Statement on Monetary Policy - RBA · 2015-10-01 · Statement on Monetary Policy November 2000 2 Some of this change in mood has flowed through to Australian financial markets. But,

November 2000Reserve Bank of Australia Bulletin

1

The Australian economy has continued torecord a strong performance during 2000.While many of the economic statistics havebeen affected by the impact of unusual events,such as the introduction of the new tax system,and the Olympic Games, the underlying rateof growth of GDP still appears to have beenover 4 per cent. This has been associated withfast growth in employment over much of theyear, and a significant further decline in theunemployment rate.

Conditions have been particularlyfavourable for Australian exporters, with worldeconomic growth at its strongest for a decade.This strength owes a good deal to theacceleration in the US economy during thefirst half of the year, but strongerperformances in Europe, east Asia and Japanhave also contributed. Most commodity priceshave firmed in foreign currency terms and,along with the depreciation in the Australiandollar, have contributed to the value of exportsrising by 25 per cent over the past year(abstracting from the recording of Olympiceffects in the month of September).

In 2001, most international forecastersexpect some moderation in world growth fromthe exceptionally strong pace recorded thisyear. Current indications are that amoderation is indeed occurring, with theclearest evidence for this being the slowing in

the US economy since mid year. This slowingis widely seen as desirable in order to forestallpossible further increases in US inflation.Provided the other major economies cansustain a good pace of growth in domesticdemand, the result will be a moderate declinein overall world growth, and a ‘re-balancing’between the major economies in a generallybeneficial direction.

Several risks to the international outlookhave been identified, including the effects ongrowth and inflation from oil prices and thepossibility of a disorderly asset marketcorrection in the US. The failure of corporateearnings, particularly of ‘technology’companies, to meet very optimisticexpectations has produced a considerablechange in sentiment in global financialmarkets over recent months. The mood swinghas been most pronounced in the US wheremarkets are behaving in a way which indicatesthat they expect adverse movements ineconomic and financial conditions. Shareprices have weakened, market interest rates,both at the short and long ends of the yieldcurve, have fallen, credit spreads in debtmarkets have widened, and new issues of debtand equity in capital markets have slowed. Theone aspect of the US economy that has notchanged is the behaviour of the US dollar,which has continued to rise strongly againstnearly all other major currencies.

Statement onMonetary Policy

Statement on Monetary Policy November 2000

2

Some of this change in mood has flowedthrough to Australian financial markets. But,on the whole, financial conditions here havebeen much more stable than in the US, lookedat in terms of either share prices, interest ratesor credit spreads. The relatively betterperformance of Australian markets has not yetbeen reflected in the exchange rate of theAustralian dollar, perhaps because, as noted,sentiment towards the US dollar has notchanged yet. The local currency has fallen by15 per cent against the US dollar over the pastsix months or so, but only a little against mostother floating currencies of industr ialcountries – a pattern which leads to theconclusion that most of the fall experiencedin the bilateral rate has been a reflection ofUS dollar strength.

Domestic demand in Australia is slowingfrom its earlier exceptionally rapid pace. Overthe year to the June quarter, final demandincreased by almost 6 per cent. While it is stillproving quite difficult to assess accurately theunderlying rate of growth, a more moderatepace is to be expected in the ensuing fourquarters. This mainly reflects a fall in spendingon dwelling investment following theexceptionally high levels of activity in the firsthalf of 2000 prior to the introduction of theGST, but also some moderation in the paceof growth of public spending. With the booststill being received from the trade sector, thisshould result in strong growth in GDP overthe year ahead, although this at presentappears likely to be at a slower pace than the43/4 per cent average rate of growth over recentyears. This outlook is, as always, contingenton the international environment notdeteriorating markedly.

The September quarter CPI rose by 3.7 percent, for an increase of 6.1 per cent over theyear. The quarterly and annual results areaffected by the tax changes, and also by thelarge rise in the price of petrol. The quarterlyresult was nonetheless lower than generallyexpected, and appears to reflect, for the mostpart, a smaller short-term effect of the taxchanges than was considered likely a fewmonths ago. There are no definitive data onthe exact impact of the tax changes on the

CPI, and the range of measures of core orunderlying inflation typically used to assessinflation trends are also affected. But makingallowances for them as best it can, the Bank’spreliminary assessment is that core inflation,net of tax effects, was of the order of 21/4 percent over the year to the September quarter.Over the preceding few quarters, annual ratesof underlying inflation had been rising, butthat trend has not apparently continued in themost recent results.

The problem of disentangling the tax effectsfrom ‘ongoing’ price changes may persist forsome time yet. The apparently smaller thananticipated impact of the GST may reflect adecision by companies to absorb part of theimpact, with the intention of passing it onlater. Or it may be that the reduction in pricesflowing from the elimination of wholesale salestaxes has occurred more quickly thanexpected. In either case, future CPI riseswould, other things equal, be higher thanhitherto expected. Alternatively, it is possiblethat the original estimates of the GST’s effectswere too large.

Prices appear to have been affected to arelatively small extent, as yet, by thedepreciation of the exchange rate. While itusually takes some time for such effects toshow up, this result suggests that there maybe some squeeze on profit margins for thoseselling imported products. If so, higher finalprices may still be observed in due course,although the experience of recent years is thatsuch effects have tended to be more mutedthan was the case in earlier times.

With all these difficulties of interpretation,assessing the outlook for inflation is unusuallydifficult. CPI inflation measured on ayear-ended basis will remain high until theimpact of the tax changes drops out of theannual calculation at this time next year, atwhich time it will fall back. Whether or not itwill be consistent with the 2–3 per cent targetthereafter will be affected by severalconsiderations, not least the course of oilprices and the exchange rate. At present, theBank (like most other forecasters) assumesthat oil prices will decline somewhat in 2001,helping to bring about a partial reversal of the


3

petrol price impacts on the CPI observed overthe past year.

On the other hand, the low level of theexchange rate, if it were to persist, would makefor upward pressure on inflation, dependingon the extent to which foreign suppliers andimporters were prepared to accept a reductionin their margins. On the assumption that asubstantial degree of pass-through occurred,underlying inflation could be around 3 percent at the end of next year, with CPI inflationtemporarily slightly below that, due to theassumed decline in oil prices. All of thisassumes that there will be no response ofwages to the GST effects or other factorstemporarily pushing up CPI inflation. Thisassumption still appears to be valid at thistime, although it naturally is kept undercontinual review, as are all assumptionsunderlying the inflation forecast.

With this outlook, the monetary policydecision has been finely balanced, and theBank has not made a change to interest ratessince August. The earlier increases appear tobe having some dampening impact on creditdemand and some asset markets. The moremoderate growth in domestic demand whichappears to be in prospect lessens, at themargin, the extent to which inflationarypressures are likely to build over the yearahead. At the same time, the current level ofthe exchange rate increases the risk thatinflation could breach the target, once thedirect GST effects have passed. In the periodahead, the Bank will continue to assess thebalance of risks to the outlook, and directpolicy to the medium-term goal of lowinflation, with sustainable growth.


4

International Economic Developments

Graph 1The world economy strengthened in the firsthalf of the year, with better than expectedoutcomes being recorded in all major regions,including Australia’s major trading partners.As a result, forecasts for world output growthwere revised higher by many commentators,including the IMF who are expecting worldoutput growth of 4.7 per cent in 2000 – halfa percentage point higher than expected sixmonths earlier (Table 1, Graph 1). The IMFexpects world growth to slow in 2001, asgrowth in the US slows from around5 per cent to 3 per cent, but still remain aboveits long-term average.

The process of upward revision toexpectations for the world economy that hasbeen occurring over the past two years appearsto have run its course, with somecommentators suggesting higher risks of asubstantial slowdown in 2001 than thatcurrently expected.

One risk to the outlook, identified by theIMF, is the possibility of a disorderlyadjustment in international equity and foreignexchange markets. In addition to the adverseeffects on the advanced economies, such

developments could also jeopardise therecoveries in the emerging market economies.Another risk is a sustained high price for oil,which has recently reached its highest levelsince the Gulf war. The IMF estimates thatworld growth in 2001 could be up to half apercentage point lower if oil prices remainabove US$31 per barrel, instead of decliningas projected. Box A examines the likely effects

Table 1: World GDPAnnual average percentage change

1998 1999 2000(f) 2001(f)

United States 4.4 4.2 5.2 3.2Euro area 2.7 2.4 3.5 3.4Japan –2.5 0.2 1.4 1.8Newly Industrialised Economies (a) –2.3 7.8 7.9 6.1ASEAN-4 (b) –9.3 2.6 4.5 5.0World 2.6 3.4 4.7 4.2Memo item:Inflation (c) 1.5 1.4 2.3 2.1

Source: IMF World Economic Outlook, October 2000, using PPP exchange rates

(a) Hong Kong, Korea, Singapore, Taiwan

(b) Indonesia, Malaysia, Philippines, Thailand

(c) Advanced economies

0

1

2

3

4

5

6

0

1

2

3

4

5

6

World GDP Growth

1989

IMF forecasts %

Source: IMF

30-year average

%

1991 1993 1995 1997 1999 2001

Oct 1999

May 2000

Oct 2000


5

of a sustained higher level of oil prices in somedetail.

Primarily as a result of higher oil prices,consumer price inflation has picked up toaround 21/4 per cent in the advancedeconomies over the year to August 2000, fromaround 11/2 per cent a year earlier. However,abstracting from the direct influence of oil,inflation remains generally subdued despitethe strong growth of the world economy.

United StatesThe US economy continues to grow at a

strong pace despite GDP growth easing in theSeptember quarter (Graph 2). The effects ofthe 175 basis points increase in the Fed fundsrate since June last year have been evident inthe housing sector, and the added effects ofhigher oil prices and the appreciation in theexchange rate have contributed to a slowdownin the part of the manufacturing sector whichis not involved in producing computer-relatedgoods. But growth in household consumptionremains robust, and export growth has alsobeen strong over the past year, despite theappreciation of the exchange rate. Reflectingthe ongoing strength of demand, thecurrent account deficit widened to around41/4 per cent of GDP in the June quarter.

While consumption has eased from its veryrapid pace of growth earlier in the year, it isstill growing strongly, supported by the highlevel of consumer confidence, and the

tightness of the labour market. Householdincomes have been bolstered by the pick-upin wages growth over the past year: theEmployment Cost Index rose by 0.9 per centin the September quarter and is now 41/4 percent higher than a year ago. Against this, thedecline in share prices over the course of thisyear should reduce the impetus to householdspending from wealth gains that has occurredover the past few years, though wealth stillremains at a high level.

Much of the growth in business investmentover the past year has come from increasedspending on computer equipment andsoftware, and orders for IT capital equipmentpoint to continued rapid growth in investmentin the near term. Output growth of thecomputer-related sector has also been animportant contributor to growth in industrialproduction in recent quarters: while totalmanufacturing production increased by61/4 per cent over the year to September,growth excluding computer-related outputwas just under 1 per cent. The NationalAssociation of Purchasing Managers’ surveysuggests that the outlook for the non-ITmanufacturing sector is not particularlyfavourable.

Consumer price inflation picked up to31/2 per cent over the year to September,principally due to higher oil prices (Graph 3).To date, the increase in energy prices has hadonly a limited effect on core measures of

Graph 2 Graph 3

-2

0

2

4

6

-2

0

2

4

6

United States – Real GDPPercentage change

1994

%

Year-ended

%

Quarterly

1996 1998 2000199219900

1

2

3

4

5

6

0

1

2

3

4

5

6

United States – Wages and PricesYear-ended percentage change

2000

CPI

Employment costindex

Core CPI

19981996199419921990

% %


6

inflation, which have increased by around halfa percentage point from the second half oflast year, but have remained at an annualisedrate of around 21/2 per cent in recent months.The absence of any significant increase in coreinflation has been aided by the appreciationof the US dollar and subdued growth in unitlabour costs – while wages growth has pickedup, this has been matched by increases inproductivity.

JapanThe recovery in Japan appears to have

consolidated in the first half of the year, withthe national accounts recording an increasein GDP of 1 per cent in the June quarterfollowing growth of 21/2 per cent in March.Private consumption and exports bothcontributed significantly to growth in the firsthalf of the year (Table 2). Alternative measuresof activity paint a similar picture of economicrecovery (Graph 4). The Ministry ofInternational Trade and Industry’s overallbusiness activity index increased by 4 per centover the six months to August. The Bank ofJapan’s Tankan survey also continued toindicate improved prospects for business.Despite these positive developments, risksremain: recent developments in the financialsector may restrict the amount ofintermediated funding available to business,

and the pick-up in consumption growth maybe limited by the slow growth of householdincomes.

The latest Tankan survey suggests that therecovery in business investment is likelyto continue. The survey reported animprovement in business confidence, apick-up in capital expenditure intentions andmore positive perceptions about access tofinance. In addition, exporters have benefitedfrom the recovery in east Asia – exports to thatregion increased by 21 per cent over the yearto September.

Table 2: Japan – GDPContributions to annualised growth

Six months to:December 1999 June 2000

Private consumption –2.2 3.4Government consumption 0.1 –0.1Business fixed investment 0.5 0.4Residential investment –0.7 0.4Public investment –2.4 0.8Changes in stocks –0.3 0.4Net exports –0.2 1.7– Exports 1.6 2.9– Imports –1.8 –1.2GDP –5.2 7.2

Source: Datastream

Graph 4

95

100

105

95

100

105

Japanese Activity1995 = 100

1994

Index

1996 1998 2000

Real GDP

Overall business activity

Index


7

The outlook for consumption is moreuncertain. Consumption spending appears tohave weakened after growing strongly in thefirst half of the year. Household incomes haveonly grown slightly over the year to Septemberbecause of a decline in employment and weakgrowth in wages. Nevertheless, consumers aremore confident about their employmentprospects and the economy generally, despitethe historically high unemployment rate.

The government’s expansionary fiscalstance is set to continue in the near term, withthe announcement of a further supplementarybudget – to be finalised this month – whichwill contain additional spending of around0.8 per cent of GDP. The size of the plannedpackage is relatively modest, but should helpto ensure that public expenditure does notsignificantly reduce growth in the periodahead.

Consumer prices continued to fall on ayear-ended basis, declining by 0.8 per centover the year to September. The sustainedstrength of the yen and comparatively efficientenergy consumption have helped to offset theinflationary pressures stemming from theincrease in oil prices.

The Bank of Japan raised the overnight callrate to 0.25 per cent in August, terminatingthe zero interest rate policy that had been inplace since February last year. In reaching thisdecision, the Bank cited the decreased risk of

deflationary problems as the economicrecovery, led by the pick-up in businessinvestment, continued. The Bank of Japan stillexpects prices to fall slightly over the year toMarch 2001.

Non-Japan AsiaThe strong growth experienced in

non-Japan Asia in 1999 has continued into2000, with GDP in the region increasing by8 per cent at an annualised rate over the firsthalf of the year (Table 3). In some countries,most notably Korea, there are signs thatgrowth may be starting to ease back to a moresustainable pace, after the very rapidexpansion in the initial phase of recovery.Exports and then consumption provided theinitial stimulus to growth in the aftermath ofthe crisis. Now a recovery in privateinvestment is also underway in all countriesin the region except Indonesia and thePhilippines.

