean 10 per cent in the quarter, while fruit prices (year-ended) 3 3 declined. 2 2 Underlying inflation has been below 2 per cent Trimmed mean (Seasonally adjusted, quarterly) for around three years. This reflects spare 1 1 capacity in the economy and associated low 0 0 wages growth. The slowing in the housing 1994 1999 2004 2009 2014 2019 * Excludes interest charges prior to the September quarter 1998; adjusted for the tax changes of 1999–2000 market, a decline in wholesale electricity prices Sources: ABS; RBA and various government policy decisions have also put downward pressure on inflation over the past year. However, inflation also remains Graph 4.2 low in many advanced economies where Consumer Price Inflation* % % unemployment rates are at multi-decade lows. Year-ended 4 4 This suggests there are common global factors also weighing on wage and price inflation. In 3 3 particular, globalisation and advances in 2 2 technology have both lowered the cost of 1 1 production of goods and services, and led to increased competition. 0 0 Quarterly (seasonally adjusted) Non-tradable inflation increased in the June -1 -1 1994 1999 2004 2009 2014 2019 quarter, but has slowed notably over the past * Excludes interest charges prior to the September quarter 1998; adjusted for the tax changes of 1999–2000 year (Graph 4.3). The decline in year-ended non- Sources: ABS; RBA
STATEMENT ON MONETARY POLICY – AUGUST 2019 51 Table 4.1: Measures of Consumer Price Inflation Per cent
Quarterly(a) Year-ended(b) June quarter March quarter June quarter March quarter 2019 2019 2019 2019 Consumer Price Index 0.6 0.0 1.6 1.3 Seasonally adjusted CPI 0.7 0.1 – – – Tradables 1.1 –0.2 1.1 0.4 – Tradables 0.5 0.2 1.0 0.3 (excl volatile items)(c) – Non-tradables 0.5 0.2 1.8 1.8 Selected underlying measures Trimmed mean 0.4 0.3 1.6 1.6 Weighted median 0.4 0.1 1.2 1.4 CPI excl volatile items(c) 0.5 0.3 1.5 1.3 (a) Except for the headline CPI, quarterly changes are based on seasonally adjusted data; those not published by the ABS are calculated by the RBA using seasonal factors published by the ABS (b) Year-ended changes are based on non-seasonally adjusted data, except for the trimmed mean and weighted median (c) Volatile items are fruit, vegetables and automotive fuel Sources: ABS; RBA
exchange rate depreciation. Grocery food Conditions in housing markets have (excluding fruit & vegetables) inflation is higher weighed on inflation … than a year ago because of the ongoing drought The two largest housing components of the CPI conditions in eastern Australia and adverse basket are rents and new dwelling purchases by weather in some other parts of Australia. owner-occupiers, which together account for around one-sixth of the CPI basket. Inflation in
Graph 4.4 Inflation by Component Graph 4.3 Year-ended, June 2019 Headline Tradable and Non-tradable Inflation* % Non-tradables** % Utilities One year New dwellings 4 4 ago Consumer durables 2 2 Rents 0 0 Other* Market services % Tradables excl volatiles % 4 4 Admin excl utilities Year-ended Volatiles** 2 2 Groceries*** 0 0 Quarterly Tobacco (seasonally adjusted) -2 -2 -5 0 5 10 15 % 1994 1999 2004 2009 2014 2019 * Includes alcoholic beverages, travel, telecommunications and pet products * Adjusted for the tax changes of 1999–2000 ** Includes fruit, vegetables and automotive fuel ** Excludes interest charges and indirect deposit & loan facilities *** Excludes alcoholic beverages, fruit, vegetables, meals out and takeaway Sources: ABS; RBA Sources: ABS; RBA
52 RESERVE BANK OF AUSTRALIA these components remains around historical offers and purchase incentives for new detached lows (Graph 4.5). dwellings were widespread in the June quarter Rent inflation has been low over the past few in several cities. These incentives typically take years because the effect of strong population the form of including appliances at no charge or growth has been offset by large additions to the direct ‘cash-back’ offers, which reduce the stock of housing. Rents were unchanged in the measured price of the dwelling. Liaison reports June quarter, although conditions in rental suggest that competition from infrastructure markets continue to vary noticeably across projects has put upward pressure on material capital cities (Graph 4.6). In Sydney, rent inflation prices and construction wages in Sydney, has continued to slow, consistent with a sharp although this pressure has eased somewhat increase in the vacancy rate and a decline in over the past year. Consistent with these reports, newly advertised rents over the past year. Perth new dwelling inflation remains relatively strong rents have fallen by 22 per cent since 2014, in Sydney in contrast to Melbourne, Brisbane although the pace of decline has eased and Adelaide, where prices for new dwellings gradually. This is consistent with an increase in have declined over the past year. New dwelling Perth's newly advertised rents and a decline in prices in Perth have steadied in recent quarters the vacancy rate. Rents have been little changed following three years of deflation. in Brisbane for some years, while Melbourne rents continue to increase at a modest rate … while government pricing decisions because a substantial increase in new housing have also lowered inflation supply has been largely absorbed by relatively Utilities prices are little changed compared to a strong population growth. Hobart rents have year ago (Graph 4.8). In the June quarter, utilities increased by more than 5 per cent over the past prices declined a little in non-seasonally year. adjusted terms owing to declines in market offer Prices of newly built dwellings declined again by electricity prices in some capital cities. Gas prices 0.2 per cent in the quarter. In year-ended terms, were generally unchanged across all capital new dwelling inflation is at its lowest rate since it cities in the June quarter. More broadly, was included in the CPI in 1998 (Graph 4.7). electricity and gas inflation has eased notably Information from liaison suggests that bonus since 2018 as the earlier strong increases in
