Glenn Stevens Global economic overview and developments in Australia
Opening statement by Mr Glenn Stevens, Governor of the Reserve Bank of Australia, to the
House of Representatives Standing Committee on Economics, Canberra, 22 February 2013.
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In the six months since the August hearing, economic and financial conditions abroad have
generally improved. We can see three key sets of developments.
First, the threat perceived in the middle of last year of extreme financial instability arising in
the euro area - and, in the eyes of some, possible disintegration of the euro - has abated.
This followed various important steps taken by European policymakers. Interest rates faced
by some of the key sovereigns which were under acute pressure have declined markedly,
and funding conditions for many European banks have improved to the point where some of
the central bank funding that had been supplied has been repaid. These countries, and
Europe generally, still face immense challenges and it is, as usual, important to stress that
sentiment remains vulnerable to setbacks. But a truly disastrous outcome was, once again,
avoided.
Second, the United States has continued its gradual recovery and has avoided the worst of
the so-called "fiscal cliff". Some of the headwinds for the US economy are subsiding - the
housing market seems to have turned, for example. There are still some key decision points
in the fiscal area ahead, but if they can be satisfactorily managed, the US has as good a
chance of delivering an upside surprise as a downside one over the period ahead.
Third, the slowdown in China's economy has come to an end. The medium-term outlook for
China is for a less hectic pace of growth than we saw on average over the past decade, and
with more attention paid to the various risks - financial and environmental included -
associated with that growth. Having said that, the greater absolute size of the Chinese
economy now means that even less hectic growth is still of global significance and of
importance to Australia.
Conditions have improved in international financial markets as the perceived probability of
very bad events occurring has declined and as major central banks have maintained highly
accommodative policies. Share prices have risen around the world, with global indexes up by
about 20 per cent from the lows in June last year. Borrowing conditions in capital markets for
creditworthy borrowers internationally remain extraordinarily favourable. For investors,
conversely, returns on "low risk" assets are very low and the "search for yield" has
intensified.
World GDP growth is thought to have been about 31⁄4 per cent in 2012 - a little below
average. Forecasts for 2013 are for something a bit higher than that, with a further pick-up in
2014. Those seem reasonable guesses at this point in time. Risks now seem less tilted to the
downside than they were.
Australia's terms of trade have declined by about 17 per cent since their exceptional peak in
the middle of 2011. We are assuming they will fall further over the next couple of years. Even
with that, however, they will probably be more than 50 per cent above their twentieth century
average over that period. This amounts to an external environment for Australia that, while
not without some challenges, is still broadly positive.
Turning to the Australian economy, the information we have at present suggests that growth
was close to trend over 2012 as a whole. There was, though, some softening around the
middle of the year, and sentiment among many businesses, including some that had seen
important positive spillovers from the mining boom, became less optimistic. Associated with
this, the labour market softened in the second half of the year, with job vacancies declining,
employment growth slowing, and unemployment increasing somewhat. Labour force
participation also declined.
Looking ahead, it appears that the peak in the level of resource sector investment is now
close. It is a very high peak, but we do not think that there will be a rapid decline in the near
term after the peak. However, it seems pretty clear that this type of investment will not be
adding to demand for much longer. Investment spending by businesses in other sectors has
thus far remained somewhat subdued in comparison. There are good reasons to expect it
will strengthen in due course, but the available indicators at present do not suggest that is
going to happen in the very near term. We will get another reading on the investment outlook
next week. The outlook for public spending is being constrained as a result of the budgetary
restraint being pursued by governments. It is also noteworthy that in several sectors of the
economy a combination of factors is putting pressure on business models, and firms have
been responding with an emphasis on lifting productivity and paring back costs. This
process, while unavoidable, doubtless feeds into measures of sentiment.
Sentiment of households, in contrast, has improved. Despite continual commentary that
households are very cautious, actual measures of confidence have in fact shown an upward
trend since the middle of last year and are currently a bit above longer-run average levels.
Admittedly, households do not feel the same ebullience they did for some years prior to the
financial crisis in the major countries. But that degree of confidence, with its associated
patterns of saving and increasing leverage, was unusual, and is not likely to recur.