Nonetheless, there remain significantdivergences in economic performances acrossthe region (Graph 5). One source of thisdivergence is the difference in exportcomposition, par ticularly in terms ofelectronic goods. In Malaysia, electronic goodsaccount for over 30 per cent of exports, whilethey represent only around 3 per cent inIndonesia. Much of the pick-up in industrialproduction in Korea, Malaysia and Taiwan

Table 3: Non-Japan Asia – Real GDPAnnualised percentage change

Six months to:December 1999 June 2000

Hong Kong 12.5 9.1Indonesia –4.9 14.1Korea 12.8 5.9Malaysia 4.3 13.4Philippines 4.0 4.8Singapore 2.9 13.2Taiwan 3.9 7.0Thailand 9.2 4.3Total 7.0 8.0

Source: CEIC


8

since early 1999 has been in the electronicssector (Graph 6). While these three economiesremain vulnerable to any slowdown in the

Graph 5

Graph 6

global electronics market, Indonesia, and to alesser extent, Thailand have not benefited fromthe strong global demand for electronic goods.

Another cause of the divergent economicperformance has been the varying sizes of therequired financial and corporate restructuringand the extent of progress that has been made.The World Bank estimates that in Indonesiaand Thailand, the ratio of non-performingloans to total loans has fallen to 40 per centand 32 per cent (as at June 2000), but is stillwell above estimates for Korea and Malaysia(12 per cent and 16 per cent respectively). Thefragile state of the banking sectors in Indonesiaand Thailand is making it difficult for banksto provide new finance to the private sectorand therefore may be retarding the speed oftheir recoveries.

Inflation has edged up throughout theregion, in large part the result of higher oilprices. Consequently, some countries havebegun tightening monetary policy. The Bankof Korea raised its key interest rate by 1/4 of aper cent in October – the first rise in eightmonths. Although inflation has picked up fromits low levels of 1999, core inflation remainswithin the Bank’s newly established target forinflation of 2.5 per cent ± 1 percentage point.

After strong growth in the second half of1999, the New Zealand economy contractedslightly in the first half of 2000 (Graph 7).Much of the weakness has been in domesticdemand, reflecting subdued private

Graph 7

Source: CEIC

80

85

90

95

100

105

110

80

85

90

95

100

105

110

Non-Japan Asia – Real GDPJune quarter 1997 = 100

1996

Index

Other east Asia

1998 20001995 1997 1999

Index

Thailand and Indonesia

Source: CEIC

1995

KoreaIndex

Total

Non-Japan Asia – ProductionJune 1997 = 100

90

110

130

90

110

130

90

110

130

90

110

130

70

90

110

130

70

90

110

130

Index

Index Index

Index Index

Excluding electronics

Malaysia

Taiwan

1996 1997 1998 1999 2000 -4

-2

0

2

4

6

-4

-2

0

2

4

6

New Zealand – Real GDPPercentage change

1992

%

Year-ended

1994 1996 1998 2000

Quarterly

%

1990


9

consumption and, in the June quarter, a23 per cent decline in housing investment.Business confidence has fallen sharply sincethe beginning of the year and is around itslowest level in ten years; consumer confidencehas also fallen considerably. In contrast,employment growth rebounded strongly inthe September quarter and the export sectorremains robust, underpinned by strongexternal demand, the lower New Zealanddollar and a good agricultural season.

EuropeIn the euro area, output grew strongly for

the fourth consecutive quarter in June,increasing by 0.8 per cent, to be 3.7 per centhigher over the year. Export growth hascontinued to benefit from the depreciation ofthe euro, and has helped underpin therecovery in employment and solid growth inconsumption in the region over the past year.

Inflation has been boosted by the rise in oilprices to be 2.8 per cent higher over the yearto September. Core inflation, at 1.4 per centover the year, has risen only slightly, whilegrowth in labour costs remains contained.Reflecting ongoing concern over oil prices,import costs and strength of the euro-areaeconomy, the ECB raised interest rates on twooccasions over the past three months by a totalof half a percentage point.

In the UK, GDP has continued to grow ata solid pace over the past year. Growth inrecent years has been underpinned by steadyconsumption growth, driven by robust growthin employment and earnings, as well as highlevels of consumer confidence. Exports havealso picked up strongly through the past year.While consumer prices have increased by over3 per cent in the past year, underlying inflationis more subdued and remains below the Bankof England’s target rate of 2.5 per cent.


10

Box A: Oil Prices and Economic Performance

Oil prices have risen to their highest levelfor about ten years in recent months(Graph A1). At over US$30 per barrel, oilcosts about three times as much as it did atits low point in late 1998. That twenty-yearlow in oil prices was a result of a combinationof an increase in the supply of oil from OPECin early 1997, and a fall in demand for oilshortly thereafter as a result of the Asiancrisis. An increase in demand as the worldeconomy has recovered, and decisions byOPEC to reduce supply, helped to pushprices higher during 1999. During 2000,ongoing growth in demand, concerns aboutthe low levels of world oil inventories andlimited global refining capacity have seen theprice of oil continue to rise. In response tothe rise, OPEC has increased its productionquotas four times this year. At present,however, oil prices remain high and are over60 per cent higher than their average for thepast three years.

This rise, while very substantial, is not ofthe same order of magnitude as those seenin the oil price ‘shocks’ of the mid and late1970s. Nonetheless, if oil prices remain high,they can be expected to put upward pressureon global inflation rates and to have somedampening influence on global economic

growth. The pressure on prices results fromthe direct impact on price indexes of thehigher prices for household expenditure onpetrol, and from the indirect impact on pricesfor a range of goods and services whichembody transportation costs. The directeffect has added about 1 percentage pointor so to CPI inflation over the past year inmost countries, with further effects likely inthe short term. The indirect impact may takesomewhat longer to come through. It mightbe mitigated to some extent by a short-termcompression of profit margins, or partlyoffset by other cost savings.

The effects on economic activity arisefirstly because the rise in oil prices pushesup the cost of production. As such, itrepresents a reduction in the aggregatesupply of goods and services that can besustained at any given price level in theindustrialised economies. Absent anoffsetting demand expansion, this means thatproduction will be lower, and prices higher,than otherwise. Moreover, since the rise inoil prices represents a loss of income to oilconsumers, it is likely that aggregate demandin energy-consuming countries will beweaker than otherwise. This income istransferred to oil producers, who are thenlikely to expand their own demand for goodsand services, providing some offsettingimpetus to the contraction in oil-consumingregions. The net result of all these forces isthat world economic growth is likely to belower, and inflation higher, than wouldotherwise have been the case.

The recent rise in oil prices is smaller, inproportionate terms, than those whichoccurred in the mid and late 1970s episodes.For this reason, the impact on global growthand inflation should be considerably smallerthan on those occasions, unless the price ofoil were to rise much further. In addition,most advanced economies have becomerelatively more efficient in their use of oil,

Graph A1

Oil PricesLog scale

2000

30

20

10

1

40

30

20

10

40

1970 prices

Current prices

US$

1995199019851980197519701

5 5

US$

OPEC 1

OPEC 2Gulf War


11

largely as a response to the earlier rises in oilprices. Graph A2 shows how the quantity ofoil consumed per unit of real GDP hasdeclined over time, so that although the priceof oil remains much higher than it was priorto the OPEC 1 increase, the share of totalincome devoted to spending on oil hasreturned to pre-OPEC 1 levels (Graph A3).

The effects on individual economies andregions can be expected to vary, dependingon the pattern of their production and theextent to which they rely on imported, asopposed to domestically produced oil. It isimportant to note that a number ofdeveloping economies have probablyincreased their reliance on oil as a result ofrapid industrialisation over the past twodecades.

In Australia’s case, the effects of rising oilprices are likely to be less contractionary thanfor most other advanced countries. WhileAustralia has in recent years been a smallnet importer of oil, it is a substantial net

Graph A2 Graph A3

Table A1: Australia’s Trade inEnergy Resources

Year to June quarter 2000, $b

Exports Imports

Petroleum 7.1 7.5Gas 2.6 0.1Coal 8.3 0.0

exporter of natural gas (Table A1), the priceof which is linked to the price of oil. Hencethere is a net transfer of income towardsAustralian producers from world consumers.All other things equal, this would tend toimpart a stimulus to the Australian economy,though the transfer within Australia fromenergy consumers to producers might be adampening influence in the short term.Should the price of oil remain high for sometime, it is also possible that prices for otherenergy sources such as coal could increase,as has tended to occur in the past. R

0.0

0.4

0.8

1.2

1.6

0.0

0.4

0.8

1.2

1.6

Oil Consumption – Share of OutputMillions of barrels per US$1 bn of output

1999Source: Datastream, Energy Information Agency, OECD

United States

AustraliaJapanEurope

199419891984197919740

2

4

6

8

0

2

4

6

8

Expenditure on Oil Consumption –Share of National Income

United States

Source: Datastream, Energy Information Agency, OECD

%

Europe

Australia

Japan

%

199919941989198419791974


12

Interest ratesThe process of global monetary tightening

that began in the United States in June lastyear has slowed over recent months (Graph 8and Table 4). After raising the Fed funds targetby 175 basis points to 6.5 per cent in the12 months to May 2000, the Federal Reservehas since left US rates unchanged, as signshave emerged that growth of aggregatedemand in the US has slowed. Financial

markets have begun to price in the possibilitythat US official interest rates could start tofall in early 2001 (Graph 9).

Of the other English-speaking countries: theBank of England has not raised rates sinceFebruary, after four increases of25 basis points in the preceding 9 months,which lifted rates to 6 per cent, and theBank of Canada and the Reserve Bank ofNew Zealand have left rates unchanged, at

International and Foreign ExchangeMarkets

Table 4: Policy Interest Rate IncreasesBasis points

6 months 6 months 6 months Total since Currentto Nov 1999 to May 2000 to Nov 2000 June 1999 level (%)

US 75 100 0 175 6.50Canada 25 100 0 125 5.75Australia 25 100 25 150 6.25NZ 50 150 0 200 6.50Japan 0 0 25 25 0.25UK 50 50 0 100 6.00Switzerland — 125 50 175 4.00Euro area 50 75 100 225 4.75

Graph 8 Graph 9

l l l l l l l l l l l l l3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

US Fed Funds Rate

1998

%

Expectations

1999M J S D M J S

%

Actual

8 Nov

End May

D M J S D M J2000 2001

1

2

3

4

5

6

7

8

1

2

3

4

5

6

7

8

Cash Rates% %

19991998

Germany/Euro

Canada

AustraliaUK

US

19971996 2000l l l l


13

5.75 per cent and 6.5 per cent respectively,since May.

In Europe, where the level of official interestrates was, and still is, well below that inEnglish-speaking countries, official interestrates have continued to rise in recent months.Since the US Federal Reserve’s last move inMay, the European Central Bank hasincreased overnight rates by a further100 basis points, to 4.75 per cent, taking thetotal tightening so far in this cycle to225 basis points. The 50-point increase inJune, followed by 25 basis points in bothSeptember and October has narrowed thespread with the US to 175 basis points.

The Bank of Japan (BoJ) raised overnightinterest rates in August as concerns aboutdeflation and the sustainability of the recoveryhad ameliorated sufficiently for the overnightcall rate to be raised from zero to0.25 per cent. The rise was the first since1994, and was widely anticipated. In makingthe announcement, the BoJ noted that it wasending what was considered an ‘extraordinary’policy, and that the increase should not betaken as the beginning of a tightening cycle.

There have been some increases in interestrates in some other Asian countries also.Building inflationary pressures led the Bankof Korea to raise official interest rates by afurther 25 basis points in October, to5.25 per cent, following a previous tighteningof the same magnitude in February. ThePhilippine central bank raised official interestrates by 500 basis points over September andOctober in an effort to slow the depreciationof the peso against the US dollar. Withpolitical uncertainty eroding confidence infinancial markets, market interest ratesincreased by much more – around20 percentage points – to levels higher thanduring the Asian financial crisis.

Bond yields in the US have generally fallenover recent months (Graph 10). An importantfactor seemed to be the changing outlook forthe economy and monetary policy. Yields onUS 10-year Treasury notes fell around60 basis points to 5.70 per cent betweenend May and early September, and have since

fluctuated within a narrow range. This level isabout 65 points below the current US cashrate. Normally, such an inverse yield curvewould be taken to indicate that markets areexpecting quite a pronounced slowing or evencontraction in the economy. On this occasion,however, other factors seem to be at work,which make it harder to interpret theimplications of movements in yields. One ofthese is the continuing budget surpluses inthe US and the resulting falls in the supply ofbonds on issue. Another factor is rising riskaversion among investors, which is adding todemand for government bonds. Yields onprivate sector bonds have not fallen as muchas those on government bonds; while AAAcorporates have fallen over recent months,they remain above the Fed funds target.However, bonds issued by borrowers of lowcredit standing have risen significantly.

European bond yields have generally beenmore stable, with the 10-year German yieldmoving between 5.10 and 5.35 per cent sinceJune. Japanese long bond yields increasedaround the time of the tightening in Japanesemonetary policy, but have since been steadyat just above 1.8 per cent.

In emerging markets, bond yields have beenrising, with the spread to US bond yieldswidening sharply, to around 800 basis pointsin early November from a low of around630 basis points earlier in the year.

Graph 10

l l l l l l l l l l4.0

4.5

5.0

5.5

6.0

6.5

7.0

1.0

1.5

2.0

2.5

3.0

3.5

4.0

Ten-year Bond Yields

2000

% %

J F M A M J J A S O N

US(LHS)

Japan(RHS)

Germany(LHS)


14

Equity marketsThe prospect of slower economic growth

and market disappointment with earningsannouncements, particularly by ‘technology’companies in the US, have weighed on equitymarkets over recent months. Looking throughthe volatility, overseas markets have fallen inrecent months (Graph 11), with the leadclearly coming from the US (Graph 12). Aftersurging to an all time high in March, theNasdaq is now down 32 per cent from its peakand a net 16 per cent for the year. The Wilshireindex, the broadest measure of US shareprices (accounting for over 90 per cent oflisted companies) is down by 3 per cent for

the year and the Dow Jones Industrial Averageis down by around 5 per cent. Thesebroadly-based indexes of share prices in theUS are now showing little net change over aperiod of at least 12 months. This is the firsttime since the mid 1990s that there has beenno net change in US share prices over atwelve-month period (Table 5).

Graph 11

Graph 12

Despite the falls in US share prices, thetraditional measure of share valuations – P/Eratios – remain significantly higher thanaverage. For the S&P 500 index, for example,the current P/E ratio is 28, down from a peakof 36 in May 1999, but still well above thelong run average of about 16. In the case ofthe Nasdaq, the average P/E ratio is stillaround 100.

Share prices in countries such as HongKong, Canada, Germany and Japan, wheremarket indices are heavily influenced by thetechnology sector, are down sharply overrecent months. The share market in Australiahas been resilient in the face of these overseastrends (see Chapter on ‘Domestic FinancialMarkets’).