Graph 4.5 Graph 4.6 Housing Inflation* Year-ended with contributions Rent Inflation % % Year-ended Housing inflation New dwelling purchase Rents Other** % Sydney Melbourne %
10 10 6 6 CPI rents
0 0 Advertised rents* 4 4 % Brisbane Perth %
2 2 10 10
0 0
0 0 2003 2007 2011 2015 2019 -10 -10 * Excludes utilities 2009 2014 2019 2009 2014 2019 ** Includes dwelling maintenance and property rates & charges * Hedonic three-month average Sources: ABS; RBA Sources: ABS; CoreLogic; RBA
STATEMENT ON MONETARY POLICY – AUGUST 2019 53 wholesale electricity and gas prices have passed vehicle-related charges, and the 2018 reforms to through. child care subsidies. Electricity prices are expected to decline in the September quarter owing to the introduction of Market services inflation remains stable the Default Market Offer and the Victorian Inflation in the prices of market services, which Default Offer. The Default Market Offer places a include hairdressing, financial services and meals cap on standing offer electricity prices in New out & takeaway, remains low (Graph 4.10). The South Wales, South Australia and southern prices of these services are generally driven by Queensland. This cap has been set at the mid- domestic factors such as commercial rents and point between the median market offer and the labour costs. Commercial rents have increased median standing offer in each electricity relatively slowly over recent years. Labour cost distribution zone. Because market offers are growth has also been relatively low since 2013, usually cheaper than standing offers, the cap is but has picked up recently, putting some likely to result in lower average electricity prices upward pressure on prices for market services. in those states. In Victoria, all standing offer electricity customers have been moved onto the Victorian Default Offer, which has been set Graph 4.8 Utilities Price Inflation* below the median standing offer price in each % Electricity % 15 15 zone. 10 10 Year-ended 5 5 0 0 Inflation in the prices of other administered Quarterly -5 -5 (seasonally adjusted) items declined a little in the June quarter and is % Gas** % 15 15 now at its lowest since 1999 (Graph 4.9). Health 10 10 5 5 inflation declined in the quarter, driven by the 0 0 smallest increase in private health insurance -5 -5 % Water & sewerage % 15 15 premiums since 2001. The decline in 10 10 administered price inflation over the past year 5 5 0 0 reflects several government pricing decisions, -5 -5 -10 -10 including lower-than-average increases in 1994 1999 2004 2009 2014 2019 * Adjusted for the tax changes of 1999–2000 property rates, public transport fares and motor ** Includes other household fuels Sources: ABS; RBA
Graph 4.7 Graph 4.9 New Dwelling Inflation and Building Costs % Building commencements* % Administered Price Inflation* (quarterly growth, LHS) % Child care & school fees Tertiary education % 10 8 New dwelling inflation** 10 9 (year-ended, RHS) Year-ended 5 4 5 6
0 0 0 3 -5 0 Quarterly % % (seasonally adjusted) 6 6 % Health State & local government** % Building materials inflation*** 9 9 4 4 6 6 2 2 3 3 0 0 0 0 -2 -2 1999 2003 2007 2011 2015 2019 -3 -3 * Volumes; six-quarter average lagged by one quarter; detached only 2005 2012 2019 2005 2012 2019 prior to 2017; thereafter attached included with a 20 per cent weight * Adjusted for the tax changes of 1999–2000 ** Adjusted for the tax changes of 1999–2000 ** Includes urban transport fares, property rates & charges and other *** Year-ended change in producer prices for inputs to house construction services in respect of motor vehicles Sources: ABS; RBA Sources: ABS; RBA
54 RESERVE BANK OF AUSTRALIA Higher import prices have put upward the past year, particularly bread (through higher pressure on retail prices grain input costs) and meat (through higher Retail prices had been declining for a sustained wholesale prices). Strong international demand, period as a result of strong competition for particularly for lamb and beef, has also put market share among retailers. Liaison reports upward pressure on meat prices over the past suggest that this competition is continuing to year. Milk prices increased in the June quarter put downward pressure on most retail prices. In following decisions by major supermarkets to recent quarters, however, retail prices have raise private-label milk prices. increased modestly and are now 0.9 per cent higher over the year. This reflects the pass- Some measures of inflation through of the exchange rate depreciation to expectations have declined a little higher import prices (Graph 4.11). Within the Wage- and price-setting behaviour can be category of consumer durable goods, year- affected by expectations about the future rate of ended motor vehicles inflation has increased to its highest level since 2002, and higher import prices have been passed through to consumer Graph 4.11 Retail Prices and the Exchange Rate prices for clothing & footwear and several Year-ended household goods. The timing of the effect of the % First-stage pass-through % depreciation on consumer prices is uncertain; 15 -15 liaison reports suggest that most large retailers 0 0 hedge their exchange rate exposure around -15 15 6–12 months in advance. Exchange rate* (RHS, inverted scale)
