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August 2000Reserve Bank of Australia Bulletin

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The Australian economy continued toperform strongly during the first half of 2000,with growth running at more than 4 per centper annum, a noteworthy performance for aneconomy that is now entering the tenth yearof an economic upswing. In line with thestrength of the economy, employment growthhas been strong, and unemployment hasfallen. At the same time, inflation has pickedup, measured either by the CPI or the variousunderlying measures.

Growth of the Australian economy is beingsupported by a strong external environmentat present and, if anything, global economicconditions have strengthened further in recentmonths. In the United States, where manyobservers had been expecting some slowing,growth remained strong in the first half of2000, while growth in the other major regionshas been decidedly firmer. The Japaneseeconomy, which has been the weakest of themajor economies in recent years, is nowshowing signs of recovery. The mainuncertainties in the global environmentconcern the United States, where someslowing in activity is widely expected, andJapan, where the strength and durability ofthe economic recovery remain uncertain.Nonetheless, the overall condition of theglobal economy represents an environmentthat is highly favourable to growth in Australia,with global growth in 2000 likely to be thehighest it has been for several years. Growthin Australia’s export income over the past year

was nearly 30 per cent, a pace which has rarelybeen exceeded in the past four decades.

It had been expected that as externaldemand strengthened, domestic spendinggrowth would decline. Several indicatorssuggested that some areas of private demandhad begun to slow in the first half of 2000.But overall demand growth has remainedquite strong, boosted to some extent bytemporary pre-GST spending, and bypublic-sector expenditure which, at least asrecorded in the national accounts, has alsoexpanded quite quickly. Consistent with this,spending on imports has increased stronglyover the past year. The net result is that thebroadest economy-wide indicators ofactivity – GDP and employment growth –have continued to show an economy that isquite robust. This has generated a continuingdecline in unemployment, bringing theunemployment rate down to around63/4 per cent in recent months, its lowest levelfor a decade.

With the implementation of major changesto tax arrangements from 1 July, a number ofeconomic indicators have already becomemore difficult to interpret over short periods,and this will continue in the months ahead.The introduction of the GST is likely to haveshifted a significant volume of housing activityfrom the second half to the first half of theyear. This is already evident in the recent sharpdeclines in the forward indicators of housingactivity after the strength recorded earlier in

The Economy and Financial Markets

The Economy and Financial Markets August 2000

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the year. There was also a very large boost tosome areas of retail spending in June which islikely to be followed by a couple of weakermonths. Working in the other direction, somebusiness investment spending may have beendeferred to the second half of the year tobenefit from the more favourable taxtreatment under the new system.

Leaving aside these short-term influences,conditions at present appear conducive tocontinued strong growth. Exports areincreasing rapidly, reflecting the favourableinternational environment as well as the boostbeing given by current levels of the exchangerate. This in turn is feeding into growth indomestic incomes. Corporate profitability ishigh, and businesses have ready access tofunding, providing a favourable environmentfor investment. Developments in householdincome and wealth remain supportive ofconsumer spending, and the substantialincome tax cuts and increases in governmentbenefit payments implemented recently willprovide further support in that area.

Notwithstanding the recent increases ininterest rates, the stance of monetary policyis not unduly restricting growth at present.Real interest rates could not be consideredhigh judged by any previous comparableperiod, and credit has continued to expandrapidly, with the pace of credit growthincreasing further in recent months. Strongdemand for credit has been particularlyevident in the household sector, where debtlevels in aggregate have increased by morethan 17 per cent over the past year. While sucha rate of expansion will clearly not besustainable in the longer run, there is littlesign at this stage that the appetite forborrowing has been restrained by the recentincreases in interest rates, even though thehigher debt burden of households might beexpected to make them more responsive tointerest rate changes.

