1. International Economic Developments

There was a broad-based pick-up in global Graph 1.1 in 2017. The Chinese Consensus Growth continued to grow at a solid rate. GDP growth Forecasts for Major * Year-average growth increased in the major advanced economies, % % from rates that were already above estimates 2017 of potential growth. Global merchandise 4.0 4.0 picked up, which contributed to higher growth 2018 2016 in the trade‑exposed east Asian economies. The 2019 2015 strength of the global expansion in 2017 surprised 3.5 3.5 most economic forecasters, and forecasts for

2018 have been revised up over the past year 3.0 3.0 (Graph 1.1). Global growth is expected to be 6–10 years ahead sustained at around recent rates over the next 2.5 2.5 couple of years, supported by accommodative 2015 2016 2017 PPP GDP-weighted average of China, Euro area, Japan and US monetary policies as well as more expansionary * Sources: Consensus ; RBA in the United States. However, most economic forecasters expect growth to ease in Graph 1.2 Global Economic Conditions the longer term; for example, population ageing index % Surveyed business Industrial production* is expected to weigh on economic growth in a conditions number of regions. In China, policies to control Services PMI financial risks could also lead to slower GDP 55 4 growth through tighter financial conditions. Investment growth and business confidence were notably stronger in 2017 in many 50 0 Manufacturing economies, following several years of weakness. PMI Growth in industrial production, merchandise China East Asia EU trade and manufacturing business conditions Japan US Other 45 -4 reached their highest levels in a number of 2014 2018 2013 2017 years (Graph 1.2). The upswing in industrial Smoothed contributions to year-ended growth Sources:* CEIC Data; CPB; IMF; Markit Economics; RBA; Thomson activity, driven by the production of capital Reuters; United Nations and intermediate , has been broad household incomes have been supported by based across economies. Financial and strong employment growth in most advanced geopolitical risks in the euro area have eased, economies; consumption growth has been which has also contributed to the increase in above average for a number of years. confidence. is high and

STATEMENT ON | FEBRUARY 2018 5 Spare capacity has diminished further, with Graph 1.4 many economies growing at rates above China – Contributions to GDP Growth ppt ppt potential growth. In particular, Consumption Investment rates in a number of advanced economies have Net exports 10 10 declined to multi-decade lows and are a bit GDP growth lower than most estimates of full employment. (per cent)

Yet growth and core consumer 5 5 globally have remained subdued to date (Graph 1.3). Some pick-up in inflation is expected over the next year or two. Oil and 0 0 other commodity have increased, which has contributed to a broader build-up of -5 -5 2001 2005 2009 2013 2017 price pressures on the producer side. Inflation Sources: CEIC Data; RBA expectations have also increased over the past year as spare capacity has diminished further. spending on infrastructure was resilient up until the closing months of the year. At the Central Graph 1.3 Economic Work Conference, which was held Global Inflation* in mid December, the Chinese Government Year-ended % % Consumer prices Producer prices** signalled continuity in for 2018. Advanced economies It also reiterated the focus on controlling financial 4 12 risks and the growth of debt, eliminating excess 3 8 capacity, supporting industrial upgrading, and Headline reducing pollution. 2 4 On the production side of the economy, the 1 0 services (tertiary) sector continued to be the Core*** main contributor to growth. In the industrial 0 -4 sector, overall growth in production has been

-1 -8 stable, but a range of other indicators suggest 2007 2012 2017 2007 2012 2017 some softening of conditions (Graph 1.5). Selected economies; PPP GDP-weighted * Core series is an aggregate of selected advanced economies Output declined for a large number of industrial ** Excludes food and fuel *** Sources: CEIC Data; Eurostat; IMF; RBA; Thomson Reuters products towards the end of 2017; growth in revenues and profits has eased in numerous China and Asia-Pacific manufacturing sub-industries in recent months. In China, GDP growth remained solid in 2017. The easing in industrial conditions can be Growth was supported by fiscal spending and partly attributed to environmental policies that continued rapid growth in aggregate financing. restricted output in a range of heavily polluting Consumption continued to be the main driver of industries in 28 cities during China’s winter growth in the year, and net exports contributed months. The steel sector experienced noticeably as global economic conditions improved further weaker activity as a result of these restrictions, (Graph 1.4). Growth in investment slowed overall, which were implemented from late October; iron which reflected a softening in property and ore imports (including from Australia) have been manufacturing investment growth, while public relatively steady in recent months, but Chinese iron ore production has declined significantly.