% Second-stage pass-through % Grocery price inflation remains elevated 15 3 due to adverse weather 0 0 Grocery price inflation moderated in the June -15 -3 Import prices for retail goods Consumer retail prices** quarter but remains higher than one year ago (LHS) (RHS) -30 -6 (Graph 4.12). Drought-related supply disruptions 1994 1999 2004 2009 2014 2019 * Import-weighted index; quarter average have put upward pressure on food prices over ** Adjusted for the tax changes of 1999–2000 Sources: ABS; RBA
Graph 4.10 Market Services Inflation Graph 4.12 % % Grocery Price Inflation* Year-ended 5 5 Market services* % Bread and cereal products Other food % 9 9 4 4 6 6 3 3 3 3
2 2 0 0
% % 1 1 Dairy and related products Meat and seafood Unit labour cost growth** 12 12 0 0 6 6 -1 -1 1994 1999 2004 2009 2014 2019 0 0 * Year-ended; includes household services, meals out & takeaway and insurance & financial services; adjusted for the tax changes of -6 -6 1999–2000 2005 2012 2019 2005 2012 2019 ** Two-year-ended annualised growth * Adjusted for the tax changes of 1999–2000 Sources: ABS; RBA Sources: ABS; RBA
STATEMENT ON MONETARY POLICY – AUGUST 2019 55 inflation. Short-term market-based measures of Wages growth remains low inflation expectations remain low (Graph 4.13). Growth in wages has picked up a little, but Long-term market-based measures of inflation remains modest (Graph 4.15). The low rate of expectations have continued to decline and are wages growth reflects a number of factors. now at their lowest since 1992 (Graph 4.14). There is still considerable spare capacity in the Similar declines have also occurred in other labour market despite strong employment advanced economies this year and reflect growth over the past year or so. The adjustment unusually low perceived uncertainty about to the end of the mining investment boom has future inflation outcomes. Survey-based led to a prolonged period of relatively weak measures of inflation expectations have eased wages growth in mining-exposed states and slightly or been little changed over recent industries, although this effect has largely months. However, they remain consistent with dissipated. Government policies have also kept the Bank's medium-term inflation target. public sector wages growth stable at around 2½ per cent over the past few years. There are a number of other potential explanations for low wages growth, both in Australia and globally, including low productivity growth, and the Graph 4.13 effect of technological change and globalisation Short-term Inflation Expectations on workers' perceived bargaining power.[1] It is Over the next year % % difficult to know how persistent or important
5 5 these structural factors are, although wages Unions growth has increased over the past year in other 4 4 advanced economies, where labour markets are 3 3 very tight.
2 2 Growth in the Wage Price Index (WPI) was Market economists
1 1 broadly steady in the March quarter at Inflation swaps 0.5 per cent to be 2.3 per cent higher over the 0 0 1994 1999 2004 2009 2014 2019 year. Year-ended wages growth in the private Sources: Australian Council of Trade Unions; Bloomberg; RBA; Workplace Research Centre sector increased to 2.4 per cent, which is its
Graph 4.14 Graph 4.15 Long-term Inflation Expectations Wages Growth % % Year-ended Unions* % % 4 4 6 6
3 3 4 4 Wage Price Index** 2 2 2 2 Consensus economics** Average earnings per hour* 0 0 % % 10-year indexed bonds % New private sector EBAs*** % 4 4 4 4 Inflation swaps*** 3 3 3 3 2 2 2 2 Average award wage increase 1 1 1 1 1994 1999 2004 2009 2014 2019 0 0 2007 2010 2013 2016 2019 * Average over the next five to ten years ** Average over six to ten years in the future * Non-farm *** Five-to-ten-year forward ** Excluding bonuses and commissions Sources: Australian Council of Trade Unions; Bloomberg; Consensus *** Average annualised wage increase; federally registered Economics; RBA; Workplace Research Centre; Yieldbroker Sources: ABS; Attorney-General’s Department; FWC; RBA
56 RESERVE BANK OF AUSTRALIA fastest pace in four years. There has been a more Australian public sector has generally been the noticeable pick-up in wages growth in industries lowest across state governments in recent years where wages are more sensitive to labour following a period of above-average growth market conditions and where workers tend to during the mining boom, while Victorian public be on individual agreements.[2] This includes the sector wages growth has been relatively strong professional, scientific & technical services and in recent years with many workers receiving mining industries (Graph 4.16) wage increases of around 3 per cent. Average The Fair Work Commission increased federal wages growth for Commonwealth Government awards and the national minimum wage by jobs has increased following a period where 3 per cent on 1 July, which followed an increase protracted EBA negotiations led to widespread of 3.5 per cent in the previous year. These recent wage freezes. Within the private sector, several increases have supported wages growth at the large retailers have recently signed new EBAs lower end of the skill distribution and for those after a lengthy period of renegotiation, during that are employed on a casual basis, given the which employee wages were frozen. This should prevalence of award-reliant jobs in these parts of boost average wages growth in the retail the labour market. The share of employees that industry in the near term. are award-reliant is around 20 per cent, although there will also be some pass-through to wage Firms' expectations of wages growth decisions that are in some way linked to awards. have stabilised Wages growth in enterprise bargaining Union and consumer expectations of wages agreements (EBAs) has been relatively steady at growth over the next year have declined a low level in recent years. This reflects that (Graph 4.18). An increasing share of firms in the public sector workers account for around two- RBA's liaison program expect wages growth to thirds of EBA employees and government be broadly stable at current levels over the next policies have been in place in many jurisdictions year. The share of firms expecting stronger to keep public sector wages growth steady at growth in the year ahead is similar to the share around 2½ per cent in recent years. There are of firms expecting weaker wages growth. some clear differences across the public sector Around 60 per cent of firms in the NAB quarterly (Graph 4.17). Wages growth for the Western survey report that the availability of labour is
