Glenn Stevens: Overview of economic developments affecting Australia
Opening statement by Mr Glenn Stevens, Governor of the Reserve Bank of Australia, to the
House of Representatives Standing Committee on Economics, Sydney, 13 February 2015.
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Chair
Members of the Committee
Since the hearing in August last year, the economy has continued to grow at a moderate, but
below-trend pace. Inflation as measured by the CPI has been affected by movements in
energy prices and government policy changes, but even aside from these effects, inflation is
low and appears likely to remain so.
The international context is one in which the global economy likewise is growing, but
according to most observers at a pace a little below its longer-run average. There are some
notable differences in performance by region. The US economy has picked up momentum,
growing above trend with a falling unemployment rate. China's economy met its growth
target in 2014. A slightly lower target seems likely to be set for 2015, perhaps something like
7 per cent. But that would still be robust growth for an economy of China's size. On the other
hand, the euro area and Japan have recorded lower growth rates than expected a year ago.
Commodity prices have fallen, in some cases quite sharply. These trends appear to reflect
primarily major increases in supply, with some moderation in demand playing a role. That
would appear to be the case for iron ore and oil prices (and, prospectively, liquefied natural
gas prices, which are typically tied to oil prices). Base metals prices, where few significant
supply changes have occurred, have fallen by much less.
So there has been what economists refer to as a "positive supply shock": more of the product
is available with lower prices. The effect of this on individual countries will vary, depending on
whether they are a producer or a consumer of such raw materials. On the whole for the
global economy, however, this is a positive development.
Inflation is quite low in a range of countries, and very low in some. The decline in energy
prices is temporarily pushing headline CPI inflation rates even lower.
The very low interest rates in evidence around the world when we last met have fallen
further. This has been most pronounced in Europe, where yields on long-term German
sovereign debt have fallen to be about the same as those in Japan. German sovereign debt
has recently traded at negative yields for terms as long as 5 years. Official deposit rates are
negative in the euro area, and the European Central Bank has announced a large-scale
asset purchase program - colloquially referred to as "quantitative easing". The euro has
depreciated. Some surrounding countries to which funds tend to flow in anticipation of further
depreciation - such as Switzerland - have reduced interest rates to significantly below zero
and indeed 10-year Swiss government debt has traded at a negative yield. The Swiss
National Bank took the decision to remove the cap on the Swiss franc, as it assessed that
the size of the intervention likely to be required to hold it was becoming just too large. This
move occasioned considerable turbulence in foreign exchange markets.
Meanwhile, the US Federal Reserve, faced with a strengthening US economy and having
ended its asset purchase program last year, is expected to begin a gradual process of lifting
its policy rate in a few months from now. So the monetary policies of the major jurisdictions
look like they will be heading in differing directions. This means there is ample potential for
further turbulence in financial markets this year.
The falls in prices for key export commodities are lowering Australia's terms of trade and
hence the purchasing power of our national income. This is a well-understood mechanism
and has been the subject of much discussion. It will continue to constrain income growth for
households and mining companies, and revenues for both state and federal governments,
over the period ahead.
Resource export shipments are increasing strongly, as the capacity put in place by the period
of high investment is put to use. At the same time, the high levels of capital spending by the
resources sector, which had been a strong driver of domestic demand for several years,
peaked during mid 2012 and turned down. All indications are that this downswing will
accelerate this year. That has always been our forecast. The recent declines in commodity
prices don't change it, though they do reinforce that this trend is well and truly under way.
The various areas of domestic demand outside mining investment are mixed. Dwelling
construction is rising strongly and commencements of new dwellings will reach a new high
over the coming 12 months. Consumer spending is responding both to income trends and
financial incentives, which are pulling in different directions. Growth in wages, by historical
standards, is quite subdued. This and the fall in the terms of trade is working to restrain
growth in disposable incomes. Working the other way, the fall in petrol prices, assuming it
persists, is adding noticeably to the real incomes of consumers. Increased asset values,
which push up gross measures of wealth, and low interest rates are also working to push
consumption up relative to income. The net effect of these opposing forces is producing
moderate, though not strong, consumption growth.
Meanwhile, at this point non-mining business investment spending is still very subdued.