There has been a gradual increase ininflationary pressures during the past year.The CPI rose by 3.2 per cent over the year toJune, slightly above the target for CPI inflationof 2–3 per cent. The large CPI rise was partlyattributable to some temporary or

industry-specific factors, most notably higherinternational oil prices. Temporary departuresfrom the target inflation rate of this natureare acceptable, as Australia’s flexible inflationtargeting policy is specifically designed to caterfor volatility in the CPI. Various core measuresof inflation point also to a gradual increase.These measures suggest core inflation iscurrently running at around 21/2 per cent,compared with around 11/2 per cent a year ago.Upstream price indicators are also indicativeof an increase in inflation pressures, in partreflecting the depreciation of the exchange ratesince late 1999. Some of these cost increaseshave probably not yet been reflected in finalconsumer prices.

Price data will become more difficult tointerpret in the period ahead because of thesignificant impact that the changes to taxarrangements are likely to have on the CPI.These will have their main impact in theSeptember quarter but it will be some timebefore the CPI, or underlying inflationmeasures based on the CPI, will provide aclear reading of annual inflation unaffectedby the tax changes. The Bank has signalled itsintention to abstract from these tax effects,and monetary policy will seek to ensure thatongoing inflation excluding the tax effectsremains consistent with the target. This willrequire careful judgments to be made as tothe respective contributions of tax effects andongoing inflation to CPI movements in thequarters ahead. In assessing the inflationoutlook the Bank continues to assume thatthere will be no significant second-roundeffects on wages and prices flowing from theimplementation of the GST. Prospects foravoiding such second-round effects appear tobe good at this stage. The Bank’s currentassessment is that inflation (excluding taxeffects) is likely to be in the upper part of thetarget zone over the next four to six quarters,though inflation risks overall are tiltedsomewhat to the upside.

Monetary policy has responded to thechanging balance of risks to economic activityand inflation, increasing the cash rate in fivesteps since last November, the most recent ofthese being in early August. The Board’s


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assessment throughout this period has beenthat, with strong growth, a gradual increasein underlying inflation, and firming demandfor credit, interest rates needed to rise to lessenthe risks of higher inflation in the future. Thestructure of market interest rates has reflectedmarket participants’ changing perceptions ofthe likely course of the economy and ofmonetary policy’s response to it. In the mostrecent period, following the tightening ofmonetary policy in May, market interest ratesdeclined for a time as participants assessedthat the cumulative tightening over theprevious six months might have been sufficientto reduce the risks on inflation. But, in July,this view began to change. With data oneconomic activity and, more importantly,inflationary pressures on the high side ofexpectations, market interest rates moved upas participants became conscious of theinflation risks and began to price-in thepossibility of a further tightening of monetary

policy. By the time of the Bank’s early Augustpolicy announcement, markets had pricedinto short-term yields about a 50 per centprobability of a change in policy that month,and close to 100 per cent by the followingmonth. The announcement caused a furthermodest rise in market yields, and someincrease in the exchange rate of the Australiandollar; the share market did not seem to bemuch affected. Most banks responded soonafter with increases in their main lending ratessimilar to the rise in the cash rate.

Under the inflation targeting framework, theobjective of monetary policy remains tocontain inflation in the medium term, therebyensuring one of the pre-conditions for theeconomy to attain its maximum sustainablegrowth. In the period ahead, the Bank willcontinue to evaluate incoming data, with aview to assessing the evolution of the economyand the risks to the outlook.


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International Economic Developments

United States

The United States economy maintainedconsiderable momentum over the first half of2000. Real GDP increased by 1.3 per cent inthe June quarter, to be 6 per cent higher thana year earlier (Graph 1). The pick-up ingrowth over the past year has been driven bya marked increase in domestic final demand.Growth in consumer spending, whileremaining high, has softened a little, andgrowth in residential investment spending hasslowed, but these have been more than offsetby an acceleration in business investment andgovernment spending. Although exportgrowth has also strengthened over this period,it has been roughly matched by a pick-up inimport growth.