Graph 4.16 Graph 4.17 Wage Price Index Growth by Industry* Wages Growth by Level of Government Year-ended Year-ended, March 2019 % % Construction Info media Retail One year ago WPI* 4 4 Manufacturing Rental Admin States & territories** Mining 3 3 Wholesale Accom & food Other services 2 2 Public admin Education Professional Financial 1 1 Transport Arts Commonwealth** Utilities 0 0 Healthcare 2007 2010 2013 2016 2019 All industries * 0 1 2 % Public; excluding bonuses ** RBA estimates based on publicly available EBA data; states and * Excluding bonuses and commissions; non-seasonally adjusted territories weighted by number of employees Source: ABS Sources: ABS; RBA
STATEMENT ON MONETARY POLICY – AUGUST 2019 57 either a minor or major constraint on their business, while job vacancies remain at a very Graph 4.18 high share of the labour force. However, there is Short-term Wages Growth Expectations little evidence that these perceived shortages Over the next year % score have translated into broader wage pressures, Unions* with reports from liaison that businesses are (LHS) 4 3 using non-wage incentives such as flexible work Firms** arrangements to attract and retain staff. (RHS) 3 2
2 1 Consumers*** (LHS)
1 0 2007 2011 2015 2019 * Median ** Average Likert score; quarterly average; trend; score of two can be interpreted as average growth and zero for no growth *** Average; trend Sources: Australian Council of Trade Unions; Melbourne Institute; RBA; Workplace Research Centre
Endnotes [1] These potential explanations were discussed at the [2] For more information on how wages growth recent RBA conference on ‘Low Wage Growth’. For dynamics can differ across different pay-setting more information, see RBA (2019), Low Wage Growth, methods, see Bishop J and N Cassidy (2019), ‘Wages Proceeding of a Conference, Reserve Bank of Australia. Growth by Pay-setting Method’, RBA Bulletin, June. Available at
58 RESERVE BANK OF AUSTRALIA 5. Economic Outlook
Domestic economic growth in the first half of and uncertainties remain about how they will be the year was a little lower than expected at the resolved. Accommodative global financial time of the May Statement. As a result, the conditions may support growth more than forecast for GDP growth over 2019 has been expected, although potential also exists for a revised down. Further out, expectations for tightening in financial conditions that would growth are marginally higher. Following the lower growth. recent data, the unemployment rate is now Domestically, the near-term risks to growth are expected to be a little higher than previously more to the downside. Some leading indicators forecast over the next couple of years, and suggest that employment growth could forecasts for inflation have been revised lower. In moderate by more than forecast, which could summary, year-ended GDP growth is expected lead to lower than expected growth in to be 2½ per cent over 2019, 2¾ per cent over household incomes and consumption. 2020 and around 3 per cent over 2021. The Conditions in the earlier stages of residential unemployment rate is expected to remain development remain weak, which raises the risk around 5¼ per cent for some time, before that dwelling investment will decline by more gradually declining to around 5 per cent as GDP than currently forecast. growth picks up. Underlying inflation is forecast In the medium term, however, there are a to pick up to a little above 2 per cent over 2021. number of upside risks that contribute to a more Growth in Australia's major trading partners has balanced outlook. In particular, the housing eased since mid 2018 but it remains reasonable. market appears to have stabilised sooner than The forecast for growth in this group of previously expected which, combined with the economies has been revised a little lower since impact of lower interest rates and tax cuts, raises the May Statement because of the escalation in the possibility that consumption and dwelling the US–China trade and technology dispute and investment could contribute more to growth the related weakness in investment indicators in towards the end of the forecast period than a number of economies. Major trading partners' previously expected. There are also a number of growth is expected to be around 3¾ per cent upside risks to the forecasts for mining activity over the forecast period, which is noticeably towards the end of the forecast period. lower than 2017 and 2018. There are a number of global and domestic Domestic growth is expected to uncertainties around the forecasts. The potential strengthen for a further escalation in trade and technology Australian GDP growth in the March quarter was tensions has increased the downside risk to the a little lower than expected (Table 5.1). Private- global growth outlook. The Chinese authorities sector demand has been weak since the middle continue to face a number of policy trade-offs