Falls in the emerging Asian share marketsthis year have been very pronounced, withmost of the decline concentrated in the InitialCrisis Economies – specifically Indonesia,Korea and Thailand. Share prices in thesecountries have dropped by an average of over40 per cent since the start of 2000 and arenow not much above the low point reached

Table 5: Changes in Major CountryShare Prices

Net Changechange sincefor year 2000to date peak

(%) (%)

US – Wilshire –3 –9– Dow Jones –5 –7– S&P 500 –3 –6– Nasdaq –16 –32

Germany – DAX 2 –12Japan – Nikkei –19 –26

l l l l l l l l l l l l l l l l l80

90

100

110

120

130

140

150

160

80

90

100

110

120

130

140

150

160

Share Price Indices

Index Index

MD

30 June 1999 = 100

2000S

Canada

US

UK

Japan

Australia

Germany

J S1999

D

l l l l l l l l l l l l l l l l l l l l l l l80

100

120

140

160

180

200

220

80

100

120

140

160

180

200

220

US Share Price Indices

Index Index

M

1 January 1999 = 100

2000

NASDAQ

Wilshire

Dow

J DS M J DS1999


15

during the crisis. Financial markets assessthese economies as vulnerable to a slowing inworld growth, in part because their financialsectors are still recovering from the crisis.Share markets in Latin America have held upmuch better than those in Asia, weakeningonly modestly this year.

Exchange ratesThe US dollar has continued to rise on a

trade-weighted basis in recent months, eventhough the factors that were used to explainits strength earlier in the year – strong US assetmarkets, a strengthening economy and risinginterest rates – no longer apply (Graph 13).This raises questions about the extent towhich the rise has become simply a reflectionof trend-following or momentum trading. Thestrength of the US dollar has been mostpronounced against the euro, but was alsoevident against other major currencies withthe exception of the yen.

intervention seems to have helped steady theeuro which is now trading around levels atwhich the ECB first intervened.

In contrast to the variability in theeuro/US dollar exchange rate, the Japaneseyen has continued to trade in a tight rangeagainst the US dollar. Elsewhere in Asia, thecountries with floating exchange rates havedepreciated against the US dollar, though tovarying degrees. Some currencies, such as theSingapore dollar, are down only a little, butothers have fallen significantly. The biggestfalls were in the Philippines, where politicaluncertainty undermined confidence and thepeso fell by 22 per cent from its level at thestart of the year, and in Indonesia where therupiah fell by 24 per cent. General US dollarstrength was also reflected in a depreciationof floating currencies in Latin America.

Australian dollarIn the period during which it has been

floating, the Australian dollar has shown quitelarge medium-term movements in bothdirections (Graph 15). The fall during 2000was the fourth time it has moved down by asignificant amount, but the first time it hasdone so without the presence of a significantnegative external shock such as a fall incommodity prices, a world recession or acontraction amongst our major regionaltrading partners. What stands out about thecurrent fall is that it has occurred at the time

Graph 13

Graph 14

The weakening of the euro against theUS dollar triggered a round of interventionby G7 countries in support of the euro in midSeptember, after the euro had fallen veryquickly to record low levels and appeared tobe the subject of ‘one-way bet’ speculation infinancial markets (Graph 14).

The European Central Bank followed upwith further intervention, this timeunilaterally, in early November. This

l l l l l l l l l l l104

106

108

110

112

114

116

118

104

106

108

110

112

114

116

118

US Dollar TWI

2000

Index

J F M A M J J A S O N D

Index

l l l l l l l l l l l90

95

100

105

110

115

0.80

0.85

0.90

0.95

1.00

1.05

US Dollar Exchange RatesDaily

US$Yen

2000MJ A OJ SF M J A N D

Yen per US$(LHS)

(RHS)US$ per Euro


16

individual moves in the exchange rate areexamined in detail. For example, from the firstsharp fall in the exchange rate in late Januarythrough to July, there were ten occasions whenthe exchange rate moved by more thanUS0.70 cents in a day. Seven of these moveswere falls, and in total they accounted forvirtually all the net fall in the exchange rateover the period. All but two of these moves inthe exchange rate came after economic newswhich changed market assessments of thegrowth outlook for either Australia or the US,and therefore expectations of future interestrate differentials. For example, weak economicdata on Australia caused market participantsto lower their expectations of future Australianeconomic growth and inflation, and thereforethe likelihood of a rise in Australian interestrates. In turn, this meant that the expectedinterest rate differential relative to the USmoved in favour of the US dollar, resulting insales of Australian dollars and purchases ofUS dollars. Box B summarises the factors thatwere reported to be linked to each of the largemoves in the exchange rate.

Other pieces of evidence supporting thisinterpretation of events can be found fromgraphs of the relevant variables. When dataon the expected growth differential, theexpected cash rate or the long-term bonddifferential between the two countries areplotted against the exchange rate, a clearrelationship emerges during the first seven orso months of 2000. During this period, forexample, forecasts of the growth differentialbetween Australia and the US prepared byConsensus Economics were revised downprogressively. Whereas in January it wasexpected that Australian growth in 2000would exceed US growth by 0.3 of apercentage point, by mid year it was expectedthat US growth would exceed Australiangrowth by 1 percentage point (Graph 16).

Against this background, not surprisingly,market expectations of the cash ratedifferential were also revised down sharplyduring this period (Graph 17). Similarsentiment was reflected in a decline in thebond spread between Australia and the US,from about 60 points at the start of the year

Graph 15

when Australia’s international tradingenvironment remains very robust, and wastherefore generally unexpected. As aconsequence, there has been much conjectureas to its causes.

Analysis of the factors causing changes inexchange rates is often difficult because theinfluences on the demand for currencies areill-defined and variable. Nonetheless, whenlooking at the causal factors in the Australiandollar’s fall this year, some patterns emerge.In the first seven months of the year, changesin the exchange rate tended to be concentratedinto a relatively small number of abruptmoves, and were associated with economicnews which were interpreted as changing thegrowth outlook for Australia and the US, andtherefore actual and expected interest ratedifferentials. More recently, the fall in theexchange rate has tended to be characterisedby a series of smaller but persistent declines,and not associated with any particular piecesof economic news. The events of the past yearare therefore best analysed in terms of thesetwo phases.

January to July

As noted, during this phase changingexpectations of interest differentials betweenAustralia and the US seem to have played animportant role in the fall of the Australiandollar. The significance of economic news andinterest rates emerges clearly when the large

0.40

0.50

0.60

0.70

0.80

0.90

1.00

30

40

50

60

70

80

Australian Dollar

US$ Index

Monthly

200019971994199119881985

US$ per A$(LHS)

TWI(RHS)


17

to close to zero mid year (Graph 18). Theseadjustments went hand in hand with the fallin the exchange rate.

Through the early part of this period, a lotof the fall in the exchange rate reflectedindependent weakness of the Australian dollar,so that the bilateral rate against the US dollarand the trade-weighted index moved similarly.From late April, however, the continued fallof the Australian dollar against the US dollarbecame more a reflection of the strength ofthe latter, following a run of very strongeconomic data in the US and a tightening of50 basis points by the Fed, a bigger move thanits earlier increases of 25 points. Similarly, the

recovery of the Australian dollar in June wasagain largely a reflection of movements in theUS dollar, this time a weakening. Thisfollowed a run of softer US data which causedthe earlier upward revisions to expectationsof US interest rates to be unwound. From lateApril through June, the trade-weighted indexof the Australian dollar was much steadierthan the bilateral rate against the US dollar.

In net terms, over the whole period fromJanuary to July, the Australian dollar fell byabout 11 per cent against the US dollar andby about 6 per cent in trade-weighted terms.

The period since August

In the period since August, the exchangerate of the Australian dollar has fallen further,by about 9 per cent against the US dollar and7 per cent against the trade-weighted index(Graph 19). While the net fall is nearly as largeas that which took place over the first sevenmonths of the year, in this latest episode therehave been only three large daily falls, and theyaccount for only about one-third of the netmove over the period. As noted, most of thefall in the exchange rate has come aboutbecause of a series of small but persistent dailyfalls.

Perhaps reflecting this pattern, marketdealers have been less able to pinpoint thefactors driving the exchange rate.Explanations have been varied and somewhat

Graph 16

Graph 17

Graph 18

l l l l l l l l l l l l l l l l l-2.4

-2.0

-1.6

-1.2

-0.8

-0.4

0.0

0.4

0.8

0.50

0.52

0.54

0.56

0.58

0.60

0.62

0.64

0.66

The Exchange Rate and the Expected GrowthDifferential Between Australia and US

1999

US$%

D M JS DS2000

Consensus GDP growthdifferential for 2000(Australia less US, LHS)

US$ per A$(RHS)

l l l l l l l l l l l l l l l l l-1.50

-1.25

-1.00

-0.75

-0.50

-0.25

0.00

0.25

0.50

0.50

0.52

0.54

0.56

0.58

0.60

0.62

0.64

0.66

0.68

The Exchange Rate and theExpected Cash Rate Differential

US$%

1999S D M J S D

2000

US$ per A$(RHS)

Differential in expectedcash rates, as at June 2001

(Australia less US, LHS)

-0.60

-0.45

-0.30

-0.15

0.00

0.15

0.30

0.45

0.60

0.50

0.52

0.54

0.56

0.58

0.60

0.62

0.64

0.66

The Exchange Rate and the Long-termInterest Rate Differential

%

US$ per A$(RHS)

US$

S D M J S1999 2000

l l l l l l l l l l l l l l l l lD

Differential in bond yields(Australia less US, LHS)


18

inconsistent. Also, there has been increasedrecourse to explanations based on chartistbehaviour and market dynamics such astrend-following or momentum trading.

Interest rates have become much lessimportant in explaining exchange rate moves.Movements in interest rate differentials, eitherthe expected cash rate differential or the bonddifferential, have reversed some of the fallsearlier in the year (Graphs 17 and 18). Mostof this adjustment to the interest raterelativities has come from the US side, witheconomic data tending to confirm that theUS economy has slowed. Market expectationsof where US short-term interest rates will bein mid 2001 have been lowered by more than100 basis points since their peak in May, withthe market now pricing in the possibility thatthe next change in US monetary policy willbe an easing. In contrast, expectations forAustralian interest rates are little changed, sothe differential has moved in a directionfavourable to the Australian dollar.

Despite the changed outlook for US interestrates, the US dollar continued to rise for most

Graph 19 of the period. All currencies apart from theyen fell against it. The euro/US dollarexchange rate fell to new lows almost daily inSeptember, sterling reached 15-year lows, andboth the Australian dollar and New Zealanddollar exchange rates also hit new lows againstthe US dollar.

With many currencies falling simultaneouslyagainst the US dollar, correlations betweenthe Australian dollar and some othercurrencies have increased recently. This wasparticularly the case for the euro, againstwhich a relationship had already started toemerge in the first half of the year. Thisrelationship has recently strengthened, withthe correlation of daily movements increasingto 0.49, twice its first-half reading. The closerelationship with the euro has causedwidespread puzzlement because, traditionally,the two currencies had not been related, andthe cyclical positions of the respectiveeconomies, as well as their overall structure,do not indicate any reason for such a closerelationship.

In recent weeks, with the US dollar levellingout in trade-weighted terms and the eurorising, helped in part by central bankintervention, the Australian dollar too hasstarted to stabilise. In net terms, the Australiandollar’s exchange rate against the US dollarhas shown little change since mid October,while the TWI has shown little change sinceearly October.

Because developments in the Australiandollar over recent months have mainlyreflected international factors rather thandomestic events, the case for independentaction by the Reserve Bank to try to avert itsfall seemed rather limited for much of theperiod. In recent weeks, however, the Bankhas entered the market on several occasionsto support the exchange rate and reinforce theemerging tendency towards stability.

l l l l l l l l l l l0.50

0.52

0.54

0.56

0.58

0.60

0.62

0.64

0.66

44

46

48

50

52

54

56

58

Australian Dollar

US$ Index

Daily

M2000

J F A M J S OJ A N D

TWI(RHS)

US$ per A$(LHS)


19

Box B: Large Movements in the Australian DollarExchange Rate During 2000

Since late January there have been 15 dayson which the exchange rate of the A$ to theUS$ moved by a large amount – defined hereas a move of more than US0.7 cents.Consistent with the overall decline of theexchange rate during the year, ten of thesewere falls.

The main causal factors reported to theBank by market dealers at the time of themoves are listed below. In the first part ofthe period, most of the factors related tonews affecting interest rate expectations (seeTable B1). More recently, the tendency hasbeen for dealers to attribute the movesin the exchange rate to a range ofnon-economic factors.

28 January: US1.6 cent fallLower Australian CPI figuresStronger US GDP & wage data

The change in sentiment towardsthe A$ began with the release oflower-than-expected CPI figures whichreduced expectations of monetary tighteningin Australia. During local trading, thecurrency declined. In the US that evening,December quarter GDP figures and theemployment cost index were bothstronger-than-expected, increasing theexpected degree of Fed tightening andtherefore the extent to which expectedinterest rates favoured US assets. This addedto the downward pressure on the A$.

24 February: US0.7 cent fallWeaker Australian investment dataStrong US durable goods figures

In Australia, the currency fellafter weaker-than-expected domesticcapital expenditure figures for theDecember quarter. That evening,stronger-than-expected US durable goods

figures for January saw the currency fallfurther.

1 March: US1.2 cent fallDeclining Australian retail sales data

The release of much weaker-than-expectedretail sales data for January saw the exchangerate fall over US1 cent in local trading.

17 April: US1.1 cent fallNo local or US releasesStrong rally in US share prices

No economic news to affect interest rateexpectations. The A$ fell against the US$ inoffshore markets, as did other majorcurrencies. Market participants attributedthis to a strong rally in US stock markets,which underpinned buoyant US$ sentiment.

Table B1

Date Exchange News Otherrate move affecting factors

(US interest ratecents) expectations

28 January –1.6 *24 February –0.7 *1 March –1.2 *17 April –1.1 *3 May 0.7 *8 May –1.3 *15 May –0.8 *2 June 0.8 *6 June 0.7 *5 July –0.9 *16 August 0.9 *22 August –0.8 *23 August –0.9 *7 September –0.9 *20 October 1.0 *


20

3 May: US0.7 cent riseRBA policy tighteningImproved current account data

The announcement of the 25 basis pointsrise in the cash rate to 6 per centpushed the A$ higher. The release oflower-than-expected current account datafor March added to the better tone and theA$ rose.

8 May: US1.3 cent fallSlower Australian retail sales growthFalling Australian job vacancies

The release of lower-than-expected Marchretail sales, a decline in ANZ job vacanciesfor April, and the NAB business surveyshowing weakening conditions in April sawthe currency slip in local trading andcontinue to decline in offshore markets.

15 May: US0.8 cent fallFalling Australian housing dataStronger US industrial production

News that housing finance for March fellsharply saw the A$ fall in the local market.Overnight, the release of strong US industrialproduction numbers added to the USdollar’s firm tone and caused the Australiandollar to slide further.

2 June: US0.8 cent riseWeaker US employment data

Weaker US payrolls data for May saw theUS$ fall against all major currencies. TheA$ rose against it.

6 June: US0.7 cent riseNo local or US releasesRumours of Bundesbank intervention

No economic news to affect interest rateexpectations. Other than reports that theBundesbank was active in the foreignexchange market, there was no specific newsto trigger the temporary bout of US$

weakness. All major currencies rose againstthe US$, including the A$.

5 July: US0.9 cent fallNo change in Australian monetarypolicy

The RBA did not announce a change inthe cash rate. The A$ gradually slipped overthe local day and in London, and was soldmore aggressively in New York.