The key question is whether the economywill slow substantially during the second halfof the year. Some slowing has been expected,on account of the tightening in financialconditions which has taken place since themiddle of last year. To date, the FederalReserve has increased the Federal funds rateby 175 basis points in this tightening phase,and recent evidence from the FederalReserve’s survey of senior loan officerssuggests that lenders are also becoming

somewhat more cautious about extendingcredit to businesses. There has also been somesoftening in the share market, particularly fortechnology stocks; the S&P 500 index iscurrently around 5 per cent below the peaklevels reached in March, and the NASDAQis currently 21 per cent lower.

Overall, however, evidence that the tighterfinancial conditions are restraining growth isonly gradually emerging. It is clearest in thehousing sector: housing starts turned downsome months ago, and imply that residentialinvestment is likely to fall in the second halfof this year. Business sentiment, according tothe National Association of PurchasingManagers’ survey, has also deteriorated andrecent monthly data suggest that underlyingemployment growth has moderated a little.Although consumption growth slowed backtowards trend in the June quarter, it is not yetclear that this slower pace will be sustained.Consumer confidence remains at historicallyhigh levels, household income growth remainsrobust and the level of household wealthrelative to current incomes is still high, evengiven the recent developments in the sharemarket. Aggregate credit growth also remainsstrong for both the household and businesssectors, suggesting that financial conditionsare not yet particularly restrictive.

Over the past decade, growth in businessfixed investment has outpaced that of theeconomy more generally (Graph 2). This hasbeen driven by a rapid expansion inequipment investment, which in turn has beendriven by the adoption of informationtechnology (computers and software) bybusinesses, and is arguably one of the factorsbehind the US economy’s recently improvedproductivity performance. Looking ahead, ifbusinesses expect that the productive gainsarising from investing will continue tooutweigh the higher cost of financing,investment may continue to grow strongly.

Graph 1

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United States – Real GDPPercentage change

1994

%

Year-ended

%

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1996 1998 200019921990


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The evidence is clear, however, thatunderlying inflation has picked up. Coreconsumer price inflation has risen to around21/2 per cent, from the 2 per cent rate thatprevailed through the second half of last year,although it does not appear to be increasingfurther at this stage. CPI inflation is runningnoticeably faster than this, at 3.7 per cent,having been boosted by higher oil prices.Several of the favourable developments thathelped restrain inflation over the past few yearsare now dissipating. Following a four-yearperiod of decline, non-oil import pricesincreased by 1.1 per cent over the year to Juneand wages growth now looks to have passedits trough. The Employment Cost Index roseby 1 per cent in the June quarter and hasincreased by 4.4 per cent over the past year,driven by a particularly strong increase ingrowth in the private sector component.Productivity, however, continues to post solidgains, increasing by 5.2 per cent over the yearto the June quarter, and will help to containgrowth in unit labour costs.

Japan

Japanese GDP grew strongly in the Marchquarter, increasing by 2.4 per cent. Growthin the quarter was driven primarily by privatespending, with consumption, housing andbusiness investment all rising strongly. Publicspending continued to fall in the Marchquarter, but the fiscal stimulus announced lastNovember is likely to boost growth in comingquarters.

Although the national accounts data havebeen volatile over recent quarters, a range ofindicators suggest that activity is improvinggradually. The pick-up in consumption in theMarch quarter appears to be continuing andis being supported by further increases inconsumer confidence; household spendingincreased by 21/2 per cent in the June quarterand consumer confidence is now at its highestlevel in 4 years (Graph 3). Businessconfidence also strengthened in the Junequarter according to the Tankan survey, andfirms expect this trend to continue into thesecond half of the year. The improvement inconfidence has been greatest formanufacturing firms, which have benefitedfrom the strong pick-up in external demand:exports increased by 8 per cent over the pastyear. Manufacturers have thus progressivelyrevised up their investment intentions, and arenow looking to increase investment in the yearto March 2001 for the first time in two years.In comparison, non-manufacturing firms stillexpect to reduce their investment spendingover this period.