6 RESERVE BANK OF AUSTRALIA Graph 1.5 prices, as well as more recent supply cuts due to China – Industrial Production environmental restrictions on output. Producer Year-ended growth % % price inflation eased towards the end of the year, consistent with slower growth in economic

Value-added Steel products activity. 10 15 Electricity Housing price inflation in China has continued generation to ease in recent quarters (Graph 1.6). The authorities have tightened restrictions on

0 0 housing purchases and loan‑to- ratios over

Gross output the past year. Indicators of residential activity Crude steel remain subdued; growth in sales and residential investment have moderated. Recent policy -10 -15 2013 2017 2013 2017 statements suggest that the central government Sources: CEIC Data; RBA continues to be focused on discouraging To cut pollution and reduce dependence on speculative real estate investment while coal-fired power, the Chinese authorities have supporting investment in rental accommodation also taken measures to encourage firms and and the renovation of unused commercial households to switch to gas (including by property for residential rental use. reducing gas prices for business use). Increased Graph 1.6 gas demand was partly met by strong growth in China – Residential Property Indicators liquefied natural gas imports in 2017. Subsequent Year-ended growth reports of some households experiencing % New property prices Investment % freezing conditions due to gas 20 40 prompted authorities to relax restrictions on 10 20

the use of coal for heating in certain locations. 0 0 In December, the government released a plan % % to phase out 70 per cent of coal-fired heating Floor space sold Inventory 100 50 systems in northern Chinese cities by 2021 and announced a plan to develop a nationwide 50 25 carbon trading scheme in the next couple 0 0

of years. -50 -25 2011 2014 2017 2011 2014 2017 Inflation in China rose a little over the past few Sources: CEIC Data; RBA quarters, partly driven by higher fuel prices. Total social financing grew by 12 per cent in 2017, Core inflation (which excludes food and energy which is consistent with the target set by the State prices) has edged higher since early 2016 Council. Estimates of the non‑financial sector and has been supported by upstream price debt-to-GDP ratio therefore rose over the year pressures and continued policy accommodation. (Graph 1.7). Financing for the corporate sector However, headline inflation remained below continued to grow broadly in line with GDP over the authorities’ upper bound of 3 per cent in 2017, but corporate borrowers have substituted 2017. Producer price inflation was elevated over towards more traditional financing channels 2017, partly reflecting the pick-up in commodity

STATEMENT ON MONETARY POLICY | FEBRUARY 2018 7 Graph 1.7 ‘shadow banking’ activities, including internet- China – Non-financial Sector Debt* based loan finance. Per cent of nominal GDP % Corporate debt % GDP growth in east Asia (excluding China and Household debt Government debt Japan) increased to around its post-crisis average 200 200 in late 2017, reflecting the recovery in growth of the high-income economies in the region 150 150 (Graph 1.8). The upturn in global trade over 2017 supported this recovery because many 100 100 of these economies are closely integrated in global production chains. The electronics sector 50 50 – particularly the semiconductor industry – has played an important role in the recovery and 0 0 2005 2009 2013 2017 was buoyed by strong demand from China Seasonally adjusted by RBA * Sources: CEIC Data; RBA to meet both Chinese domestic demand and demand for inputs into global production chains. in response to tighter regulation of financing Strong semiconductor demand has also boosted outside the formal banking system. Household business investment, but has had little effect on credit expanded at a rapid pace over 2017, employment growth because the industry is not despite slower growth in mortgage borrowing labour intensive and has only weak connections in response to constraints on property purchases to other domestic industries. Nonetheless, the and borrowing. Government debt also grew overall improvement in economic conditions has strongly, reflecting continued support for public contributed to stronger consumer confidence investment. Average nominal bank lending rates and retail sales growth in some of the higher- have remained relatively low, although they did income economies in the region; this is likely to edge higher in 2017. support consumption and near-term growth In recent months, the authorities have taken more broadly. In the middle- income east Asian additional measures to tighten financial regulation and strengthen oversight of ‘shadow Graph 1.8 East Asia – Economic Indicators banking’ activity (see ‘International and Foreign Year-ended Exchange Markets’ chapter). Financial regulators % GDP growth* Core inflation % jointly published updated rules for the asset 10 6 Middle-income*** management industry (a central part of the 5 4