16 August: US0.9 cent riseWeaker US housing dataRelease of RBA quarterly report

The release of weak US housing data sawthe A$ r ise in New York. This wasconsolidated after the release of the RBA’squarterly report which was regarded ashawkish.

22–23 August: US1.7 cent fallNo local or US releasesWeak euro and NZ dollar

No economic news to affect interest rateexpectations. Dealers attributed the fall toweakness in the euro and the NZ dollar.

7 September: US0.9 cent fallNo local or US releasesA$/yen selling and weak euro

No economic news to affect interest rateexpectations. A rise in the yen triggered about of stop-loss selling of the A$ when theA$-yen cross rate fell to 60. A fall in the eurothat evening took the A$ lower.

20 October: US1 cent riseNo local or US releasesStrong euro and NZ dollar

No economic news to affect interest rateexpectations. Dealers reported that news ofthe possible sale of assets by a majortelecommunications company had added todemand for A$. Strength in the euro and NZdollar reinforced the rise. R


21

Domestic Economic Activity

The Australian economy has continued togrow strongly, although the introduction ofthe GST in the middle of the year and thestaging of the Olympics Games in Septemberhave made interpreting recent data moredifficult than usual. Over the year to the Junequarter, real output expanded by around43/4 per cent (Graph 20), and most indicatorssuggest that further solid growth occurred inthe September quarter. The composition ofgrowth, however, has clearly changed duringthe last year. Consumer spending has slowedfrom the very strong rates of growth recordedin 1999, while export growth has accelerated(Table 6).

The rate of growth of the economy in thefirst half of the year is likely to have beenboosted by the introduction of the GST on1 July, as some spending on goods whoseprices were expected to be increased by thechange in taxation arrangements was broughtforward from the second half of the year. Thelargest transitional effects have clearly beenin the housing sector, which recorded

extraordinary levels of activity in the first halfof 2000, and for which forward indicatorsimply that a sharp slowing is in train. The netimpact on consumer spending and purchasesof investment goods, by contrast, appears tohave been small. In the September quarter,the Olympics are likely to have provided afurther net boost to output.

Graph 20

Table 6: National AccountsPercentage change, 1998/99 prices

Year to:December 1999 June 2000

Consumption 5.3 4.1Dwelling investment 7.0 23.1Business investment(a) 3.4 3.7Private final demand(a) 5.3 5.5Public final demand(a) 6.7 7.2Domestic final demand 5.6 5.9Change in inventories(b) –0.1 –1.2Exports 7.4 12.2Imports 13.2 11.3Net exports(b) –1.3 –0.2Gross domestic product 4.1 4.7

(a) Excluding transfers between the public and private sectors

(b) Contribution to growth in GDP

-6

-4

-2

0

2

4

6

-6

-4

-2

0

2

4

6

GDP%

Year-endedpercentage change

2000

%

19981996199419921990

(contribution to year-ended growth in GDP)Net exports


22

Household consumptionOver the first half of 2000, consumer

spending grew at an annual rate of around21/2 per cent, less than half the rate of growthrecorded in the second half of 1999.Underlying these figures was a fall inexpenditure on goods and a slowdown in therate of growth of expenditure on services.Some moderation in growth from the highrates experienced in the second half of 1999was expected, given that monetary policy hasbeen progressively tightened since Novemberlast year, and the gains in wealth, which haveprobably boosted consumption spending overthe past couple of years, have slowed. The risein petrol prices over the past year could havealso contributed to this slowdown in consumerspending, as some households may havecurtailed their expenditures on other goodsand services.

The indicators of consumer spendingaround the middle of the year were, asexpected, very volatile, as consumersresponded to the relative price changes causedby the change in the indirect taxation system(Graph 21). Overall, and despite surveyevidence suggesting that consumers were notwell informed about the details of the taxpackage, consumers’ responses to theanticipated changes in relative prices werebroadly as expected. In the monthimmediately preceding the tax change, largeincreases were recorded in sales of itemswhose prices were expected to rise, such asclothing and footwear, with sales beingcorrespondingly weaker in July. These effectswere amplified by the decision made by anumber of major retailers to hold theirmid-year sales in June, rather than July. Salesof motor vehicles, by contrast, were subduedthrough much of the first half of the year, inanticipation of lower prices after 1 July, andthen boosted in July and August. Once again,these swings were amplified by themanufacturers’ decisions to delay the launchof a number of new models onto theAustralian market until after 1 July. Littletransitional effect on sales was evident forgoods, such as food items, the prices of whichwere not expected to be affected by the tax

changes. By international standards thedistortions to consumer spending wererelatively small.

In net terms, consumer demand wasbrought forward in anticipation of the taxchanges, and this resulted in a decline in retailsales in the September quarter in real terms,after the strong growth recorded in the Junequarter. Looking through the mid-yearvolatility, consumer spending appears to becontinuing to grow quite well. In September,the value of retail sales was 4.2 per cent higherthan in May, the last month for which dataappear to have been relatively unaffected bythe tax changes. With retail prices up byaround 3 per cent over that period (includingtax effects), this would imply growth in realterms of around one per cent. Sales inSeptember were boosted in some areas by the

Graph 21

$bConsumption Indicators

9

10

11

12

13

27

30

33

36

39

20

30

40

20

30

40

90

100

110

120

90

100

110

120

Retail trade

Consumer sentiment

Private motor vehicle sales

2000

Index

$b

Volumes

Values

(quarterly, RHS)

(monthly, LHS)

Long-run average = 100

1999

‘000 ‘000

Index

Sources: ABS; Federal Chamber of Automotive Industries;Westpac Melbourne Institute

19981997199619951994


23

Olympics, with sales in New South Walesparticularly strong in the month. At the sametime, Olympic-related spending by consumersand their tendency to stay at home during theOlympics may have temporarily dampenedother areas of expenditure such as inrestaurants and department stores. The overallimpact of the Games on the retail sales datatherefore remains unclear.

Consumer sentiment has fluctuated overquite a wide range since the beginning of theyear, possibly reflecting a number of factorsincluding uncertainties about the tax changes,higher interest rates and financial marketvolatility. In aggregate consumer sentiment,after recovering strongly in the middle of theyear when much of the uncertainty about thetax package was resolved, has weakened againin recent months and remains lower thanlevels recorded a year ago. Most componentsof the survey, however, remain around theirlong-run averages and would be consistentwith continued moderate growth in consumerspending.

Household disposable income grew by alittle over 2 per cent in the June quarter,reflecting increases in wage and salaryearnings and an increase in dividends receivedby households, and the household saving ratioincreased to 3.4 per cent, its highest level sinceJune 1997 (Graph 22). The reductions inpersonal income taxes and increases in socialbenefits since 1 July imply that stronger

growth in disposable income is likely to berecorded in the September quarter. Thedemutualisation of the NRMA could providea small boost to household spending, as it hasmade a small proportion of household wealthmore liquid, although it is only worth around$41/2 billion or 0.2 per cent of total householdassets. To some extent this may be offset bythe payment deadline for Telstra 2 instalmentreceipts, which could also have been acash-flow consideration for some households.

Household assets have continued to rise,increasing by 3 per cent in the June quarter,and 12 per cent over the last year, althoughgrowth has moderated from the very rapidpace recorded in 1999 (Table 7). Increases in

Table 7: Household Assets

Level Average annualised growth (per cent)at June 2000 Six months to:

June 1999 December 1999 June 2000

Tangible assets 1789 16.3 21.2 2.5– Dwellings 1665 17.5 22.7 2.5– Consumer durables 124 2.9 4.0 3.2Financial assets 1182 10.9 13.9 7.9– Currency and deposits 247 –0.3 5.4 1.3– Equities 237 12.8 36.4 9.5– Superannuation and life offices 613 16.5 13.1 9.3– Other 86 5.3 –5.3 13.9Total assets 2972 14.1 18.3 4.6

$b

Graph 22

0

2

4

6

8

10

0

2

4

6

8

10

Household Saving

2000

% %

19981996199419921990

Per cent of household disposable income


24

the value of both dwellings and financial assetshave contributed to the latest rise. Theestimated value of dwellings rose by just under4 per cent in the June quarter, more thanreversing a fall in March. This was driven byincreases in dwelling prices in all capital citiesand most country areas but, as discussedbelow, these figures may have been boostedby compositional effects which are likely tobe unwound in the September quarter.Household financial asset holdings increasedby 2 per cent in the June quarter, driven byboth net acquisitions of shares and increasesin share prices.

Households are continuing to increase theirindebtedness, although this too has moderatedin recent months. An acceleration in housingcredit, probably fuelled by attempts toexpedite payments ahead of the GST, tookgrowth to an annual rate of above 19 per centover the six months to June. Since then it haseased back to around 13 per cent over the sixmonths to September. Personal credit growthhas also moderated slightly since earlier in theyear but remains strong at around 14 per centon a six-month-annualised basis. Within thiscomponent, margin lending has slowed,perhaps reflecting the more mixedperformance in equity markets.

The effect of the tightening in monetarypolicy since last November is clearly evidentin household interest payments. In the Junequarter, the household interest burdenincreased to be 7.1 per cent of householddisposable income, which is slightly above therecent peak recorded in late 1995 (Graph 23).This rise has reflected increases in nominalinterest rates and a larger household debtburden. The ratio of household debt to incomeincreased to around 103 per cent of disposableincome in June, up from around 98 per centat end 1999. Despite the increase in householddebt, the ratio of household debt to assets hasremained steady at around 13 per cent for thepast four years, which implies little change inthe leverage of households. Information onhousing loans in arrears provides anotherindication of the impact of recent interest rateincreases on households. Housing loans inarrears still remain very low, accounting for

only one-third of one percent of all housingloans outstanding, although they increased inthe June quarter after trending downwards forthe past three years.

Dwelling investmentHousehold spending on dwellings reached

record levels as a percentage of GDP in thefirst half of the year; private dwellinginvestment grew by 10 per cent in the Junequarter and by 23 per cent over the year. Thestrong growth in dwelling investment in thefirst half of the year appears to have beenstrongly influenced by the incentive tocomplete as much work as possible prior tothe introduction of the GST. This factorreinforced a housing upswing that had alreadybeen underway.

The unwinding of the pre-GST surge,combined with the dampening effects of risinginterest rates and higher house prices onaffordability, are evident in the leadingindicators of dwelling activity (Graph 24).Private building approvals have fallen for thepast eight months, and are 47 per cent belowthe January peak. The recent falls have beendriven by approvals for houses, which hadexperienced the strongest growth in thesecond half of 1999. The value of loanapprovals has also been falling sharply,although a modest rise in August (for bothowner-occupiers and investors) suggests thatthe outlook may be stabilising. Total loan

Graph 23

1

3

5

7

9

Household Finances

0.1

0.3

0.5

0.7

0.9

%% Interest paid Housing loans inarrears

2000199819962000199319861979

Per cent of householddisposable income Per cent of housing loans


25

approvals are now 20 per cent lower than theirpeak, or 9 per cent lower than a year ago. Thedeclines in loan approvals and buildingapprovals from their recent peaks have beenabout the same as those that occurred in themid 1990s.

All states have experienced both theexceptionally strong growth in buildingapprovals over 1999 and the sharp declinesmore recently. The pick-up was strongest inMelbourne and Adelaide, which hadexperienced relatively low levels of dwellinginvestment earlier in the decade, while therecent weakening has been sharpest in NSW,which had been investing at a very high ratefor several years. A similar pattern is evidentin the state loan approvals data (Table 8).

The housing sector will clearly subtract fromgrowth of domestic demand over the comingyear, primarily due to the unwinding of theGST-related surge in investment. In thenear-term, however, the increased presenceof first home buyers in the market after 1 Julyshould see renewed interest at the lower endof the market. In the months prior to theintroduction of the GST, the share of loanapprovals attributed to first home buyersreached record lows, but then rebounded to24 per cent in July, and has since stayedaround that level. This pattern has reflectedthe incentive for first home buyers to delaypurchases until after 1 July when they wouldbe eligible to receive the CommonwealthGovernment’s first home-owners’ grant.

Despite the recent surge in housingconstruction activity, it appears unlikely thatthis will lead to a large build-up of excesssupply in the sector. While the current housingcycle, as measured by dwelling investment asa share of GDP, has exceeded the strength ofprevious cycles, this is because much of thestrength of the current upturn has been dueto consumers building bigger and betterdwellings (Graph 25) and spending more onalterations and additions. The number ofdwellings commenced, even including therecent build-up, remains well below the levelsof the two previous cycles. Other indicatorsof excess supply, such as vacancy rates andrental rates also suggest that, at this stage,there is little evidence of over-investment in

Graph 24

Table 8: Housing ApprovalsPercentage change, year to latest 3 months

Private Building(a) Loan(b)

New South Wales –42.7 –15.8Victoria –25.5 –13.5Queensland –28.7 –7.2Western Australia –37.1 –10.9South Australia –31.1 1.2Tasmania –28.9 8.5Australia –33.9 –12.4

(a) Value; houses and medium-density dwellings; latest observation is September

(b) Value; for owner-occupation; latest observation is August

8

10

12

14

16

18

20

2

3

4

5

6

7

8

Housing

2000

$b‘000

1998199619941992

Total loan approvals

Private buildingapprovals

(RHS)

(LHS)


26

housing. Rents have, if anything, beenincreasing across most capital cities, andalthough vacancy rates have increased inSydney, Melbourne and Adelaide, they remainat historically moderate levels.

House prices continued to rise through themiddle of the year. Established house prices,as measured by both the REIA and the ABS,grew strongly in the June quarter after havingsoftened earlier in the year. The latest figuresmay, however, have been boosted bycompositional change, as the withdrawal offirst home buyers from the market may haveled to lower than usual turnover at the cheaperend of the market. To the extent that this isthe case, these aggregate price measures willbe correspondingly weaker in the Septemberquarter. There are also signs that house pricesmore generally may be softening due to theweaker demand conditions now prevailing inthe sector.

The business sectorWhile the economy has grown strongly over

the past year, conditions have varied quitewidely across industries. The impact of thepick-up in world economic growth and thedepreciation of the currency has beenparticularly evident in the mining sector,which has been the fastest growing sector overthe past year with real output rising by 13 percent (Graph 26). Growth in the output ofblack coal, iron ore and gold were particularlystrong recently. The communications sector

Graph 25

continued to grow rapidly, underpinned bythe development of mobile telephone and fibreoptic networks. Output growth in the servicessector has also been buoyant. Property andbusiness services, reflecting, inter alia, workassociated with the implementation of theGST, as well as finance and insurance services,added to the strong gains earlier in the year,growing in aggregate by over 2 per cent in theJune quarter and by 7 per cent over the year.Construction output rose only moderately asthe very strong growth in dwellingconstruction was partly offset by falls innon-residential building work and engineeringconstruction.