While several key fundamentals are in place for stronger performance, clear signs of a
nearterm strengthening remain unconvincing at this stage. This is a weaker outcome than we had
expected six months ago. Public sector final spending - about one-fifth of aggregate demand
- is fairly subdued, and the intent of governments, as you know, is to restrain their own
spending over the period ahead. The lower exchange rate is likely to help export volumes
outside the resources sector, and of late better trends have been observed in some services
export categories including tourism and education.
Overall, growth in non-mining economic activity has picked up, but is still a little below
average. Our expectation had been that a further pick-up would occur in 2015. When we
reviewed our forecasts in late January, we didn't feel that growth in the recent past had been
materially different from what we had estimated a few months ago. But when we tried to look
ahead, we concluded that there were fewer signs of a further pick-up in non-mining activity
than we had hoped to see by now. As a result, the revised forecasts we took to the February
Board meeting embodied a longer period of below-trend growth, and a higher peak in the
rate of unemployment, than earlier forecasts. They also suggested that inflation was likely to
remain pretty low over the forecast horizon. The inflation outlook was revised slightly lower,
in part reflecting the effect of declining oil prices as well as the weaker outlook for economic
activity.
At its meeting in February the Board considered that this revised assessment - that is,
sub-trend growth for longer, a higher peak in the unemployment rate, slightly lower inflation -
warranted consideration of some further adjustment to monetary policy, after a fairly long
period during which the cash rate had remained steady. These were incremental changes to
the outlook but all in a consistent direction.
Another factor in our consideration was dwelling prices, which have continued to increase.
Price rises in Sydney are very strong, and they are pretty solid in Melbourne. On the other
hand they are much more mixed elsewhere. Excluding Sydney, the rise for Australia as a
whole over the past year was about 5 per cent. That is a healthy pace but not alarming, and
some cities have seen price falls. Developments in the Sydney market remain concerning,
but in the end we did not see these trends as overwhelming a case for a further easing in
monetary policy that was made on more general grounds.
I note that, on the regulatory front, APRA has announced its supervisory approach to
managing the potential risks posed by the rise in lending to investors in housing. This
involves more intense scrutiny of investor loan portfolios growing at over 10 per cent per
year, with the possibility, ultimately, of additional capital being required if APRA deems it
necessary. APRA has also reiterated its expectations for other elements of lending standards
such as interest rate buffers and floors. And ASIC has begun a review of interest-only
lending in the context of consumer protection legislation. The Bank welcomes these steps
and will keep working with other regulators in these areas.
The Board is also very conscious of the possibility that monetary policy's power to summon
up additional growth in demand could, at these levels of interest rates, be less than it was in
the past. A decade ago, when there was, it seems, an underlying latent desire among
households to borrow and spend, it was perhaps easier for a reduction in interest rates to
spark additional demand in the economy. Today, such a channel may be less effective.
Nonetheless we do not think that monetary policy has reached the point where it has no
ability at all to give additional support to demand. Our judgement is that it still has some
ability to assist the transition the economy is making, and we regarded it as appropriate to
provide that support.
The forecasts published last week in the Statement on Monetary Policy assume a lower path
for interest rates and a lower exchange rate than both earlier forecasts and the ones the
Board responded to at the February meeting. These are assumptions rather than forecasts
or commitments to a course of action.
It is worth noting that, despite concerns at various times about whether the exchange rate
would adjust appropriately to our changing circumstances, it has been doing so over the
period since we last met with the Committee. Against the US dollar it has fallen by around 17
per cent since our last hearing. The US dollar itself has been rising against all currencies, of
course, so much of this movement is an American story rather than an Australian one.
Against a basket of relevant currencies the Australian dollar has fallen by less, but the
decline is still about 11 per cent since August. Further adjustment is probably going to occur.
One other development since our last meeting with the Committee was the final report of the
Financial System Inquiry. This was quite a wide-ranging report and there is now a further
period of consultation. I simply note that the Inquiry did not find major problems in the
financial system, but did make recommendations about capital, to enhance the resilience of
the banking system, and about loss-absorbency more broadly in the context of resolution.
These will be mostly in the province of APRA to consider. The Inquiry also made some
observations about payments matters, generally supporting the steps the Payments System
Board has taken since its inception in 1998, and pointing to some areas where further steps
may be appropriate. The Payments System Board will be considering these matters at its
meeting next week.
We now await your questions.