STATEMENT ON MONETARY POLICY – AUGUST 2019 59 Table 5.1: Output Growth and Inflation Forecasts(a) Per cent Year-ended June 2019 Dec 2019 June 2020 Dec 2020 June 2021 Dec 2021 GDP growth 1¾ 2½ 2¾ 2¾ 3 3 (previous) (1¾) (2¾) (2¾) (2¾) (2¾) (n/a) Unemployment rate(b) 5.2 5¼ 5¼ 5¼ 5 5 (previous) (5) (5) (5) (5) (4¾) (n/a) CPI inflation 1.6 1¾ 1¾ 1¾ 2 2 (previous) (1¾) (2) (2) (2) (2) (n/a) Trimmed mean inflation 1.6 1½ 1¾ 1¾ 2 2 (previous) (1½) (1¾) 2 2 2 (n/a) Year-average 2018/19 2019 2019/20 2020 2020/21 2021 GDP growth 2¼ 2 2½ 2¾ 3 3 (previous) (2¼) (2) (2½) (2¾) (2¾) (n/a) (a) Technical assumptions set on 7 August include the cash rate moving in line with market pricing, TWI at 59, A$ at US$0.68 and Brent crude oil price at US$58 per barrel; shaded regions are historical data; figures in parentheses show the corresponding forecasts in the May 2019 Statement (b) Average rate in the quarter Sources: ABS; RBA
of 2018, mainly because consumption growth to increase gradually alongside an increase in has been weighed down by an extended period household disposable income growth. The signs of low growth in household income and weak of stabilisation in the housing market reduce conditions in the housing market. Dwelling one possible source of downside risk to investment has also declined. Some of the other consumption growth and could provide some contributors to the slow growth in the domestic upside risk towards the end of the forecast economy in recent quarters, particularly slower horizon. Dwelling investment is expected to mining activity, were transitory. Partial indicators subtract from GDP growth for several quarters, point to reasonable GDP growth in the June though the drag on growth is expected to quarter. diminish by late 2020. Public demand and non- Year-ended growth is expected to be mining business investment are expected to 2½ per cent over 2019, 2¾ per cent over 2020 continue supporting growth over the forecast and around 3 per cent over 2021, supported by period, complemented by ongoing export accommodative monetary policy and some growth. Mining investment is expected to turn recovery in household income growth, boosted around from being a drag on growth to making by tax cuts. The outlook for consumption a material contribution over the latter part of the growth continues to be one of the important forecast period. sources of uncertainty for the domestic growth The domestic forecasts are conditioned on the forecasts, although the risks in the medium term technical assumption that the cash rate moves are more balanced than they have been for in line with market pricing. Current market some time. Growth in consumption is expected pricing implies one 25 basis point cut in the cash
60 RESERVE BANK OF AUSTRALIA rate by the end of this year, to 0.75 per cent, and net interest payments for the household sector, a further 25 basis point cut in the first half of which is a net borrower in aggregate. 2020. This compares with market pricing for an Over coming years, growth in nominal ongoing cash rate at around 1 per cent at the household disposable income is expected to time of the May Statement. The exchange rate is pick up to around 4 per cent annually, assumed to be constant at around 2 per cent supported by growth in employment. However, below where it was at the time of the May the expected contribution from labour income Statement. The oil price is assumed to remain at has been revised a little lower over 2020 the current level, which is about 15 per cent reflecting the downward revision to wages lower than at the time of the May Statement. The growth. Beyond 2019, growth in consumption is population aged 15 years and over is assumed forecast to increase gradually, consistent with to grow by 1.8 per cent per annum over 2019 the underlying improvement in household and 2020 (up from 1.7 per cent at the May disposable income growth and a recovery in Statement) and by 1.7 per cent in 2021, which is housing market conditions. Consumption is unchanged compared with the assumption in forecast to grow by 2¾ per cent over 2021, May. which is unchanged relative to the May Statement. The household saving ratio has Consumption growth has been revised increased modestly over recent quarters and is lower in the near term expected to increase a little further over coming Growth in consumption was a little lower than quarters. expected in the March quarter and recent partial indicators suggest this softness continued into Dwelling investment will decline further the June quarter. As a result, year-ended growth over coming quarters in consumption is expected to slow to Dwelling investment has declined broadly in line 1¼ per cent over the year to June 2019. Growth with expectations at the May Statement to be in consumption is expected to pick up in the around 5 per cent below the September quarter second half of 2019 because of the boost to 2018 peak. Dwelling investment is expected to income from lower tax payments, including the continue to decline for several quarters. The low- and middle-income tax offset, and lower near-term outlook for dwelling investment has been revised lower partly because of slightly weaker-than-expected building approvals data Graph 5.1 over recent months. However, the projected GDP Growth Forecast* Year-ended trough in dwelling investment is now expected % % 70 per cent interval in late 2020. This is about half a year earlier than 5 5 previously anticipated because of the earlier-
4 4 than-expected signs of a turnaround in established housing market conditions and the 3 3 lower profile assumed for the cash rate.
2 2
1 1 Public demand is expected to continue 90 per cent interval supporting growth … 0 0 2013 2015 2017 2019 2021 The forecast for growth in public demand is * Confidence intervals reflect RBA forecast errors since 1993 Sources: ABS; RBA unchanged relative to the May Statement.