‘shadow banking’ sector). These rules, which are 0 2 High-income** scheduled to be implemented in 2019, aim to make regulations more consistent across financial % Exports growth Domestic final demand growth % 20 8 institutions, reduce opportunities for regulatory 10 4 arbitrage and improve risk management. 0 0 Additional measures have also been announced -10 -4 that aim to increase oversight of entrusted -20 -8 lending (a form of inter-company financing in 2007 2012 2017 2007 2012 2017 Estimate for December quarter 2017 which banks act as agents) and a range of smaller * Hong Kong, Singapore, South Korea and Taiwan ** Indonesia, Malaysia, Philippines and Thailand *** Sources: CEIC Data; IMF; RBA; Thomson Reuters

8 RESERVE BANK OF AUSTRALIA economies, private consumption growth has Graph 1.10 continued to be resilient. Across the east Asian New Zealand – Economic Indicators Year-ended region, headline and core inflation remain ppt GDP component contributions Housing price growth % subdued. Overall, monetary and fiscal policies 6 Smoothed 16 Total Other remain accommodative and were little changed 3 8 over the past year. 0 0 Consumption -3 -8 In India, GDP growth has moderated over the Residential investment past couple of years, to around 6 per cent % Unemployment rate Inflation % 7 6 (Graph 1.9). Growth in private investment was Headline 6 4 subdued; a contributing factor has been weak 5 2 supply of credit from state‑owned banks, which Trimmed mean 4 0 have been constrained by high levels of bad 3 -2 debt in recent years. The Indian Government’s 2007 2012 2017 2007 2012 2017 Sources: RBA; REINZ; Statistics NZ; Thomson Reuters recapitalisation plan for state‑owned banks over the next two years is therefore expected population growth has sustained private to support investment. CPI inflation has picked consumption growth. However, growth in both up since mid 2017 – partly because food price residential investment and housing prices eased inflation and housing rent allowances for public over 2017. Housing developments have sector employees have both increased – to be been influenced by the tightening of loan-to- above the Reserve Bank of India’s medium‑term value and investor housing lending restrictions inflation target of 4 per cent. Inflation may ease in 2016 by the Reserve Bank of New Zealand in coming months, however, following a decision (RBNZ), as well as supply constraints in the by India’s Tax Council to construction sector. More recently, the RBNZ revise down tax rates on a broad range of items. announced some easing of its loan-to-value lending restrictions, and there has been a modest New Zealand GDP growth was around its pick-up in residential investment growth and long-run average over 2017 (Graph 1.10). Strong building approvals. Accommodative monetary Graph 1.9 policy, as well as increased government spending India – GDP Growth and Inflation announced by the recently elected government, Year-ended % GDP growth Inflation % should also support growth in the period ahead. The supply of labour has grown strongly in New 12 15 Zealand, driven by high net immigration and a marked rise in the participation rate. Employment 8 10 growth remains very high and the unemployment rate has declined to its lowest level since 2009. 4 5 Excluding food Nominal wage growth remains subdued, however, and fuel and growth in labour productivity has been weak. 0 0 Quarterly* Inflation has increased over the past two years and

-4 -5 is close to the RBNZ’s target. 2007 2012 2017 2007 2012 2017 Seasonally adjusted by RBA Sources:* CEIC Data; RBA