Recent business surveys suggest that tradingconditions and levels of confidence havedeclined from the high levels seen at the endof last year. Both the NAB survey and theACCI-Westpac survey recorded a softeningin trading conditions in the first half of theyear, with some pick-up occurring in theSeptember quarter (Graph 27). The surveyssuggest that perceived trading conditionsremain close to or above their long-runaverages. Not surprisingly, the expectations forexport demand remain strong. Tradingconditions for the mining sector havecontinued to improve after a period whenconfidence in the industry had been low.According to the Yellow Pages survey,confidence of small businesses also declinedsharply in the first half of the year, althoughmuch of that decline was reversed in the

Graph 26

60

80

100

120

140

160

60

80

100

120

140

160

New Dwelling Activity1992 = 100

2000

IndexWork done

Index

Volumecommenced

Numbercommenced

19971994199119881985 -15 -12 -9 -6 -3 0 3 6 9 12 15

GDP by IndustryYear-ended percentage change

Communication

%

Mining

Property & finance

Utilities

Transport & storage

Wholesale & retail

Manufacturing

Culture & accommodation

Construction

Public administration

Health & education


27

Graph 27

September quarter.Business investment has continued to be

volatile from quarter to quarter, around amodest upward trend (Graph 28), with adecline in buildings and structures investmentbeing offset by growth in the othercomponents. Investment in machinery andequipment fell by just over 11/2 per cent in theJune quarter, but is 131/2 per cent higher overthe year. The outlook for machinery andequipment investment, according to the latestABS Capital Expenditure Survey, is for furthergrowth in the year ahead, though at a fairlymodest pace. Firms have upgraded theirmachinery and equipment investment plansslightly for 2000/01 to around 31/2 per centgrowth in nominal terms. This is likely to havebeen boosted by the introduction of input taxcredits as part of the tax reform process,though offsetting this, some investmentintentions may have been dampened by theincreased cost of imported capital goods onaccount of the depreciation of the Australiandollar.

Investment in new buildings and other

structures has been on a downward trend forthe past year and a half. This trend continuedinto the June quarter, with buildings andstructures investment falling by 3 per cent, asseveral large engineering projects werecompleted. Forward indicators fornon-residential building activity, whichaccounts for about 60 per cent of investmentin buildings and structures, have been morepositive. The value of private non-residentialbuilding approvals in the June and Septemberquarters was about 5 per cent higher than inthe corresponding period last year. Theincrease was concentrated in offices and shops.The pick-up in approvals in offices has beensupported by strong demand conditions inmost major CBD office property markets,where average vacancy rates have fallen totheir lowest levels since the late 1980s.Demand for new office space is particularlystrong in Sydney and Melbourne, where therehave been limited new completions in recentyears, and where there has been a withdrawalof a considerable amount of office space dueto strong demand for residential cityproperties. The strength in shops relateslargely to refurbishments.

Graph 28

Trading Conditions

2000

%

-25

0

25

-25

0

25

-60

-30

0

30

-60

-30

0

30

19981996199419921990

Mining

All other industries

%

%%

* Deviation from long-run average

Net balance*

(output)ACCI-Westpac

NAB

(NAB)

(NAB)0

2

4

6

8

10

12

14

16

18

0

2

4

6

8

10

12

14

16

18

Business Investment1998/99 prices

$b $b

Total

Machinery andequipment Buildings and

structures

Other

200019981996199419921990


28

Engineering construction, which accountsfor the remaining 40 per cent of investmentin buildings and structures, has beenparticularly weak. Spending is one-third belowits peak in December 1998, due largely toweakness in investment by the mining sector.Forward indicators, such as private sectorcommencements, work-yet-to-be done andthe listing of projects in the Access InvestmentMonitor, point to subdued activity in theimmediate future. On the other hand, thestrength in commodity prices in Australiandollar terms, and the correspondingly highlevel of profitability of the mining sector,would appear to provide a more positiveoutlook if these conditions are sustained.

The other major component of businessinvestment, expenditure on intangible fixedassets, fell in the June quarter, but hasincreased by 14 per cent over the past year.Falls in both computer software and mineralsexploration contributed to the decline in thequarter, although this weakness appearsunlikely to persist. In coming periods, mineraland petroleum exploration expendituresshould be encouraged by the record highcommodity prices in Australian dollar terms.

Total investment in computer hardware andsoftware and other electronic equipment hascontinued to increase, as a share of GDP, in

recent years. Private investment of this naturewas over 31/2 per cent of GDP in 1999/00,almost double its level of a decade earlier, andhas been increasing at broadly the same rateas in the US (Graph 29). The lower recordedlevel of investment in Australia is, in part,related to the fact that some of Australia’stelecommunications sector remains inmajority public ownership and hence is notincorporated in these figures. By industry,investment in hardware and electronicequipment, as well as growth in thisinvestment, has been concentrated in the

Graph 29

0

1

2

3

4

5

0

1

2

3

4

5

Private Investment in Computers, Softwareand Electronic Equipment

Per cent of GDP

99/00

%

United States

%

96/9793/9490/9187/88

Australia

Table 9: Private Investment in Hardware and Electronic Equipment(a)

Current prices, $ billion

Industry 1993/1994 1996/1997 1999/2000

Communications 0.5 1.8 4.6Property and finance 2.1 2.7 3.0Utilities 0.6 1.4 1.6Retail and wholesale trade 1.3 1.3 1.6Manufacturing 0.8 1.1 1.1Cultural, recreation and accommodation 0.5 1.1 1.1Transport and storage 0.5 0.5 0.5Agriculture and mining 0.4 0.5 0.5Construction 0.4 0.4 0.4Health, education and other 0.3 0.3 0.3Total 7.6 11.0 14.6

(a) Note that private sector expenditure on software data are not available by industry and are therefore notincluded in these figures.


29

business credit growth eased to an annualisedrate of around 9 per cent over the 6 monthsto September, around the same pace as wasrecorded in March. On the markets, the netamount raised through debt and equity alsoappears to have eased; firms are continuingto return surplus capital through equitybuy-back activity. This moderation in externalfunding could imply that the interest rateincreases have started to affect corporatefunding and investment decisions. Sinceinternal sources of funding have remainedstrong, corporates might, in particular, havetaken the opportunity to reduce gearing. TheGST and Olympic games, however, may alsohave influenced the timing of funding activity.

The labour marketOver the year to the September quarter,

employment increased by 31/2 per cent, withthe gains in employment shared fairly evenlybetween full-time and part-time positions.Much of the recent strength in employmentgrowth has been in private-sector services,reflecting the relatively strong growth inoutput of these industries. The most recentmonthly figures have shown some volatilityin aggregate employment and suggest thatsome easing in employment growth may nowbe occurring from the very high rates seenearlier in the year. Nonetheless, labour marketconditions overall remain strong.

The strength in employment growth hasseen the unemployment rate fall by almost afull percentage point over the past year, withsome increase in the participation rate alsohelping to meet the growing demand forlabour (Graph 32). The unemployment rateaveraged 6.3 per cent in the Septemberquarter, its lowest level in a decade. At thesame time, the participation rate rose tohistorically high levels. This resulted from anincrease in the female participation rate of11/2 percentage points over the past18 months, presumably buoyed by the recentlabour market strength, after remaining flatfor the previous three years.

Employment growth has been strongest inNew South Wales and Victoria, although most

communications, and property and financeservices industries (Table 9).

The profitability of the corporate sectoroverall remains high. Although growth incorporate profits moderated in the Junequarter, profits as a share of GDP remainedaround 16 per cent, well above the historicalaverage (Graph 30). Corporate net interestpaid rose by only 2 per cent, so profits afterinterest also remained strong. The businesssector’s raisings of external finance also pickedup further in the June quarter (Graph 31).Debt raising activity was particularly strong,both through intermediaries and markets.

More recently, however, growth in externalfunding has moderated a little. Overall

Graph 30

7

9

11

13

15

7

9

11

13

15

7

9

11

13

15

7

9

11

13

15

Corporate ProfitsPer cent of GDP

2000

%

GOS after interest

%

GOS

199719941991198819851982

Graph 31

-5

0

5

10

15

20

-5

0

5

10

15

20

New Corporate Sector FundingPer cent of GDP, privatisation adjusted

% %

20001998199619941992* Includes domestic raisings only. Net of buybacks from 1997.

Total funding

Debt

Total external funds

Equity*


30

States have continued to record above-trendgrowth in employment and decliningunemployment rates (Table 10). The strengthof employment in New South Wales does notappear to have been directly due to theOlympic Games. A rescheduling of theSeptember labour force survey in New SouthWales avoided much of the disturbance arisingfrom the direct employment effects of theGames, and, although employment growthwas quite strong in Sydney immediately priorto the Games, it was not unusually so. Overall,employment has grown as strongly outside themajor capital cities as within them over the

Graph 32

Table 10: Labour Market Conditions by StatePer cent

NSW Vic Qld SA WA Tas Australia

Employment growth– Year to Sep quarter 2000 4.2 3.9 3.3 2.6 2.5 1.2 3.5Unemployment rate– Sep quarter 1999 6.5 7.3 8.0 8.3 6.7 9.0 7.1– Sep quarter 2000 5.4 6.2 7.6 7.6 6.1 9.5 6.3

past year, with commensurate declines in therates of unemployment. However, substantialdifferences persist between regions, with theaverage unemployment rate in non-metropolitan areas remaining above thenational average.

Labour productivity, measured in terms ofoutput per hour worked, increased by around11/2 per cent over the year to the June quarter.This was slightly slower than the averageincrease recorded during the course of thecurrent economic expansion, and down froman increase of 23/4 per cent over the precedingyear. The slower productivity growth appearsto reflect a recent catch-up in employment tothe unexpectedly strong output growth seenin the past couple of years.

Forward-looking indicators of labourdemand have been difficult to interpret formuch of the past year, providing contradictorysignals about near-term prospects.Newspaper-based measures of jobadvertisements have been declining for severalmonths. In contrast, the level of job vacanciesas reported by the ABS survey of employershas increased for the past six consecutivequarters, supported recently by large increasesin the number of vacancies in Victoria(Graph 33). The declines in newspaper jobadvertisements may partly reflect a movementtowards the use of the internet for job search.Internet-based job advertising has beengrowing rapidly during the past year, thoughits scope appears to be narrowly based, withadvertisements seeking information-technology professionals still dominatinginternet recruitment sites. The strongestdeclines in newspaper advertisements have

%

EmploymentLabour Force

8.5

9.0

8.5

9.0

1 1

62

63

64

6

8

10

199919981995 1996 1997

Contributions to quarterly growth

%

MM

Part-time

Full-time

%pts

%pts

00

2000

Participation rate(LHS)

Unemployment rate(RHS)


31

been for tradespersons; advertisements forprofessionals remain at a high level.

The difficulty firms face in finding suitablelabour, as reported in both the ACCI-Westpacsurvey of manufacturers and the broader NABsurvey of business conditions, has eased sincea few quarters ago but remains quite high(Graph 34). Employment intentionsaccording to these surveys remain aroundtheir long-run average, although they are nowwell below the high levels seen towards theend of 1999.

Graph 34

0

25

50

75

100

0

50

100

150

200

Job Vacancies

2000

Index

(a) September quarter 1990 = 100; per cent of labour force

ANZ Bank (a)

199819961994199219901988

‘000

ABS (a)

Internet (b)

(ANZ Bank, RHS)

(LHS) (LHS)

(b) Contains breaks when new sites are included.

Graph 33

Labour Demand and Availability

2000

Employment intentions*Quarter ahead

%

-24

-12

0

12

24

-2

0

2

4

6

0

5

10

15

20

0

5

10

15

20

%

% %

NAB survey

Availability of suitable labour is significantlyconstraining production

Per cent of respondents

* Net balance, deviation from long-run average

19981996199419921990

ACCI-Westpacsurvey

NAB survey(LHS)

Employment growth(year-ended, RHS)


32

Balance of Payments

The external accounts have continued thetrend improvement of the past year, reflectingrobust trading partner growth and thedepreciation of the Australian dollar. TheOlympics also provided a sizeable once-offboost to exports in the September quarter.The trade deficit narrowed to $1.1 billion inthe September quarter, around 0.7 per centof GDP (Graph 35). Abstracting from theestimated direct effects of the Olympics, thedeficit would have been around $2.5 billion,still considerably narrower than the peakreached in the middle of 1999. Assumingthe net income deficit remains stable as ashare of GDP, the current account deficitin the September quarter would bearound 31/2 per cent of GDP, or a little over41/4 per cent excluding the effect of theOlympics.

non-Japan east Asia have grown most rapidlyand have now regained the ground lostfollowing the onset of the Asian crisis.

The Olympic Games is estimated to haveadded about $1.4 billion to service exportsin the September quarter, through the sale ofoverseas broadcast rights and extraordinaryinbound tourism, according to the AustralianBureau of Statistics. Increased revenue fromtourism has been contributing to stronggrowth in service export revenue for a numberof months: overseas arrivals increased by

Graph 35

The value of exports grew by almost 30 percent over the year to the September quarter,reflecting both higher export prices and robustvolume growth. While the growth in the valueof service exports was particularly strong,principally due to the boost from theOlympics, strong export growth has alsooccurred in all major categories (Graph 36)and has been spread across all majordestinations (Graph 37). Exports to

7

8

9

10

11

12

13

7

8

9

10

11

12

13

Trade in Goods and Services*

-3

-2

-1

0

-3

-2

-1

0

1999

Balance

$b

$b$b

$b

Imports

Exports

20001997199619951994* Excludes RBA gold transactions and frigates

1998

Graph 37

1

3

5

7

9

1

3

5

7

9

Merchandise Exports by Destination*Seasonally adjusted, current prices

2000

$b

19981996199419921990

Japan

Europe and US

NZ, Middle East,Pacific, South Asia

$b

* Excludes re-exported gold and frigates

East Asia(excluding Japan)

Graph 36

Value of Exports*

4

5

6

7

8

9

2

3

4

5

6

7

4

5

6

7

9

11

13

15

$b $b

$b $b

2000

Rural Resources

Services Manufactures

19981996 200019981996

* Estimates for September quarter 2000; data excludes RBA goldtransactions, re-exported gold and frigates.

1994


33

61/2 per cent in the six months to August,before the surge in September, when arrivalsincreased by a further 17 per cent. However,the composition of the arrivals changednoticeably in September with arrivals from theUS increasing sharply, and those from Asiadeclining significantly.

Rural export revenues in the quarter wereboosted by strong increases in rural prices,particularly for wheat and sugar, coupled withrecord levels of farm production. Rural exportprices rose by about 4 per cent in the quarterwhile volumes increased by about 5 per cent.Farm production is expected to fall slightlythis year according to the Australian Bureauof Agriculture and Resource Economics, fromthe record level of 1999/00. The wheat crop,in particular, is estimated to be significantlylower than last year’s record crop, because ofdrought conditions in some of the majorwheat-growing areas. A locust plague, whichis expected to be one of the largest on record,poses a downside risk to the outlook.

The value of resource exports (excludingre-exported gold) has grown by around40 per cent over the past year, primarilyreflecting additional capacity coming onstream, the strong growth in east Asia andrising non-rural commodity prices and thedepreciation of the Australian dollar. Inparticular, higher energy prices have boostedthe value of Australia’s exports of oil andnatural gas. Increased demand for energy isevident also in stronger exports of coal.

Resource exports to non-Japan east Asia grewby nearly 40 per cent over the year toSeptember, while exports to Japan increasedby around 50 per cent. This growth reflectedapproximately equal increases in prices andvolumes.

Strong trading partner growth and thedepreciation of the Australian dollar have alsoboosted the value of exports of manufactures,which increased by around 16 per cent overthe year to the September quarter. Much ofthe growth continues to be in exports oftransport equipment, particularly to theMiddle East. Exports of manufactures to eastAsia have grown by just under 30 per cent overthe past year.