STATEMENT ON MONETARY POLICY – AUGUST 2019 61 Growth in public consumption is expected to is currently incorporated into the outlook. There moderate but remain above 3 per cent over are also several projects under consideration but much of the forecast period, partly supported by not yet approved. The recent strength in iron ore ongoing spending on the National Disability prices is not expected to drive much change in Insurance Scheme (NDIS). Spending on the NDIS the outlook for iron ore investment, given is projected to increase as much this financial industry expectations that the recent price year as it did last year. The pipeline of increase is largely a response to supply infrastructure work to be done is elevated constraints that will be resolved over time. relative to work done, pointing to growth in public investment in the near term. However, Exports continue to contribute to growth in public investment is also expected to growth moderate over coming years because additional Recent trade data indicate that exports investment projects are considered likely to continued to expand in the June quarter; sustain the relatively high level of activity rather growth in resource exports is expected to have than contribute much more to growth. picked up, partly because iron ore exports are recovering from earlier disruptions. The outlook … along with growth in business for exports remains broadly unchanged since investment the previous Statement. Resource exports are The outlook for business investment is little expected to grow over the remainder of 2019 changed from the previous Statement. Both and into 2020, supported by some growth in non-mining and mining investment are iron ore and coking coal production, as well as expected to contribute to growth throughout the continued ramp-up of LNG exports from the the forecast period. In non-mining sectors, the final projects. Growth should then slow as this outlook for non-residential construction remains ramp-up finishes. From mid 2021, some decline positive; building approvals remain fairly steady, in LNG exports is expected as existing gas fields and there is a solid pipeline of private are depleted; although some replacement infrastructure projects (particularly transport and projects are under consideration, lags in electricity). Investment in machinery & construction mean that they are unlikely to equipment and software is also expected to commence production during the current grow throughout the forecast period. forecast period. Mining investment declined further in the March Service exports are expected to continue quarter as construction on the final liquefied growing steadily, underpinned by overseas natural gas (LNG) projects continued to wind student enrolments. Data for the June quarter down. The decline in the quarter, taken together suggest manufactured exports were stronger with the ABS Capital Expenditure survey and than previously expected and the lower business liaison information, suggests that exchange rate is expected to continue mining investment is close to its trough. Mining supporting growth in this category. In addition, investment should gradually pick up over the the underlying rate of growth in exports of some next year or two as sustaining investment categories of manufactured goods, including continues, along with some expansionary medicinal & pharmaceutical goods and projects. However, there is a fair degree of professional & scientific instruments, has uncertainty regarding the timing of expenditure increased in recent years as markets for them for mining investment and some risk that there open up. Rural exports are expected to be will be more expenditure on these projects than modestly higher in the near term, largely
62 RESERVE BANK OF AUSTRALIA reflecting elevated slaughter rates, but to ease away from coal-fired power generation are by more than previously forecast further out expected to weigh on thermal coal prices. because dry conditions are expected to persist at least until the end of the year. Rural exports The unemployment rate is expected to are now expected to trough around the remain higher for longer September quarter of 2020 before picking up, The unemployment rate increased by assuming a gradual return to average weather ¼ percentage point in the June quarter conditions supports increased crop production (Graph 5.3). Leading indicators suggest that the over time. unemployment rate is likely to remain around Imports are expected to grow a little more 5¼ per cent for some time. As GDP growth picks slowly than at the time of the previous up to an above-trend pace, the unemployment Statement, reflecting slower domestic demand rate is expected to edge lower to around growth and the recent exchange rate 5 per cent. The upward revision to the depreciation, which has increased the relative unemployment rate outlook suggests that there price of imports. will be more spare capacity in the labour market over the next few years than previously forecast, Elevated iron ore prices have lifted the although there is considerable uncertainty terms of trade around its extent. The terms of trade have been revised higher, Employment growth has been stronger than largely driven by higher-than-expected iron ore expected over the past year, despite the slowing prices in recent months (Graph 5.2). Iron ore in economic activity. Leading indicators such as prices rose considerably in the months following job vacancies and firms' hiring intentions point the previous Statement, reaching their highest to a slowing in employment growth over the level since early 2014. Supportive factors remainder of the year, although growth is included limited supply in the seaborne market expected to remain a little above working-age (mainly because of disruptions in Brazil) and population growth over the next couple of more resilient Chinese demand than previously years. Consistent with solid employment expected. The escalation in trade tensions has growth, the participation rate is expected to led to sharp falls in iron ore prices since the start remain around its current record level. However, of August. Iron ore prices are expected to there is considerable uncertainty around how decline further as supply gradually comes back on line and Chinese demand moderates. Graph 5.2 However, there is considerable uncertainty Terms of Trade around the outlook. 2016/17 average = 100, log scale index index Forecast Coking coal prices have also been revised a little 150 150 higher in light of the lift in expected Chinese 125 125 steel production, but are still expected to decline over the forecast horizon. Thermal coal 100 100 prices have declined further since the previous 75 75 Statement because seaborne supply has continued to increase while there has been some softening in Asian demand. Further out, 50 50 1971 1981 1991 2001 2011 2021 rising seaborne supply and a gradual transition Sources: ABS; RBA