Our expectation is that consumer demand will record growth roughly in line with the trend
rise in income over the period ahead. Housing investment should strengthen given that
several factors are supportive - interest rates are low, housing prices are tending to rise,
gross rental yields have increased, population growth remains strong and is even picking up
a little. Admittedly, we are as yet very early in this phase. The increased capacity to extract
and ship raw materials will see export volumes continue to strengthen, probably quite
substantially, over the next couple of years. Some other categories of exports seem to have
stopped declining, notwithstanding that the exchange rate remains high.
Putting all that together, while growth was probably about trend in 2012 as a whole, our
sense is that the economy has entered 2013 at a pace a little below that. We have been
inclined to think that the near-term outlook could be for more of the same, but things are
likely to strengthen further out. We are, of course, conscious that forecasts have a
considerable margin of error. We have put some emphasis on this point in the way we
present our forecasts in recent times.
Stepping back from the numbers, in broad terms, the economy will be adjusting to the peak
of the mining boom and some other areas of demand will have room to grow more quickly
than they have in recent years. This transition will not necessarily be seamless - these things
seldom are - but there are reasonable prospects of it occurring over time. As we go through
this period, the pressures to adapt business models, contain costs, increase productivity and
innovate will remain. But such adjustments are actually positive for longer-run economic
performance.
Inflation is currently consistent with the target. The high exchange rate has lowered prices for
tradable goods and services and so helped to hold down measures of inflation over the past
couple of years. But some domestic costs have also slowed, in response to softer demand
conditions in some areas, even as prices for things such as utilities have risen sharply. The
effect of the carbon price on the CPI so far has, as best we can judge, been broadly as
expected. Our assessment is that inflation will be consistent with the target over the next one
to two years.
Taking account of the evolving outlook for growth and inflation, the Board eased monetary
policy further in the last quarter of last year, following up its easing actions in mid year, and
earlier actions in the last quarter of 2011. The cash rate has been reduced six times over the
past sixteen months, for a total decline of 175 basis points. Allowing for some change in the
gap between the cash rate and other rates, lending rates nonetheless have fallen to be not
far from their historic lows. The share of household income devoted to interest payments has
likewise declined considerably. Indeed housing "affordability" as conventionally measured,
for purchasers, has improved a lot over the past two years.
That represents quite a substantial change in policy settings. It is having an effect. Housing
prices have been rising since last May, having declined for a period prior to that. Share
prices have also risen quite significantly, and if anything by a little more than in comparable
markets overseas. The returns available to savers on safe assets - like bonds and bank
deposits - have fallen by enough to prompt Australian savers to consider shifting their
portfolios towards other assets. These are channels of monetary policy at work.
At the same time, as we have noted repeatedly, the exchange rate remains somewhat higher
than one might have expected given the decline in export prices so far observed. This has
been a relevant factor in the setting of interest rates. It is not that interest rates are seeking a
particular exchange rate response, but they are being set with a recognition of the exchange
rate's effect on the economy.
Overall, there is a good deal of interest rate stimulus in the pipeline. At its meeting earlier this
month the Board judged that it was sensible to allow it time to do its work. The Board
believed that the inflation outlook, at least as we assess it at present, would provide scope to
ease further, should that be necessary to support demand. But for now, the Board decided it
was prudent to sit still.
Turning briefly to other areas of the Bank's responsibilities, in June last year the Payments
System Board released the Conclusions from its Strategic Review of Innovation in the
Payments System. The review identified areas in which innovation in the Australian
payments system could be improved through more effective cooperation between
stakeholders and regulators. One of the gaps identified in the review was the inability of
businesses and consumers to make payments through the banking system that are received
immediately, including when the payer and receiver have their accounts with different
institutions. The Payments System Board believes that Australia should develop such
capability over the medium term, and proposed a target for the payments industry to achieve
that goal by the end of 2016. The Board met last week and reviewed an industry proposal for
real-time payments that was submitted to the Bank in late 2012. The Board considers that
the industry has made good progress and endorsed the proposal in an announcement earlier
this week. There are many details to be resolved that will require the Bank and industry to
work closely together over the next few years, within a governance framework that gives
appropriate voice to the various stakeholders. But we view this as a very positive
development and we welcome the industry's commitment to deliver world-class
improvements to the payments system by the end of 2016.
My colleagues and I are here to respond to your questions.