STATEMENT ON MONETARY POLICY | FEBRUARY 2018 9 Major Advanced Economies Graph 1.12 Major Advanced Economies – GDP in the major advanced economies grew Structural Fiscal Deficits faster than estimates of potential growth Per cent of potential GDP, annual % % over 2017, partly driven by stronger business US Euro area* Japan Incoming investment growth (Graph 1.11). In the euro administration** area, GDP growth has increased to its highest 9 9 rate since 2011 and the increase has been broad Tax changes** based across the member countries. 6 6

Graph 1.11 Major Advanced Economies – 3 3 GDP and Components IMF Year-ended growth forecast*** % % GDP Business investment 0 0 4 12 2013 2021 2013 2021 2013 2021 US RBA potential GDP estimate from 2019 2 6 * CBO estimate of increase in deficit from the ** Tax Cuts and Jobs Act (2017); adjusted to calendar year IMF forecasts from latest WEO; 2017 figures are an estimate 0 0 *** Sources: CBO; RBA; Thomson Reuters Euro area* % % Private consumption Residential investment Business investment picked up across the 3 10 major advanced economies over 2017, to be 0 0 above long-run average growth rates; however, -3 -10 investment remains below its pre-crisis level Japan -6 -20 in the euro area. Machinery and equipment 2013 2017 2013 2017 investment has been the main driver of this Business investment is public and private non-residential investment; * excludes Ireland due to data measurement issues growth. A range of indicators point to continued Sources: RBA; Thomson Reuters strong business conditions, particularly in Growth in the major advanced economies is manufacturing, and investment intentions are expected to continue to exceed potential over especially elevated in the United States, partly the next two years, which should ultimately owing to the recent tax changes (Graph 1.13). lead to higher inflation. Monetary policy has Household consumption growth remained at been supporting growth for nearly a decade above-average rates in the United States and the and is expected to remain expansionary euro area over 2017, and recovered somewhat even as some central banks move to a less in Japan. It has been supported by robust accommodative stance. Fiscal policy has become employment growth as well as a modest pick-up less contractionary over the past year or two, in wage growth. This should continue – and particularly in the United States, and this has also even strengthen – in the period ahead as labour supported growth (Graph 1.12). The recent tax markets tighten further. In the United States, the changes in the United States will boost activity reduction in personal income taxes should also over the next two years, although the expected boost consumption growth over the next couple consumption tax increase in Japan in late 2019 of years. Residential investment growth has eased is likely to subtract from growth there in the across the major advanced economies, although subsequent year. it remains above its long-run average rate in the euro area. In the United States, housing market

10 RESERVE BANK OF AUSTRALIA Graph 1.13 Graph 1.14 Major Advanced Economies – Investment Major Advanced Economies – Intentions and Business Sentiment Unemployment Rates* st dev % % % United States Euro area Japan United States Euro area Japan LHS LHS RHS

2 3 12 5 Unemployment rate 2012 2015 0 0 9 4 2009 2016 2007 -2 -3 6 3 Business 2017 sentiment Intentions* (LHS) (RHS) -4 -6 3 2 2008 2018 2007 2017 2007 2017 2007 2017 2007 2017 2007 2017 Investment intentions mapped to year-ended Line represents NAIRU estimate made that year * investment growth Sources:* CBO; OECD; RBA; Thomson Reuters Sources: RBA; Thomson Reuters A range of other measures suggests that labour activity picked up in the December quarter, in markets are tight (Graph 1.15). Survey measures part reflecting rebuilding after hurricane-related of employment conditions have reached record damage in the previous quarter. highs across the major advanced economies. Labour markets in the major advanced Job vacancies (as a ratio to the number of economies have tightened significantly over unemployed) have increased strongly in the recent years. Unemployment rates are at United States and Japan, where they are around multi‑decade lows in the United States, Japan record highs. The vacancy ratio has increased and some European economies (such as only a little in the euro area, but is high relative Germany and the United Kingdom). For the to its history. Participation rates have increased euro area in aggregate, the unemployment rate in Japan, supported by increasing female has declined to a nine-year low; the decline has been broad based, but unemployment Graph 1.15 rates vary significantly across the member Major Advanced Economies – Labour Market Indicators states. Unemployment rates in the major st dev Surveys* Vacancies to unemployed ratio Euro area ratio advanced economies have fallen to below the 1.5 1.5 rates consistent with most estimates of full 0.0 1.0 Japan employment (the non-accelerating inflation US -1.5 0.5 rate of unemployment or NAIRU). The NAIRU