STATEMENT ON MONETARY POLICY – AUGUST 2019 63 much any increase in labour demand will be assumes that the compositional changes in the met by unemployed workers finding jobs, labour market or weakness in non-wage labour existing employees working more hours or a costs that have been holding average earnings further increase in the participation rate. growth below WPI growth in recent years will have dissipated by then. How far this pick-up in Wages growth has been revised a little earnings growth translates into inflationary lower pressures will depend on whether there is an Wages growth is expected to remain stable over accompanying increase in productivity growth. the next year. At the time of the May Statement, wages growth was expected to continue to lift Inflation has been revised lower modestly over the year ahead. However, there is The June quarter inflation outcome was largely limited upward pressure stemming from current as expected. However, the forecast for year- labour market conditions and the majority of ended underlying inflation over the next couple surveyed firms in the liaison program now of years has been revised lower by around anticipate little change in wages growth over ¼ percentage point. Underlying inflation is the next year. The 3 per cent increase in award expected to be around 1½ per cent over 2019 and minimum wages (which is lower than in and gradually increase to a little above previous years) and wage increases in a number 2 per cent in 2021 (Graph 5.4). Headline inflation of significant enterprise bargaining agreements is expected to be a little higher than underlying have been incorporated into the near-term inflation over 2019 as a result of earlier increases forecasts. Private sector wages growth is in volatile prices. expected to increase modestly from 2020 as the In the near term, there has been a modest unemployment rate declines. Public sector downward adjustment to the September wages growth is expected to remain stable over quarter forecast for inflation to incorporate some the next couple of years, consistent with government policy changes that will affect government wage policies in most jurisdictions. administered and electricity prices, and the Average earnings from the national accounts, recent decline in fuel prices. Further out, the which is a broader measure of labour costs, is downward adjustment reflects more spare expected to be growing at a slightly faster pace capacity in the labour market than previously than the wage price index (WPI) by 2021. This
Graph 5.3 Graph 5.4 Unemployment Rate Forecast* Trimmed Mean Inflation Forecast* Quarterly Year-ended % % % %
90 per cent interval 7 7 70 per cent interval 3 3
6 6 2 2 5 5
1 1 4 4 90 per cent interval 70 per cent interval
3 3 0 0 2001 2005 2009 2013 2017 2021 2011 2013 2015 2017 2019 2021 * Confidence intervals reflect RBA forecast errors since 1993 * Confidence intervals reflect RBA forecast errors since 1993 Sources: ABS; RBA Sources: ABS; RBA
64 RESERVE BANK OF AUSTRALIA forecast and the associated lower wages growth. the European Union and sovereign Nevertheless, a modest increase in underlying indebtedness in some euro area economies inflation is still expected to occur over the next continue to pose risks to growth in Europe. few years alongside the gradual increase in Negative developments on these issues could wages growth from 2020 and GDP growth have significant spillovers to other economies picking up to be above potential. through trade, investment and confidence. Inflation is expected to remain low across a The Chinese authorities continue to face a range of components of the CPI. Rent growth is number of policy trade-offs and uncertainties expected to remain low in some capital cities for about how they will be resolved present risks to some time; over the longer term, rent growth the outlook for the Chinese economy, demand will depend on the balance between for bulk commodities and Australia's terms of construction activity and population growth. trade. To date, policy easing measures have Inflation in the prices of newly built dwellings is supported Chinese domestic demand and partly expected to remain subdued until dwelling offset the effects on overall activity of the trade investment begins to pick up again. Retail and technology disputes with the United States. competition is expected to continue to weigh The stimulus to the Chinese domestic economy on prices, but the recent modest exchange rate has benefited Australia and mitigated some of depreciation will continue to put some upward the impact of the trade dispute on the pressure on the prices of consumer durable Australian economy. However, the Chinese goods over the year ahead. The recent increase economy was already facing headwinds as a in grocery food inflation related to the drought result of the earlier deleveraging and a range of is likely to be temporary. A number of structural factors. A further escalation of disputes commentators also anticipate that wholesale with the United States would be likely to disrupt electricity prices will decline over the next investment plans and the downward pressure couple of years as a large volume of new on growth could be larger than current policy renewable energy generation comes on line. settings can counteract. In that event, the government could introduce further policy There are a number of uncertainties easing but would be constrained by a desire to around the global growth forecasts avoid a rebound in economy-wide leverage. A Over the past three months, the global growth further depreciation in the renminbi could also outlook has been revised slightly lower and support growth, but recent currency moves downside risks have increased because of the re- have already aggravated trade tensions. The escalation of US–China trade and technology evolution of policies towards property markets, tensions. In addition to the direct effects of any infrastructure spending and the environment further escalation of trade tensions on trade, a will also be significant for China's growth long period of unresolved trade tensions poses a trajectory and, in particular, the outlook for risk to global growth because the associated Chinese steel demand. uncertainty could depress business investment. Global financial conditions have become more Further US–China tariff rate increases or accommodative since the turn of the year, restrictions on technology transfers, trade and which will offset some of the impact of the trade investment would have the most significant dispute on the global economy. A material effects on growth in the United States, China tightening in financial conditions could still and highly trade-exposed economies in east weigh on global growth, however, and there are Asia. The United Kingdom's expected exit from several possible triggers for such a scenario. Risk