The value of imports of goods and servicesgrew only slightly in the September quarter,with about half of the growth accounted forby higher import prices. The volume ofimports has only risen by around 2 per centin the past six months, considerably slowerthan the pace earlier in the year. Over the yearto September, imports from non-Japan eastAsia have increased most rapidly and nowaccount for nearly one-third of all imports(Table 11).

Consumption imports continued to growstrongly in the September quarter, despite theunwinding of pre-GST spending on someimports. Notably, growth in the value ofimports of motor vehicles has eased, afterstocks of motor vehicles were built up in thefirst half of the year. This stock build-up

Table 11: Imports by Source(a)

Per cent

Share of total Growth

1999/2000 1990/1991 Year to Septemberquarter 2000

East Asia (ex Japan) 28.1 18.1 29.4European Union 22.7 24.3 6.4United States 21.2 23.8 9.0Japan 13.2 18.3 21.2Rest of World 14.8 15.5 22.5

(a) Excludes imports of gold


34

occurred in anticipation of stronger demandafter 1 July due to tax-related falls in new carprices and the launch of a number of newmodels. After excluding aircraft, the growthin capital imports has maintained the pace ofthe first half of the year, reflecting healthydemand for electronic data processing andtelecommunications equipment. The value ofimports of intermediate goods was boostedby the higher prices for fuels and lubricants,which offset a large decline in imports of goodsfor processing, primarily gold.

The net income deficit widened slightly inthe June quarter, though as a share of GDP,there has been a gradual improvement overthe past couple of years. The increase in thedeficit in the June quarter was primarily dueto growth in dividends paid to foreign holdersof Australian equities. Reflecting strong exportgrowth, the ratio of net income payments toexports decreased by 1.6 percentage pointsover the first half of 2000 to be 13.6 per centin the June quarter.

Australia’s net foreign liabilities increasedby $21 billion in the June quarter to$404 billion, around 64 per cent of GDP. Overa third of this increase reflected the betterperformance of the Australian equity marketthan those offshore, which boosted the valueof foreigners’ equity holdings in Australiarelative to the value of foreign equities heldby Australians. The composition of net inflows

of debt and equity has shifted recently. Aftera few years where equity investmentaccounted for the bulk of capital inflows,recently debt inflows have been moreprominent (Graph 38). This increase in netdebt inflows reflects borrowing by the privatesector as the public sector has continued torepay foreign debt. Over the year to Marchthe outstanding stock of public sector foreigndebt fell by almost $9 billion.

Commodity pricesCommodity prices have increased at a fast

pace over the past year, reflecting the strengthof the world economy. As discussed in Box A,oil prices have risen to levels not seen sincethe Gulf War in 1990, and this has boostedthe prices of other energy commodities. TheBank’s commodity price index increased bynearly 3 per cent in SDR terms over theSeptember quarter and by 10 per cent overthe year (Graph 39). In Australian dollarterms, the increase has been much greater,with the index 7 per cent higher over thequarter and nearly 22 per cent higher over theyear.

Graph 38

Graph 39

Commodity Prices1994/95 = 100

2000

90

95

100

105

110

115

90

95

100

105

110

115

70

80

90

100

110

70

80

90

100

110

SDR

A$

Rural

Basemetals

Index(SDR)

19991998199719961995

IndexIndex

Index(SDR)

1994

Non-rural(excluding base metals)

0

1

2

3

4

5

6

0

1

2

3

4

5

6

Capital InflowsGross, per cent of GDP

99/00*

%

Equity

%

97/9895/9693/9491/9289/90

Debt

* Data to March 2000


35

However, in recent weeks, the prices of somecommodities, most notably base metal prices,have reversed the gains seen earlier in the yearas sentiment about the global outlook hasweakened. This is particularly the case foraluminium and nickel prices.

The price of West Texas Intermediate crudeoil rose by around 10 per cent in theSeptember quarter and has since risen furtherto be around 70 per cent higher than theaverage price for 1999. Some of the increasein price is due to the strength of the globaleconomy, as evidenced by the low level ofinventories of many petroleum products andthe global shortage of oil tankers. The increasein tensions in the Middle East has contributedto the reversal of most of the fall in price thatoccurred in late September when the

US government announced the release of oilfrom its strategic reserve. The rise in oil priceshas boosted the price of coal and other energycommodities. Coal prices, along with the priceof iron ore, have also benefited from a reboundin world steel production, the recovery inAsian demand and tightening supplies in theAsia-Pacific region.

Rural commodity prices rose by 4 per centin SDR terms over the September quarter andincreased further in October. The prices ofwheat and sugar have been boosted byexpectations of smaller harvests, but beefprices declined a little. Despite falling slightlyin recent months, wool prices are 15 per centhigher than a year earlier, supported bydemand from China.


36

Domestic Financial Markets

Market interest ratesThe upward trend in short-term market

interest rates that began in mid 1999 haslevelled out in the past six months (Graph 40).After rising by about 150 points betweenmid 1999 and May this year, the yield on90-day bank bills has shown little net changesince, and is currently around 6.35 per cent.

Just as the rise in market yields over the yearto mid 2000 was in anticipation of thetightening of monetary policy that has takenplace over the past year, the more recentflattening in these yields reflects a view thatofficial interest rates may be at or near thepeak, at least for the time being. For the firsttime since mid 1999, the pattern in short-termyields, including in futures markets, issuggesting that the probability of furthermonetary tightening is low.

Markets moved to this view following theBank’s decision to keep the cash rate constantin October and it was reinforced by thepublication of inflation data which were betterthan expected. It is also in line withdevelopments overseas, particularly in the US,where markets in the past six months haveswung from expectations of further tightening

by the US Fed to pricing in some likelihoodof an easing in the first half of next year.

Since mid year, long-term bond yields inAustralia have moved around a flat trend,within a range of between 6 and 61/4 per cent(Graph 41), which is about a percentage pointlower than their level at the start of the year.The flat trend in Australian yields over thepast four months is in contrast to some fall inUS yields. As a result, whereas there was littledifference between Australian and USlong-term bonds yields around mid year,Australian yields are now about 30 basispoints above corresponding US yields (stilllow by decade average comparisons).

Graph 40

Graph 41

With the strong growth in thenon-government bond market in Australia(the stock of non-government bonds is nowlarger than the stock of either Commonwealthor State government bonds), developments inthis market segment have become morerelevant.

Yields on bonds issued by highly-ratednon-government borrowers (AA or better)have fallen by less in 2000 than yields on CGS(Graph 42). That is, the spread between thesebonds and government bonds has widened.

Australian Short-term Interest Rates%

Cash rate

%

90-day billyield

1999 2000DM MJ S J S D

l l l l l l l l l l l l l l l l l l l l l l l4.0

4.5

5.0

5.5

6.0

6.5

4.0

4.5

5.0

5.5

6.0

6.5

l l l l l l l l l l l l l l l3

4

5

6

7

8

3

4

5

6

7

8

10-year Bond Yields%

US

%

Australia

1997 1998 1999 2000MDSJMDSJM DSJM J S D


37

This mainly reflects the rise in the creditspread on the debt of Telstra, the largestcorporate borrower in Australia. Creditspreads on debt of all telecoms around theworld have risen in the past six months, asmarkets have become concerned thatexcessively high prices may have been paid inrecent auctions of spectrum licences.Abstracting from Telstra debt, spreads onother highly-rated Australian borrowers havenot changed much, although there has beensome rise over the past month or so. Spreadson lower-rated debt have also risen somewhatrecently, though the deterioration in spreadshas been much less than in the US, wherecredit concerns have risen significantly inrecent months. This less pronounced rise inspreads in Australia is due to the fact that,whereas in the US there are clear expectationsof a slowing in economic activity, theeconomic outlook in Australia is more robust.The sharp downturn in the US share marketwould also have heightened credit concerns.

Less concern about a deterioration in creditquality in Australia may also explain thestronger performance of bank share prices inAustralia relative to those in the US over thepast year. Share prices of US banks haveweakened significantly although they haverecovered a bit as expectations have taken holdthat the US interest rate cycle has peaked.

Issuance in the non-government market hasremained strong over the past six months, with

bonds outstanding rising by another$101/2 billion, to $77.5 billion as atend October (Graph 43). The flow of newissues did slow in the June quarter as investordemand stalled temporarily in response torising corporate bond spreads and theanticipated downgrading of Telstra’s creditrating. But the September quarter saw aresurgence in issue activity to around previousrecord levels. This, however, was concentratedin the financial, non-resident and asset-backedsectors. Issuance by corporates has tended toslow. This is consistent with the pattern inother sources of corporate financing thisfinancial year; both credit and IPOs haveslowed over recent months (Table 12). It istoo early, however, to conclude whether thisreflects some underlying slowdown in the pace

Graph 42

Graph 43

Table 12: Corporate Financing

Year to July–OctoberJune 2000 2000

Credit(per cent per month) 0.7 0.4(a)

Bond issuance($m/month)(b) 590 536IPOs($m/month)(c) 525 190

(a) July to September

(b) Corporate issuance only

(c) Excludes privatisations

l l l l l l l l l l l l l

0

25

50

75

100

125

0

25

50

75

100

125

Non-government Bond Spreads

BBB

20001998 1999

AAA

A

AA

M J SM J DS M J DSS D D

Bps Bps

1997Source: Based on information provided by UBS Warburg Australia Ltd.

1990 1992 1994 1996 1998 20000

20

40

60

80

0

20

40

60

80

Domestic Bonds OutstandingMonthly

Stategovernment

Non-government

CommonwealthGovernment*

$b $b

* Excluding own holdings


38

of financing, simply some noise in the data,or a lull due to the Olympics.

Intermediaries’ interest ratesThe major influence on intermediaries’

interest rates over the past year or so has beenthe tightening of monetary policy. In addition,some banks increased rates on some businessloans to reflect the fact that their overallwholesale funding costs had risen faster thanthe cash rate. Also, a range of rates wasincreased by a few basis points by some banksto cover costs associated with the introductionof the GST. (Financial services are‘input-taxed’, meaning that providers offinancial services cannot claim a tax credit forthese costs.)

Movements in, and the level of, selectedlending rates of intermediaries aresummarised in Table 13.

Banks matched rises in the cash rate inlifting their housing rates, with the standardvariable rate now 8.05 per cent, on average.This remains 70 basis points lower than at thecyclical low-point in interest rates in 1994.

Interest rates on most personal loans haverisen by a similar amount to the cash rate overthe course of this tightening cycle. Businessindicator rates have, on average, increased bya little more than the cash rate, for the reasonsmentioned above, though rises in the interestrate on residentially-secured term loans forsmall businesses, a popular product, have beenbroadly in line with the cash rate (Graph 44).

Table 13: Major Banks’ Indicator Loan RatesPer cent

Change since Current Level of cyclicalOctober 1999 level low in 1993/94

HouseholdHousing

Standard variable 1.50 8.05 8.75Basic 1.55 7.50 na

PersonalResidential-secured overdraft 1.55 8.20 9.75Credit card(a) 1.40 16.70 14.35

Memo item:Mortgage managers’ rate 1.60 7.80 7.70

BusinessSmall Business

Residential-secured– Overdraft 1.65 8.60 na– Term 1.55 8.20 naOther(b)

– Overdraft 1.75 9.20 9.30– Term 1.65 8.70 na

Large Business– Overdraft 1.80 9.75 9.00– Term 1.70 9.60 na

Cash Rate 1.50 6.25 4.75

(a) With interest-free period

(b) Both secured by other assets and unsecured


39

The all-up interest cost of variable-rate loansto small businesses (i.e. indicator rates plusapplicable risk margins) has increased alittle less than the cash rate. It increasedabout 1.1 percentage points betweenSeptember 1999 and June 2000, comparedwith a rise in the cash rate of 1.25 percentagepoints over that period.

Interest rates on fixed-rate loans for housingand small businesses have fallen from theirpeaks of early this year. This reflects falls incapital market interest rates which form thebasis for the banks’ pricing of retail fixed rates(Graph 45).

Share marketBy international standards, the Australian

share market has performed well over the pastsix months or so. The ASX 200 has risen by8 per cent since end April, compared with aslight fall in broad-based share price indexesin the US over the same period (Graph 46).The Australian market reached a new high inAugust, and again in early November.

The relatively good performance of theAustralian share market has beenunderpinned by the banking and financesector and the resources (excluding gold)sector (Graph 47). Share prices of companiesin banking and finance have risen by

Graph 44

Graph 45 Graph 47

Graph 46

4

6

8

10

12

4

6

8

10

12

Small Business Variable Interest Rates%

Small businessweighted-average rate

Small businessoverdraft rate

Cash rate

%

1994 1996 1998 2000

4

6

8

10

12

4

6

8

10

12

Interest Rates3-year fixed

%

Housing

Smallbusiness

Swap rate

%

1994 1996 1998 2000

l l l l l l l l l l l

80

100

120

140

160

80

100

120

140

160

Australian and US Share PricesEnd December 1997 = 100

Index

S&P 500

ASX 200

Wilshire500

M J S1998 1999 2000

Index

M J S D M J S D D

l l l30

100

30

100

Australian Share PricesLog scale, end December 1995 = 100

Index

Banks and insurance

Other industrials

Other resources

Gold

1997 1998 1999 2000

Index

200

140

65

45

200

140

65

45


40

19 per cent over the past six months, reflectingthe sector’s strong earnings record. The indexof share prices of resource companies(excluding gold producers) rose by 14 per centover the same period, due to a combinationof strong earnings growth, takeover activityand higher commodity prices, including oilprices, especially when measured in Australiandollars. The industrial sector (excluding banksand insurance) has been volatile, often drivenby fluctuations in the share price of NewsCorporation. (News Corporation accounts forabout 13 per cent of total marketcapitalisation.) News Corporation’s shareprice has recently fallen which, together withcontinuing weakness in the price of telecoms,has caused the price index for the ‘otherindustrials’ segment of the market to showlittle net change in recent months. The fall intelecom stocks in Australia is part of a globaltrend (Graph 48).

Share prices of technology stocks,particularly online retailers, have also fallensharply in Australia, as they have in allcountries. The earlier extreme optimism thatcharacterised investors in these shares hasbeen deflated in part by disappointingearnings results (Table 14). Compared withearlier highs, share prices of online retailershave, on average, fallen by around 70 per centin both Australia and the US. These stocksnow also tend to be significantly below theirissue prices.