estimates are subject to significant uncertainty, % Participation rate Underemployment rate** % however, and have been repeatedly revised 66 9

lower since 2012 for a range of advanced 62 6 economies as actual unemployment rates 58 3 have declined without inflation picking up 54 0 (Graph 1.14). The modest pick-up in wage growth 2005 2011 2017 2005 2011 2017 and continuing subdued inflation may indicate Simple average of multiple employment and labour market surveys * Involuntary part-time and marginally attached workers as a share that there is more spare capacity than is implied ** of extended labour force Sources: Eurostat; MIC; OECD; RBA; Thomson Reuters by the current NAIRU estimates.

STATEMENT ON MONETARY POLICY | FEBRUARY 2018 11 participation, and have been little changed in the Graph 1.17 euro area and the United States at a time when Major Advanced Economies – population aging might have been expected Inflation and Expectations Year-ended to induce declines. Underemployment rates % Headline inflation Core inflation % have also been declining. In the United States Euro area 3 3 and Japan they have fallen to below or around US*

their pre-crisis troughs, but underemployment 0 0 remains elevated in the euro area suggesting that

there may be more spare capacity there than % Consumer expectations** Market expectations*** % indicated by the unemployment rate. 4 2 Wage growth has picked up a little across the 0 0 major advanced economies over recent years, Japan****

but it is well below its pre-crisis average in the -4 -2 euro area (Graph 1.16). In Japan, the increase in 2007 2012 2017 2007 2012 2017 PCE inflation wage growth has been most pronounced in the * One year ahead; euro area series is a diffusion index mapped to ** historical inflation more flexible part-time sector. One reason for the Monthly average of 5–10 year ahead inflation expectations implied *** from inflation swaps limited pick-up in wage growth might be that Excludes the effects of the consumption tax increase in April 2014 **** labour productivity growth has been slow for Sources: Bloomberg; Consensus Economics; ECB; RBA; Thomson Reuters many years in these economies. months in the United States and Japan and has been steady in the euro area. Headline inflation Graph 1.16 Major Advanced Economies – was higher in 2017 in all three economies, driven and Productivity by higher oil prices. Market measures of inflation Year-ended growth % % expectations are above their post-crisis troughs Wages* Productivity Smoothed and have increased a little further recently. Euro area Consumer inflation expectations have been 4 Japan 4 US steady in the United States and Japan, but have part-time increased in the euro area over the past year. As 2 2 spare capacity diminishes, central banks in the major advanced economies expect inflation to Japan increase towards the central banks’ targets over 0 0 the next few years. Japan full-time Economic developments in the United Kingdom -2 -2 2004 2011 2018 2005 2011 2017 have differed from those in the major advanced Average hourly earnings for the US; compensation per employee for * the euro area; smoothed average full-time scheduled wages and economies over the past year or so. GDP growth part-time hourly wages for Japan Sources: CEIC Data; ECB; RBA; Thomson Reuters slowed a little and inflation has picked up strongly due to the depreciation of the pound With significant wage pressures yet to emerge, following the Brexit vote. As a result, real wage core inflation has remained low in the major growth has fallen sharply and was negative for advanced economies (Graph 1.17). Core inflation most of 2017, consumer confidence declined fell noticeably in the United States in 2017, to be below average and consumption growth although this largely reflected temporary factors. has slowed. Growth in business investment has Core inflation has increased a little in recent