STATEMENT ON MONETARY POLICY – AUGUST 2019 65 premiums are currently very low and could In the near term, administered and housing- increase if market participants become more related inflation are likely to remain low. A concerned about the global growth outlook. number of state governments announced Conversely, there are also scenarios where global further cost-of-living initiatives, which will also financial conditions could remain weigh on inflation. Electricity prices are likely to accommodative for an extended period. grow at a below-average pace over the forecast period, and may even fall. Wholesale electricity The near-term risks to domestic growth costs are expected to decline on the back of a and inflation are more to the downside large increase in renewable energy generation In the near term, the risks to domestic growth capacity, while recent regulatory determinations are more to the downside. It is possible that suggest that network costs will increase only employment growth, which is stronger than can modestly over the forecast period. Advertised be explained by recent activity indicators, will rents are falling or stable in most capital cities moderate by more than forecast. If these and some developers have been offering outcomes occur, wages growth and labour purchase incentives on new dwellings, which income growth may be lower than expected lowers measured prices. Any turnaround in and this would have implications for these housing-related costs seems some way off. consumption growth in coming quarters. Weak While there is some uncertainty around how residential construction activity in the near term long developers will offer discounts on new may depress profits from unincorporated dwellings, the longer building activity stays low, businesses by more than expected, which would the more likely it is that population growth will weigh on household income growth if the induce demand pressures on rents further out. owners of these businesses are unable to find Other sources of uncertainty around the opportunities in other sectors of the economy. inflation forecast have more two-sided risks. Weak conditions in the earlier stages of These include uncertainty about the extent of residential development also raise the risk that any further pass-through from the earlier dwelling investment will decline by more than exchange rate depreciation to retail prices in the currently forecast in the near term. near term, and how long the temporary effects For some time, it has been noted that the of the drought will persist in food prices. Overall, gradual increase in inflation that is forecast over dynamics in retail prices will depend on a the next two years is underpinned by a forecast number of factors, such as movements in the for a gradual pick-up in wages growth. There is exchange rate (which is assumed to remain now less certainty around the increase in wages constant over the forecast period), the degree to growth. Furthermore, there has been little which consumer spending will pick up and the inflationary pressure evident in advanced effect of heightened competition. economies that have experienced a stronger pick-up in wages growth associated with very The medium-term risks to the economic tight labour market conditions. It may be the and inflation outlook are more balanced case that the lags between any pick-up in wages The medium-term risks around the household growth and price inflation are longer than they consumption forecasts are more balanced than have been in the past, or it may be that other they have been for some time. This is partly more structural factors, such as the ongoing because consumption has already slowed, and disinflationary effects of technological advances partly because some established housing and globalisation are more material. markets appear to have stabilised earlier than
66 RESERVE BANK OF AUSTRALIA previously assumed. This has reduced the risk of global demand (led by China) drove an intensive sustained weakness in some types of housing- period of investment to lift export capacity. related consumption, such as household Although the forecasts assume that the higher appliances and furnishings. iron ore prices will not significantly increase Recent policy measures, including the cuts in mining investment or exports, the strength in the cash rate and the tax offsets, provide a prices over 2019 is nonetheless materially reasonable amount of stimulus for the boosting mining sector profits. While the bulk of household sector. Together with the stabilisation these profits will accrue to foreign shareholders, in the housing market, the combined effect some will flow to domestic households through could be larger than is embodied in the forecast. direct and indirect share ownership. The However, the high level of household debt combination of additional household income remains a key consideration for household and an increase in household wealth could consumption, and it is uncertain how much of provide additional support for consumption. the stimulus will be used by households to pay Public sector revenue will also receive a boost, down debt more quickly. Household mainly through Australian Government income consumption accounts for close to three-fifths tax receipts and Western Australian Government of GDP so, if consumption growth was to exceed mining royalties. It remains uncertain how the expectations, it would affect the forecasts for public sector might respond to the revenue overall GDP growth, employment growth and gains. inflation. Separate from the effects of higher iron ore The signs of stabilisation in some established prices, it is also possible that mining investment housing markets also present some upside risk in general could be stronger than currently to dwelling investment towards the end of the expected. There is some uncertainty regarding forecast period. If housing prices recover faster the timing and magnitude of spending on than expected, property developers could projects that are under way or that have been respond by more than expected. This scenario is approved and are expected to commence more likely if the weakness in construction is within the forecast period. There are also some initially more prolonged than expected because, projects that have not had a final investment in an environment of strong population growth, decision but which are likely to proceed. Given this will lead to an undersupply of housing and these uncertainties, a conservative outlook has more upward pressure on prices. been incorporated into the central forecast. Activity in the mining sector may also support Should there be more expenditure on approved the economy by more than expected. Based on projects than is currently incorporated, or if current information, the strength in iron ore more projects are approved and commence, prices over 2019 is expected to have only a small there would be a larger contribution to growth direct effect on the real economy. Information from the mining sector. from liaison and company reports suggest that Overall, this range of developments suggest mining investment and export volumes are that, beyond the next few quarters, the risks unlikely to respond much to these higher prices, around the forecasts are more balanced. Should since a large part of the iron ore price increase is a number of the upside risks come to pass, it is because of temporary supply factors. This is in possible that the combined effect would be contrast to the response to higher prices seen a greater than the sum of the expected effects decade ago, when a large structural increase in from each individual source of stimulus.
STATEMENT ON MONETARY POLICY – AUGUST 2019 67 68 RESERVE BANK OF AUSTRALIA