Financial aggregatesCredit growth remains strong, although it

has moderated in recent months (Graph 49).Total credit grew at an annual rate of 12 percent over the 6 months to September,compared with the 15 per cent growthrecorded over the six months to June(Table 15). The deceleration, which is evidentin both business and household activity, mayreflect a response to earlier increases in interestrates, although the GST and to a lesser extentthe Olympic Games are likely to have affectedrecent data. Both housing and businessborrowing accelerated in the June quarter butsubsequently slowed, probably reflecting a

Graph 48

Table 14: Share Prices of New Economy StocksPercentage change

Australia US

Since end Since peak Since Since peak1999 in 2000 end 1999 in 2000

Overall market 7 0 –3 –6Telecommunication stocks(a) –22 –31 –18 –18Technology stocks(b) -6 –32 –16 –32

Online retailers –67 –72 –69 –71

(a) Weighted average of S&P Telecommunications (Long Distance) Index and S&P Telephone Index

(b) UBS Warburg Technology Index for Australia and Nasdaq for US

l l l l l l l

60

80

100

120

140

160

180

60

80

100

120

140

160

180

Telecommunication Share PricesEnd 1998 = 100

Index

World*

Australia

M J S1999 2000

Index

M J S D D

* MSCI World Telecommunication Services sector Index (local currency)Sources: MSCI; Standard and Poors


41

Growth in the deposit aggregates hasgenerally picked up since March, with growthparticularly strong in the June quarter. Therates of increase in M3 and broad money havesubsequently eased to be running at annualrates well below their mid-1999 peak. Thecontinuing slower growth of money relativeto credit reflects the fact that intermediariesare funding some domestic lending withinternational raisings. Over the 6 months toSeptember, funds raised internationally by allfinancial institutions grew at an annualisedrate of 37 per cent.

Funds under management grew by a robust3.6 per cent in the June quarter, to be13 per cent higher than a year earlier(Table 16). The increase in assets in Junereflected strong growth in Australian equitiesoutweighing a decline in foreign assets, andwas consistent with the outperformance of theAustralian equity market over the period.Domestic equities and units in trusts nowaccount for nearly one-third of total assets ofmanaged funds. The addition of overseasassets, which are predominantly equities,increases the ratio to 50 per cent, a4 percentage point increase since end June1999.

Growth in margin lending for equities hasslowed. In the September quarter, it rose by3 per cent, whereas it had been growing at aquarterly rate of about 10 per cent at around

Graph 49

Table 15: Financial Aggregates(a)

Seasonally adjusted annualised growth rates, per cent

Six months to: Three months to:

March June September March June September2000 2000 2000 2000 2000 2000

Total Credit 13.9 15.4 12.3 15.6 15.3 9.4– Personal 18.4 15.0 14.1 17.4 12.8 15.4– Housing 17.2 18.7 16.1 18.0 19.4 12.9– Business 10.4 12.9 8.8 13.3 12.5 5.2Currency 7.0 6.1 10.4 4.0 8.2 12.8M3 5.2 10.1 9.2 7.0 13.3 5.2Broad money 6.9 8.7 8.5 11.4 11.0 6.0

(a) Adjusted for privatisations and infrastructure bond purchases.

Credit GrowthSeasonally adjusted

2000

Six-month-ended annualised rate

%

Year-ended

8

10

12

14

8

10

12

14

2

6

10

14

18

2

6

10

14

18

%

Six-month-endedannualised

Household

Business

1997 1998

% %

1999

tendency to draw down loans and finalisepayments ahead of the GST. The OlympicGames may have also served to dampenlending activity in both sectors in September.Overall, annualised 6-month growth inhousehold and business credit is running ataround 16 per cent and 9 per cent, botharound 2 percentage points below growthrates in March.


42

the turn of the year. Margin lending nowrepresents about 8 per cent of all personalloans (excluding housing).

In the September quarter, the main lendinginstitutions have provided additionalinformation about margin lending. This issummarised in Table 17.

Total margin debt is currently about$63/4 billion, representing slightly morethan half of the limits approved by financialinstitutions. These loans are backed by a totalshare portfolio of about $13.2 billion,representing about 2 per cent of total sharemarket capitalisation. The average leverageratio (the ratio of loans to shares) is 51 percent, well below the maximum rate of 70 percent that banks say they will make availablefor ‘blue chip’ shares.

Banks and brokers had about86 000 customers with margin loans at endSeptember, with an average loan of just over$78 000. There were just over 12 000 margincalls to customers in the September quarter.Anecdotal evidence is that the frequency ofmargin calls has recently increased and that,when calls are made, instead of subscribingnew money, borrowers usually instruct thelending institution to sell shares.

Table 16: Managed Funds

Percentage change % of total

June 2000 Year to June 2000

By Asset:Cash & deposits 6.3 6.8 7Loans & placements 2.0 13.8 5Short-term securities 3.4 -8.8 10Long-term securities 2.9 7.0 13Equities & units in trusts 8.0 23.0 31Land & buildings 2.6 13.2 11Assets overseas -3.6 22.0 19Other assets 11.7 3.4 4Total 3.6 13.0 100

Table 17: Margin Lending:September Quarter 2000

Total margin debt ($b) 6.7Total margin loans approved ($b) 12.2

Credit limit use (per cent) 55.0

Value of underlying shares ($b) 13.2Leverage (per cent) 51.0

Number of margin loans (’000) 86.4Average loan size ($’000) 78.0Number of margin calls (’000) 12.1


43

Recent developments in inflation

Consumer prices

The Consumer Price Index increased by3.7 per cent in the September quarter and by6.1 per cent over the year (Graph 50). Mostof the rise in the quarter reflected the net effecton prices of the introduction of the GST andthe removal of wholesale sales tax (WST) on1 July. However, the size of the net tax effectscannot be determined with certainty. Standardmeasures of underlying inflation that arenormally used to extract temporary factorswere also significantly affected by the taxchanges (Table 18), and hence they cannotbe used as indicators of the non-tax-relatedcomponent of inflation. Based on earlierestimates of the tax effects published by theTreasury and the Australian Competition andConsumer Commission (ACCC), the taxchanges appear to have contributed around21⁄2–3 percentage points to the CPI increasein the September quarter. While estimates ofthe tax effects are subject to a range ofuncertainty, underlying inflation net of taxeffects appears to have been around

Inflation Trends and Prospects

Table 18: Measures of Consumer PricesPercentage change

Quarterly Year-ended

June Sep June Sep2000 2000 2000 2000

Headline CPI 0.8 3.7 3.2 6.1– Tradeables 1.0 2.1 2.0 3.4– Non-tradeables 0.7 5.1 4.2 8.4CPI excluding volatile items 0.6 3.5 2.6 5.5Market goods and services 0.6 3.7 2.4 5.6 excluding volatile itemsWeighted median(a) 0.4 3.6 2.4 5.4Trimmed mean(a) 0.6 3.9 2.7 5.9

(a) For details on the calculation of these measures, see ‘Measuring Underlying Inflation’, RBA Bulletin,August 1994.

Graph 50

21⁄4 per cent over the year to the Septemberquarter.

The net effect of taxes on the Septemberquarter CPI appears to have been less thanwas expected, a result that is open to a numberof possible interpretations. Some businessesmay have delayed passing on the tax increasesto consumers and instead absorbed part ofthe tax in their profit margins, presumably

-1

0

1

2

3

4

5

6

-1

0

1

2

3

4

5

6

CPI Inflation

2000

%

Quarterly

Year-ended

1998199619941992

%


44

with the potential to reverse some or all ofthat absorption at a later date. Anotherpossibility is that the WST removal may haveflowed through to final prices more quicklythan anticipated. In that case, the pricereductions that had been expected to comefrom this source in the next couple of quarterswould be correspondingly less. Still anotherpossibility is that the initial estimates of thelong-run tax effects may turn out to have beentoo high. Most likely, more than one of thesefactors is at play, and their relative importanceshould become clearer as future developmentsin consumer prices unfold.

The September quarter is the first quarterof data for the 14th series CPI, whichintroduces a new set of weights based on the1998/99 Household Expenditure Survey anda re-organisation of expenditure componentsinto eleven expenditure groups, comparedwith the previous eight. The revision of weightsin the CPI basket is one factor thatcontributed to a smaller net tax effect thanpreviously estimated for the Septemberquarter, in part due to a higher weight onmotor vehicles, the prices of which werereduced by the tax changes.

Increases in retail petrol prices, of around10 per cent, also contributed significantly toCPI inflation in the September quarter. Overthe year to the September quarter, retail petrolprices have increased by 24 per cent,contributing 1 percentage point to inflation.The increases continue to reflect acombination of a higher world price for crudeoil and further depreciation of the exchangerate.

Apart from rising petrol prices, the majorcontributions to the CPI increase in theSeptember quarter were from prices of itemsthat became subject to GST but whose costswere not previously heavily affected by theWST, for example house purchase, tobacco,domestic holiday travel and accommodation,meals out and take-away foods, andtelecommunication. Partly offsetting theseincreases were price falls mainly for items thatwere formerly taxed at relatively high ratesunder the WST regime, for example motorvehicles and audio, visual and computing

equipment. Prices of the latter items appearto have fallen more during the past year thancould be explained by the removal of WST.Some government subsidies, which wereintroduced as part of the tax package on 1 July,also had an influence on prices in theSeptember quarter CPI. The First HomeOwners’ Scheme, which provides a grant of$7,000 to first home buyers, had a smallnegative effect on the recorded rise in housepurchase prices in the quarter, and is likely tohave subtracted around 0.1 percentage pointfrom the CPI. The new Child Care BenefitScheme, which replaces two previousassistance schemes, led to a 15 per cent fallin the effective price of child care, and alsosubtracted close to 0.1 percentage point fromthe CPI in the quarter.

The exchange rate and inflation

In import-weighted terms, the Australiandollar has depreciated by around 14 per centsince the beginning of the year (Graph 51).Over the course of the year, the exchange ratedepreciation has contributed to the increasein the Australian-dollar price of crude oil, withthe pass-through to the retail petrol price, andtherefore CPI inflation, occurring quiterapidly. Apart from the effect via oil prices,the exchange rate depreciation has also beenevident more broadly in import prices at thedocks and in the prices of manufacturinginputs, with some of that effect likely to have

Graph 51

90

95

100

105

110

115

90

95

100

105

110

115

Import Prices and the Exchange RateMarch 1992 = 100

2000

Index

1998199619941992

Index

Import prices ‘at the docks’

Average exchange rate for December quarter to date

(import-weighted index, inverted)Exchange rate


45

flowed through to prices of final manufacturedgoods.

The effect of the depreciation on the pricesof items in the CPI other than petrol is moredifficult to establish, partly due to thedominant influence of tax effects on theSeptember quarter CPI, and partly due tothe more protracted pass-through ofexchange rate movements to retail prices inrecent years. Nonetheless, a smaller thanexpected fall in the retail price of importedmotor vehicles (of 1.3 per cent in the quarter)may be partly attributable to the depreciationof the exchange rate in recent quarters.Moreover, the further depreciation over thepast two months is yet to appear in theconsumer prices data. While firms might beexpected to offset some of the depreciationwith temporarily reduced margins and the useof exchange-rate hedges, their scope to absorbthe price impact of a sustained depreciationmay be limited, particularly if margins havealready been squeezed by absorption of someof the tax effects and by the effects of earlierexchange rate depreciation which was notfully passed on.

Producer prices

Aggregate indices of producer prices bystage of production have recorded strongincreases during the past year, particularly atthe preliminary and intermediate stages ofproduction (Table 19). With the exception ofconstruction prices, where input costs hadbeen affected by the WST, producer priceindices are not affected by the recent taxchanges. The increases over the past year havein part reflected rapidly rising prices ofcommodities such as petroleum and basicmetal products, as well as more broadly basedincreases in other raw materials costs. Finalproducer prices, excluding export prices,increased only moderately in the Septemberquarter but are still significantly higher overthe year. Around a third of the increase in finalprices over the past year reflects the rise inpetroleum and chemical product prices;excluding this item, final prices increased by3.2 per cent.

Part of the disparity between the priceincreases at earlier and later stages ofproduction reflects the greater importance ofraw commodities as a share of costs at theearlier stages of production. As inputs fromearlier stages of production represent only aportion of the cost of producing final goods,final prices would not need to rise by as greata percentage as the increase in input costs forprofit margins to be maintained. Evenallowing for that, however, there may havebeen some absorption of rising input costsrecently, which could imply further upwardpressure on final prices if the higher inputcosts are sustained.

Industry-specific price indices point torelatively strong increases during the past year

Table 19: Producer and Trade PricesPercentage change

Year toSeptember September

quarter quarter2000 2000

Stage of productionPreliminary 2.4 8.8Intermediate 1.8 7.1Final (excluding exports) 0.5 4.6ManufacturingInput prices 3.5 18.0– Domestic 4.3 19.8– Imported 2.1 15.5Final prices 1.9 7.2– Excluding petroleum 0.2 3.9ConstructionMaterials used inhouse building –0.8 3.3Materials used inother building –1.6 0.3ServicesTransport and storage 0.0 1.7Property andbusiness services 2.0 6.6Merchandise tradeExport Prices 2.1 17.9Import Prices 1.3 10.9


46

in manufacturing (in both input and outputprices) and in some service industries. In theconstruction industry, materials prices fell inthe September quarter following the removalof the WST. Excluding this effect, the pricesof construction materials for both housing andother building increased in the quarter, butat a slower pace than had been evident duringthe previous year, consistent with recentindications of a decline in demand pressuresin the building industry.

Labour costsThe wage cost index (WCI) and average

weekly ordinary-time earnings (AWOTE)measures continue to provide differingpictures of recent wage developments(Graph 52, Table 20). The WCI increased by2.8 per cent over the year to the June quarter2000, unchanged from the year-ended raterecorded in the March quarter. In contrast,preliminary estimates suggest that AWOTEincreased by 5.9 per cent over the year toAugust, a sharp pick-up from the growth rateof 2.1 per cent recorded a year earlier. Thedifferences between these two measures reflecttheir differing sources and methods ofconstruction as well as an importantconceptual difference, with the WCI being ameasure of the change in wage rates, whileAWOTE is a measure of the change in thewage bill. Some implications of thesedifferences are discussed in Box C.

The volatile nature of the AWOTE datamakes it difficult to assess the extent to whichthese data may indicate an increase inunderlying wage pressures at present. Theseries is susceptible to compositional changein the employment survey underlying theestimates, and the recent strong increase couldat least partly represent a reversal of any sucheffects that may have contributed to theunusually low growth recorded a year ago.That interpretation would be consistent withthe overall picture presented by other wageindicators, which do not record either thesharp dip or subsequent pick-up in wagepressures. On the other hand, in anenvironment of declining unemployment,strong growth and, more recently, risinginflation, it is possible that the survey issignalling some genuine pick-up in wagesgrowth, even if its extent is overstated. Aclearer interpretation of these trends shouldbe possible once the other major measures ofwages for the September quarter becomeavailable.

At this stage, data for new enterpriseagreements appear broadly consistent with the

Graph 52

Table 20: Indicators of Labour CostsYear-ended percentage change

Mar June Sep2000 2000 2000

Wage cost index(a)

Private 2.9 2.9Public 2.5 2.7Total 2.8 2.8Average weekly earnings surveyAWOTE 4.1 4.3 5.9AWE 2.8 3.9 6.5Executive remunerationBase salaries 4.6 4.5 4.6New federal enterprise agreements(b)

Private 3.6 3.8Public 3.1 3.0Total 3.4 3.4

(a) Total pay excluding bonuses

(b) Average annualised increase

-2

0

2

4

6

-2

0

2

4

6

WagesPercentage change

2000

%

(year-ended)

* Total pay excluding bonuses

Ordinary-time earnings

%

1998199619941992

(year-ended)Wage Cost Index*

(quarterly)

Ordinary-time earnings(quarterly, nsa)

Wage Cost Index*


47

wages picture given by the WCI up to the Junequarter. The average annualised wage increaseyielded by enterprise agreements certified inthe June quarter was 3.4 per cent, unchangedfrom the previous two quarters and noticeablybelow the figures being recorded two to threeyears ago. There are some signs, however, thatthese may have begun to pick up, with anumber of more recent agreements yieldingsomewhat higher increases than wereobserved earlier in the year.