These improved demand conditions havebeen reflected in the output data. The Ministryof International Trade and Industry’s indexof overall business activity consolidated itsstrong increase in the March quarter, andincreased by 2.3 per cent over the year to May.Both industrial production and service sectoroutput contributed to this increase, continuingthe positive trends prevailing since early lastyear.

Graph 2

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United States – Business InvestmentPer cent of nominal GDP

2000

Total

%

Equipment

%

Equipment less IT

Structures

19921984197619681960

Graph 3

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Japanese SentimentDeviation from long-run average

2000

%

199819961994199219901988

%

Business(LHS)

Consumer(RHS)


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While the prospects for the Japaneseeconomy appear to be improving, someshort-term risks to the recovery remain.Despite recent strength, consumer demandis perhaps the greatest area of uncertainty, andthe weakness of labour market conditions willnot help in this regard. Wages growth remainsweak and employment is 0.2 per cent lowerthan a year ago. Evidence from the Tankansurvey indicates that while there has beensome improvement in firms’ hiring intentions,firms still perceive current employment levelsto be excessive.

Consumer prices continue to fall, and are0.7 per cent lower than a year ago. While thesizeable output gap has significantlycontributed to this outcome, other factorshave also been important: non-oil importprices have been declining (in line with theexchange rate appreciation), deregulation inthe service sector has dampened prices, andfood prices have been lowered by favourableweather conditions. Higher oil prices havepartly offset these factors.

Non-Japan Asia

Activity in non-Japan Asia remained strongduring the first half of 2000, though the paceof growth varied widely across countries; overthe past year, growth has been strongest inHong Kong, Korea and Malaysia and weakest

in Indonesia (Table 1). Until recently, thegrowth in output in the region was drivenprimarily by the external sector. Strong exportgrowth has continued, but there has also beena pick-up in domestic demand in a numberof economies in the region, reflecting increasesin both consumer spending and, in a few cases,investment (Graph 4). Domestic demand hasbeen supported by an improvement in labourmarket outcomes, with unemploymentgenerally falling across the region.

Through most of this recovery, the weakestcomponent of demand in non-Japan Asia hasbeen investment. This has particularly beenthe case in those countries that were worst hitby the Asian crisis, such as Indonesia andThailand. More recently, however, investmenthas rebounded sharply in several countries.While construction investment continues tobe weighed down by the ongoing weakness inproperty markets throughout the region, thestrength in the region’s exports has led to theneed for increased equipment investment inexpor t-focused industries, despite theexistence of excess capacity in other sectors.

Export growth has been driven by theongoing strength in world demand, as well asthe rebound in domestic demand within theregion, as noted above. While exports toall major destinations have grown solidly,intra-regional trade and exports to Japan have

Table 1: Non-Japan Asia – Real GDPPercentage change

Year toNet change

March qtrMarch qtr

sinceJune 1997

Hong Kong 5.3 14.3 7.0Indonesia 4.8 3.6 –8.9Korea 1.8 12.6 9.4Malaysia 5.7 11.7 6.3Philippines 0.0 3.4 4.2Singapore 3.1 9.2 11.6Taiwan 2.3 7.9 17.2Thailand 1.5 5.2 –5.0Non-Japan Asia 2.8 9.2 6.1

Source: CEIC database


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increased particularly strongly of late. Exportgrowth has also been fairly broadly basedacross all major categories of goods, althoughelectronics exports remain especially strong.

Despite the increase in world oil prices,consumer price inflation in non-Japan Asiaremains subdued, with inflation at or below2 per cent in most countries, a good dealbelow pre-crisis rates (Graph 5). This hasenabled monetary policies to remain generallysupportive of growth.

