Glenn Stevens: Australia's economy against the background of recent
international developments
Opening statement by Mr Glenn Stevens, Governor of the Reserve Bank of Australia, to the
House of Representatives Standing Committee on Economics, Sydney, 7 March 2014.
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Madam Chair
Members of the Committee
Thank you for the opportunity to meet with you today.
When we met with the Committee just prior to Christmas, I suggested that, taking an
international view, 2013 could be described as a year that turned out not to be quite as good
as hoped for, but not as bad as feared. Nothing that has occurred in the period since then
would change that assessment.
One prominent international event was that, within hours of that hearing, the US Federal
Reserve commenced the "tapering" of its monthly asset purchases. This was a possibility we
talked about at the time and, although the timing of it wasn't known, it was considered likely
that it would begin before long. A further reduction in asset purchases was decided at the
Fed's January meeting.
After all the anticipation of this change, the actual announcement of the Fed's decision
caused little disruption in markets in December. During January there was more volatility in
markets, and a few emerging economies came under pressure, with bond yields spiking and
exchange rates declining.
It is important to keep this in perspective. Periods surrounding changes of course by the Fed
have often been times when market participants re-assess their positions and their appetite
for risk, and this occasion has been no exception. It isn't necessarily the Fed action per se
that is most important, but rather what it conveys about the overall economic and financial
environment. At such times investors sometimes start to focus on risks to which they had
hitherto been attaching little significance.
Investors have not, however, fled from risk indiscriminately on this occasion, at least to date.
They have drawn distinctions between alternative classes of investment and different
countries. Long-term sovereign yields of the core advanced countries have increased a little,
but they remain low. With compressed risk spreads, this means that borrowing costs for
many private-sector borrowers remain very low. The spreads over German yields for
European sovereigns have continued to fall. This suggests that actions by European
policymakers have had more influence on European markets than actions by the US
authorities. This is as one would expect, but it hasn't always been the case in the past.
Moreover, not all emerging markets are experiencing the same pressure. Some that
experienced considerable turbulence in the middle of last year, when tapering was first
mooted, have seen less of that recently. This owes something at least to policy responses in
those countries in the intervening period. Among those countries that have been under most
pressure of late, genuine domestic sources of risk can be observed in most instances. In
several cases the market pressure has resulted in policy responses, which were perhaps
needed anyway.
In general then, tapering is proceeding, so far, about as well as can be expected.
In the meantime, forecasts for the global economy haven't changed much in recent months.
If anything they have inched higher. They suggest that 2014 growth will be higher than in
2013, and at about average pace. More of the growth is coming from the advanced
countries, and proportionately not quite so much from the emerging ones. That, too, is
probably a welcome re-balancing in some respects after the weakness of the advanced
countries in recent years. Australia's terms of trade have been little changed over the past
year, though we still assume they will decline further in the future.
Turning to the Australian economy, for some time our view has been that growth has been
running below its trend pace. The national accounts released a couple of days ago don't
significantly change that assessment. For the year to the December quarter of 2013, real
GDP rose by about 23⁄4 per cent. This is roughly in line with the forecasts we have had for a
while. The drivers of growth are shifting. As we have been saying for some time now, and as
confirmed in the recent survey of capital expenditure intentions by firms, the very high level
of investment spending by mining companies has turned down, and the decline will
accelerate over the coming year. Other areas of demand will provide at least some offset.
Export volumes for resources are growing strongly, as the capacity that has been put in
place by the high levels of investment comes on line. For example, iron ore shipments have
risen by about 85 per cent from their levels of five years ago, to around 1.5 million tonnes per
day. They will rise further over the coming year or two.
It is clear that dwelling investment activity will rise strongly over the period ahead. Over the
past three months, approvals to build private dwellings numbered almost 50,000. That is an
increase of about 27 per cent from the figures of a year earlier, and is the highest
threemonth total in the 30-year history of this series.
Consumer demand has had a firmer tone over the summer, after a fairly lengthy period of
more subdued outcomes. This is evidence in the retail trade and national accounts data and
is confirmed in information from the Bank's liaison. Consumer sentiment does still seem a
little skittish, though, and while we expect consumption spending to grow in line with income
or perhaps a little faster, consumers are unlikely to be the drivers of growth that they were
prior to the financial crisis.