12 RESERVE BANK OF AUSTRALIA also eased, despite relatively strong conditions Graph 1.18 in the manufacturing sector owing to the Commodity Prices index US$/b pick-up in global trade and the exchange rate January 2010 average = 100 depreciation. Uncertainty about the future 150 120 EU–UK relationship and the higher cost of Rural* 125 100 imported investment goods are likely to be constraining investment. Despite these 100 80 developments, the labour market has remained 75 60 tight and reports of difficulties in recruiting Base metals* suitable labour are becoming increasingly 50 40 widespread. Bulk* Brent crude oil (spot prices) 25 20 2012 2015 2018 2012 2015 2018 Commodity Prices RBA Index of Commodity Prices (ICP) sub-indices; SDR Sources:* Bloomberg; RBA Global commodity prices were generally higher over recent months, led by bulk commodity Graph 1.19 prices, reflecting continued strength in demand Chinese Steel and Iron Ore Spot Prices US$/t US$/t and a range of supply-side factors (Graph 1.18). Chinese steel* The spot price of iron ore has rebounded, coking (RHS) coal prices have increased significantly and oil 150 600 prices have continued to rise (Table 1.1). Rural prices are slightly higher, while base metals prices 100 400 continue to be supported by the improvement in Iron ore** global economic conditions and reduced supply (LHS, fines) following production cuts in China. As discussed 50 200 in the ‘Economic Outlook’ chapter, Australia’s terms of trade are expected to decline over the 0 0 2010 2012 2014 2016 2018 forecast period, consistent with lower Chinese Average of hot rolled steel sheet and steel rebar prices * 62% Fe index; free on board basis demand and further increases in low-cost supply ** Sources: Bloomberg; RBA of bulk commodities. However, there is a risk of some near-term volatility given the interplay March. Elevated Chinese steel prices have also between demand for steel, environmental reportedly increased expectations that steel restrictions in China and temporary supply production, and therefore demand for iron ore, disruptions. may increase after winter. There continues to The spot price of iron ore has increased sharply be a large premium for higher-quality iron ore since the previous Statement, retracing the products, partly because Chinese steel producers decline over the previous quarter (Graph 1.19). are trying to minimise pollution by favouring Prices have been supported by Chinese import high-quality iron ore. demand, which has remained at a high level The spot price of hard coking coal has also despite cuts to steel production in a number increased notably since the previous Statement, of Chinese regions for environmental reasons; partly because congestion and maintenance at constraints on heavily polluting activities key ports in Queensland has constrained supply are expected to remain in place until mid (Graph 1.20). The spot price of thermal coal is

STATEMENT ON MONETARY POLICY | FEBRUARY 2018 13 Table 1.1: Commodity Price Growth(a) SDR, per cent Since previous Statement Over the past year Bulk commodities 19 2 – Iron ore 24 –16 – Coking coal 20 24 – Thermal coal 3 24 Rural 2 0 Base metals 1 13 Gold –1 0 Brent crude oil(b) 3 21 RBA ICP 11 –2 – Using spot prices for bulk commodities 11 3 (a) Prices from the RBA Index of Commodity Prices (ICP); bulk commodity prices are spot prices (b) In US dollars Sources: Bloomberg; IHS; RBA

Graph 1.20 Oil prices increased to their highest level in Coal Prices over three years, but have eased recently. Prices Free on board basis US$/t US$/t were supported by an agreement between Thermal coal Hard coking coal the Organization of the Petroleum Exporting Countries (OPEC) and non-OPEC countries 150 300 to extend the production cap, as well as the Contract improvement in the near-term outlook for global 100 200 oil demand. R

Spot 50 100

0 0 2012 2015 2018 2012 2015 2018 Sources: Department of Industry, Innovation and Science; IHS; RBA

slightly higher since the previous Statement. Prices have been supported by a number of factors over the past few months, including industrial disputes at mines in New South Wales and strong global manufacturing activity. More recently, prices have also been supported by demand from China, after authorities relaxed import restrictions on thermal coal following gas shortages.

14 RESERVE BANK OF AUSTRALIA