Recent business surveys also point to somemodest upward pressure on wages growth inthe context of a tightening labour market. TheNAB survey of non-farm businesses indicatesthat growth in actual and expected labourcosts has continued to pick up, albeit slowly.The September quarter ACCI-Westpacsurvey of manufacturers indicates that the netbalance of firms finding it more difficult toobtain labour remains close to cyclical peaklevels. Both surveys suggest that where firmsare due to complete a new enterpriseagreement, these are expected on average toprovide for higher wage increases than theagreements they replace.

In some instances, wage increases fromenterprise agreements could be subject tomodification in light of the effect of the recenttax changes on the CPI. Some agreementscontain clauses that provide for a full or partialindexing of wages to the CPI, while othersprovide for wage increases to be reviewed inthe event that the effects of the GST oninflation exceed expectations or exceed somedefined benchmark. In these latter cases,agreements vary as to how the benchmark isdefined and the period over which the taxeffect is to be assessed, and the provisions arein many cases open to interpretation by theparties to the agreement. Hence the overallimpact of such renegotiation clauses remainsuncertain. Nonetheless, the proportionof agreements that contain a GST-relatedclause has remained quite low, and thelower-than-expected outcome for the CPI inthe September quarter appears at this stageto have reduced the likelihood of significantadditional wage increases being generated bythis mechanism.

The Mercer Cullen Egan Dell salary reviewindicates that growth in executive pay has beenrelatively stable for some time now. TheSeptember quarter survey indicates that thebase salary of executives has been growing ataround 41⁄2 percent over the past year. Thebase salary component does not incorporateany bonuses or returns from participation incorporate share schemes.

The Australian Council of Trade Unionsannounced in early November that it intendsto make an application to the AustralianIndustrial Relations Commission to varyaward rates of pay. The claim, to be heard aspart of the Safety Net Review early next year,will seek a $28 per week increase in pay forall weekly award rates from the federalminimum wage ($400.40 per week) up to$492.20, and a 5.7 per cent increase for awardrates above this level.

Inflation expectationsConsumers’ expectations of inflation have

declined considerably in recent months afterthe sharp increases seen in the period leadingup to the implementation of the GST(Graph 53). According to the MelbourneInstitute survey, the median inflationexpectation in October was 4.5 per cent,about the same as had been recorded in theprevious couple of months but well down fromthe peak of over 8 per cent in June. The survey

Graph 53

0

2

4

6

8

0

2

4

6

8

Inflation Expectations% %

Source: Melbourne Institute20001998199619941992

ConsumersYear-ahead inflation


48

also suggests a tighter concentration ofresponses in the 2–3 per cent range, with adeclining number of consumers expectinginflation of 10 per cent or more. The resultsthus seem consistent with consumersincreasingly expecting the effect of the taxchanges to be of a one-off nature rather thanrepresenting a general rise in ongoinginflation. The recent declines bringconsumers’ inflation expectations back toaround the levels prevailing in early 1999.

The latest business surveys indicate thatprice increases following the introduction ofthe GST were lower than expected, althoughthere was a pick-up from earlier quarterlyrates. The outlook reported by businesses forthe coming quarter is for a smaller increasein prices than occurred in the Septemberquarter, but one that is still relatively high.Abstracting from the September quarter, boththe broad NAB survey and the ACCI-Westpacsurvey of manufacturers suggest that there hasbeen some upward trend in ongoing inflationin recent quarters. In part, this is likely to havereflected the effects of higher oil prices andthe recent depreciation of the Australiandollar.

The inflation forecasts of financial-marketeconomists changed only slightly in the latestsurvey conducted by the Bank following therelease of the September quarter CPI(Table 21). The median forecast for the year

to June 2001 declined to 5.4 per cent;excluding tax effects, the forecast wasunchanged at 2.8 per cent, which implies thatthe downward revision comes from lowerestimates of the effect of the tax changes onthe CPI over this period. The median inflationforecast for the year to June 2002 increasedslightly to 2.4 per cent. The majority ofrespondents do not expect the tax changes toaffect inflation over the year to June 2002. Itis likely that respondents’ inflation forecastsincorporate assumptions of some reversal ofrecent exchange rate and oil price movements.

Trade union officials, as surveyed by theAustralian Centre for Industrial RelationsResearch and Training (ACIRRT) followingthe release of the September quarter CPI,continue to revise up their forecasts forinflation for the year to June 2001. Somewhatsurprisingly, union officials expect inflation toremain high in the following year, despite thetax effects dropping out of the annual inflationrate.

Longer-term inflation expectations offinancial market participants, measured by thedifference between nominal and indexed10-year bond yields, have remained relativelystable since April, at between 23⁄4 and3 per cent, after reaching a peak of33⁄4 per cent in mid January.

Table 21: Median Inflation ForecastsPer cent

Year to June 2001 Year to June 2002

May August November August November2000 2000 2000 2000 2000

Market economists(a)

CPI 5.3 5.5 5.4 2.3 2.4– Excluding GST 2.6 2.8 2.8 2.4 2.4Union officials(b)

‘Inflation’ 4.8 5.3 6.0 4.2 5.0

(a) RBA survey

(b) ACIRRT survey


49

Inflation outlook The tax effects which caused the headline

measure of inflation to increase sharply in theSeptember quarter will keep the headlineinflation rate high in year-ended terms untilthey drop out of the calculation in theSeptember quarter 2001. As discussed above,there are considerable uncertainties inestimating the net contribution of the taxchanges to the quarterly and annual inflationfigures, and hence it is more difficult thanusual to extract a measure of the underlyingtrend. At this stage inflation excluding taxeffects, and also excluding the effects of oiland other temporary factors, appears to havebeen around 21⁄4 per cent over the latest year.

On this basis, inflation remains noticeablyhigher than it was a year ago, even if theupward trajectory does not appear to havecontinued into the September quarter. Theoverall increase in inflation over the past yearhas had some industry-specific elements,notably in relation to house prices and petrolprices, but looks to have been driven morebroadly by the continued strength of thedomestic economy. With GDP having grownat an annual rate of 43⁄4 per cent during thepast three years, and levels of capacityutilisation increasing, demand conditions haveclearly been placing greater upward pressureon prices than was the case a couple of yearsago.

At this stage, the recent depreciation of theAustralian dollar does not seem to have had anoticeable impact on consumer prices apartfrom petrol, but, if the exchange rate remainsaround current levels, it will clearly representa source of upward pressure on prices in thenext one to two years. In import-weightedterms, the exchange rate has depreciated by afurther 6 per cent in the past two months, tobe 14 per cent lower than it was at thebeginning of the year. While importers mayto some extent be able to hedge againstcurrency movements and temporarily absorbexchange rate changes within their profitmargins, their scope to do so may be quitelimited given that margins may already havebeen squeezed by absorption of some taxeffects and higher input costs.

Another important near-term factor forinflation will be developments in internationaloil prices. Higher crude oil prices, with thelower exchange rate, have resulted in a largeincrease in domestic petrol prices. As in othercountries, this has added about 1 percentagepoint to the CPI increase over the latest year,and has added significantly to business inputcosts. In assessing underlying inflationprospects, the Bank seeks to abstract from theinitial impact of oil prices in much the sameway as is done for tax effects, but to be alertfor signs that higher fuel costs are feeding intoinflation on a more sustained basis throughindirect channels. Oil prices are unlikely tocontribute to headline inflation in the yearahead to the same extent that they have in therecent past, and indeed the Bank’s forecastsassume that there will be some decline ininternational oil prices in the period ahead.Were oil prices to remain at current high levels,that would probably imply some upwardpressure on underlying inflation in the nearterm as the indirect effects of higher fuel costsflow through to the general price level.

Longer-term prospects for inflation willdepend importantly on developments inlabour costs. Wage indicators have providedmixed signals recently, with the wage costindex and data on new enterprise agreementsindicating that wages growth remainedmoderate up to mid 2000, while more timelydata on ordinary-time earnings point to asharp pick-up in wages growth over the yearto August. These latter figures are often subjectto spurious volatility and should therefore notbe relied upon too heavily, but some pick-upin wages growth would appear consistent withthe continued tightening in labour marketconditions seen over the past year and morerecent signs of somewhat higher settlementsbeing reached in enterprise agreements.Recent business surveys also suggest modestupward pressure on wages growth at present.

While the September quarter CPI result wasa little weaker than expected, the combinedeffects of several years of strong growth, atightening labour market, high oil prices anda low exchange rate could still be expected togenerate further upward pressure on inflation


50

over the next year or two. There does, however,appear to have been some change in the mixof these forces over recent months. Onbalance, the risks to inflation arising fromdomestic demand pressures may have easedslightly, while the further depreciation of theAustralian dollar has added to inflationarypressures.

A forecast made on the standard technicalassumption that the exchange rate stays at ornear recent levels, would have inflation inunderlying terms, net of tax effects, graduallyincreasing further, to be around 3 per cent bythe end of 2001, and likely to remain at thatrate for some time thereafter. Until the Junequarter 2001, CPI inflation measured on afour-quarter-ended basis can be expected toremain high – probably over 5 per cent –because of the effects of tax reform.Subsequently, with these effects dropping out,and assuming a reduction in international oilprices (and hence domestic fuel costs), CPIinflation would be somewhat lower thanunderlying inflation after June 2001, althoughtending to drift back up towards it as those

temporary factors waned. These projectionsassume that there is no response of wages orprice expectations to the temporarily higherheadline rates of inflation now being observed.

The forecast is subject to a number ofsources of uncertainty. On the upside, theassumption that wage and price expectationswill be unaffected by the current high rates ofCPI inflation may still prove to be unfounded,although that risk appears to have diminishedrecently. This source of upside risk to theforecast would, however, be amplified if oilprices were to remain high or if they were toincrease further, instead of gradually decliningas assumed. The forecast is also sensitive tothe assumption about the exchange rate, andany further currency depreciation wouldsimilarly add to upside risks to inflation. Onthe other hand, with the currency already athistorically low levels, there is clearly potentialfor it to appreciate in the forecast period. Werethat to occur, it would imply a more benigninflation outlook than would be generatedfrom an exchange rate close to its currentlevel.R

9 November 2000


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Box C: Alternative Measures of Labour Costs

Graph C1

The growth of labour costs is an importantfactor in assessing trends and prospects forinflation. In Australia there are severaldifferent measures that attempt tosummarise economy-wide developments inwages or labour costs.1 Of these, four arecommonly cited:• average weekly earnings (AWE) per

non-farm wage and salary earner;• average weekly ordinary-time earnings

(AWOTE), which is derived from theAWE survey but includes only theordinary-time earnings of adults workingfull-time;

• average compensation per wage andsalary earner, published in the nationalaccounts; and

• the wage cost index (WCI).The behaviour of these four measures

during the past decade is shown inGraph C1.

Why do the measures differ?The first three indicators listed above are

measures of the labour cost or wage bill peremployee. At times, there can be significantdivergences among them, arising partly fromdifferences in coverage and sources; forexample, the national accounts measure candiffer from the other two because it is derivedfrom a different survey, and because itincludes non-wage costs.

All of the wage-bill measures are subjectto variability induced by compositionalchange, arising because fluctuations in therelative representation of low- and high-wageemployees in a survey will affect the recordedlevel of average wages. In the case of the AWEmeasure, a particularly important issue is theimpact of changes in the relative shares offull-time and part-time workers – an increasein the proportion of part-time workers willreduce AWE because part-time workers earnless per week than the average. In additionto generating short-run volatility, this effectis likely to result in a longer-rununderstatement of wages growth by the AWEmeasure, due to a trend increase in the shareof part-time workers in total employment.The ordinary-time earnings measure, whichis based only on full-time workers, is notaffected by this form of compositionalchange, and in this respect is conceptuallycloser to an hourly wage measure. Its growthis likely, however, to have been boosted onaverage by a tendency for ordinary-timeworking hours to increase, and it remainssubject to the more general problems ofvolatility affecting all wage-bill measures.

The WCI differs from the other threeindicators in that it is a measure of wage ratesrather than the wage bill. It attempts tomeasure changes in the cost of purchasing afixed quantity and quality of labour input.

1 Some of these issues were discussed in more detail in ‘Measuring Wages’, Reserve Bank of Australia Bulletin,December 1996.

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Labour Costs: AustraliaYear-ended percentage change

2000

%

National accounts

AWOTE

%

AWE

WCI

19981996199419921990

(non-farm)


52

The characteristics of each selected job inthe WCI are specified in detail and jobs withthe same description are matched over time,allowing the index to be constructed fromthe change in hourly wage rate for each job.As a result of these features, the WCI mightbe expected to generate a lower averagegrowth rate in the long run than would berecorded by an hourly wage-bill measure.This difference would arise if there was atendency over time for lower-skill jobs to bereplaced by higher-skill jobs, which typicallyattract higher earnings.

Without a longer run of historical data, itis difficult to say how large such a differencemight be. The experience of New Zealandsuggests that the average difference betweenwage-bill and wage-rate indicators could bequite significant. Statistics New Zealandpublishes a labour cost index (LCI), whichis similar in concept to the WCI, and anaverage hourly earnings (or wage bill)measure. The difference between the twoseries has averaged close to 1 percentagepoint per annum since the early 1990s(Graph C2). On the other hand, in theUnited States, which also publishes anemployment cost index (ECI) similar toAustralia’s WCI, there appears to be littlesystematic difference between that measureof wages growth and an hourly earningsmeasure.

Which is the best indicator forassessing trends in inflation?

In order to assess developments ininflation, wages need to be compared withproductivity to derive a measure of unitlabour costs. In practice, none of theindicators discussed above is likely to be idealfor this purpose. Wage-bill measures, suchas those derived from the AWE survey ornational accounts data, are conceptually themost appropriate, since unit labour costs canbe thought of as representing the overallwage bill per unit of output. However, thesemeasures, as noted above, can be subject tosignificant short-run volatility driven byfluctuations in the composition ofemployment between surveys. This can makeshort-run developments in the series difficultto interpret.

The WCI, being a wage-rate measure fora fixed basket of jobs, is not fully compatiblewith economy-wide productivity measuresfor the purposes of deriving unit labour costs.For the reasons discussed above, the WCIappears likely to grow less rapidly on averagethan measures derived from the wage bill,and hence a unit labour cost seriesconstructed by combining the WCI witheconomy-wide productivity would tend tounderstate the inflation trend. The extent ofthis effect is difficult to assess, given the shorthistory of the series. At the same time, sincethe WCI is less affected by short-runcompositional change, it can be expected tobe less volatile than wage-bill measures inthe short run. This implies that the WCI maygive more reliable signals of changes in thetrend in wage rates, although, given itsrelatively short history, its behaviour has notyet been tested over an economic cycle. R

Graph C2

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Labour Costs: New ZealandYear-ended percentage change

2000

%

Average hourly earnings

Labour cost index

%

19981996199419921990

Statement on Monetary Policy - RBA · 2015-10-01 · Statement on Monetary Policy November 2000 2 Some of this change in mood has flowed through to Australian financial markets. But,

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