Business investment spending outside mining, which has been very low indeed, is bound to
pick up at some stage. The signs of improved conditions and confidence that we have
observed in some sectors will help, and the early indications of an improvement in capital
spending expectations are apparent. Those are, however, quite tentative at this point and
firms are looking for recent signs of improved conditions to persist before committing to
expanded investment spending. Public final spending is scheduled, according to the
announced plans of federal and state governments, to be quite weak.
The expected ongoing effects of very low interest rates and a somewhat lower exchange rate
have resulted in a slight lift in forecast growth for the second half of this year and in 2015.
This was reflected in our most recent published forecasts released last month. We haven't
made any further changes since then.
With growth having been below trend, job vacancies declined, employment growth weakened
and unemployment rose in 2013. Some forward indicators have stabilised and then improved
a little of late, which is promising. But even with this, and with a slightly better growth outlook,
the labour market will probably remain soft for a while yet, given that it lags changes in
activity. This has seen the pace of growth of wages decline noticeably.
Turning to consumer price inflation, the recent data show inflation in underlying terms at
about 21⁄2 per cent over the course of 2013, and a pace higher than that in the second half of
the year. This is a change from the middle of last year, when we were receiving data that
were lower than expected.
Part of the increase in inflation is explained by the effect of the depreciation of the exchange
rate, which has resulted in increases in prices of traded goods and services. But that does
not account for all the result and it is, at least on the surface, something of a puzzle that
underlying inflation moved up while growth in labour costs moved down. There may be a
rebuilding of margins in some areas, particularly those where demand conditions have
improved a little from the very weak situation earlier. There may also be an element of noise
in the quarterly data.
The view we have taken, pending further evidence, is that there is probably both noise and
signal in the result. Hence, our assessment is that inflation is not quite as low as it might
have looked six to twelve months ago, but nor is it accelerating to the extent a literal reading
of the latest data might suggest. The general situation - 18 months of below-trend growth, a
rise in unemployment, a marked slowdown in wages - is not one that would be obviously
associated with a sustained rise in price pressures. Our view remains that the outlook for
inflation, while a little higher than before, is still consistent with the medium-term target.
Monetary policy is very accommodative. The cash rate has been unchanged since August
last year. It and most borrowing rates are at multi-decade lows. The sorts of things that are
normally expected to result from low interest rates are increasingly in evidence:
• savers are looking for higher return assets as the yield on safe assets has fallen
• asset prices have risen
• credit growth has picked up somewhat for households, and particularly for investors
in housing, where it is running at an annualised pace of close to 9 per cent
• construction of dwellings is set to rise, probably quite strongly
• liaison suggests that lenders are becoming more accommodating to potential
business borrowers and few complain about availability of credit
• the exchange rate has depreciated, though it is still high by historical standards.
On the whole, then, accommodative monetary policy is playing its part in supporting
sustainable growth in demand, consistent with the inflation target.
Of course, the outlook contains many uncertainties, not least the 'hand over' from mining
investment spending to sources of demand outside mining. In some important respects, the
basis for such a handover is coming into place, as I have just described. The question then
is: will the additional demand likely to be generated outside mining as a result of these trends
be just the right amount to offset the large decline in mining investment spending, so keeping
the economy near full employment?
No-one can answer that question with great confidence. Moreover, even if it were possible
for forecasts to be much more accurate than experience could possibly lead us to hope, it
could not be assumed that a shortfall in demand could necessarily be made good in short
order by monetary policy. Monetary policy can have a powerful effect on the general
environment, but it cannot hope to fine-tune the quarterly or even annual path of aggregate
demand.
At the present time we judge monetary policy to be doing the things it can reasonably be
expected to do in the circumstances we face. We have signalled the likelihood, if the
economy evolves more or less as expected, of a period of stability in the cash rate. As well
as the low level of interest rates generally, a sense of stability should be of some help for
businesses and households as they form their plans.
My colleagues and I are here to respond to your questions.