While significant progress has been madeon financial restructuring in the crisis-affectedcountries, much work remains to be done.Significant amounts have been spentrecapitalising weak financial institutions andremoving non-performing loans from thefinancial sector, mostly through the use ofgovernment-supported asset managementcompanies (Table 2). However, theproportion of these problem loans actuallyresolved remains small. The collapse ofDaewoo in Korea in mid 1999 and theassociated problems in the investment trust

Graph 4

Non-Japan Asia – Production and Demand1996 = 100

2000

Index

Production

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130

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Index

19981996 20001998

Exports

Investment

Consumption

Source: CEIC database

Table 2: Non-performing LoansShare of total loans in financial system, per cent

Indonesia Korea Malaysia Thailand

Before transfer to asset management companies 31.4 17.9 24.0 41.0After transfer to asset management companies 12.4 10.1 17.5 38.5

Source: World Bank, East Asia: Recovery and Beyond, May 2000

industry, as well as the suspension of threemerchant banks this year, highlight theweakness that remains in Korea’s financialsector and the potential risks to the regionmoving forward.

Less progress has been made on corporaterestructuring in the region. Most emphasishere has been on voluntary restructuringwhich has come up against considerableresistance. A recent report by the World Banksuggests that in Korea, Malaysia and Thailand,at least one-quarter of firms listed on the stockexchange were not able to meet their interestpayments from operational cash flows in 1999;this proportion was close to two-thirds inIndonesia.

Real GDP in New Zealand rose by 0.8 percent in the March quarter to be 51/2 per centhigher than a year earlier. Domestic demandgrowth was noticeably weaker in the quarter,following very strong growth through 1999,while the contribution to growth from netexports picked up. Although output growthremains strong, the labour market has been

Graph 5

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Non-Japan Asia – Consumer Prices*Year-ended percentage change

1996

%

* Excluding ChinaSource: CEIC database

Total

%Initial-crisis economies

Other east Asia

1997 1998 1999 2000


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subdued; employment fell slightly in the Junequarter, to be 1 per cent higher than a yearearlier. Looking ahead, domestic demandgrowth may be tempered by the weakening inboth business and consumer confidence thathas taken place in recent months, thoughoffsetting this, the lower level of the NZ$should continue to support strong growth inthe external sector.

Inflationary pressures have increased overthe past year. The consumer price indexincreased by 0.7 per cent in the June quarter,to be 2.0 per cent higher than a year earlier,in part reflecting the increase in oil prices.Upstream price pressures have also beenboosted by the rise in oil prices, as well as thedepreciation of the exchange rate and theincrease in world commodity prices; producerinput and output prices have increased moresharply over the past six months than theyhave since the early 1990s. The Reserve Bankof New Zealand has increased the OfficialCash Rate by 200 basis points sinceNovember, to 6.5 per cent.

Europe

The economic outlook remains favourablein the euro area with output increasing firmlyin the March quarter, to be 3.4 per cent higherover the year (Graph 6). The depreciation ofthe euro and strong world growth has provideda fillip to domestic producers with exportsincreasing strongly over the past year. Thepick-up in growth has helped boostemployment, with the unemployment ratefalling to 9.1 per cent in June, the lowest ratesince mid 1992. Steady employment andwages growth have helped underpinhousehold incomes and provided support forcontinued growth in consumption. Positiveconditions in the euro area are also reflectedin both consumer and business confidence,which are now at or around record highs.

Although core inflation – at 1.3 per cent –remains subdued, headline inflation picked up

sharply in June to be 2.4 per cent. Currently,ten of the eleven EMU countries haveheadline inflation above the euro area targetrate of 2 per cent. The European Central Bank(ECB) raised its key refinancing rate by50 basis points to 4.25 per cent in early June.The ECB has raised interest rates five times,and by 175 basis points, since last November,expressing concern that the recent increasein imported goods prices, driven by both thedepreciation of the euro and the pick-up inoil prices, poses risks for price stability overthe medium term.

The UK economy strengthened in the Junequarter, with real GDP increasing by0.9 per cent, compared with growth of0.5 per cent in the preceding quarter. Thispick-up reflected stronger growth in bothindustrial production and service sectoroutput. Nevertheless, survey evidencesuggests that growth may begin to moderatemoving forward, in line with a slowing indomestic demand. Consumer price inflation(excluding mortgage interest payments) was2.2 per cent over the year to June, boosted byaround three quarters of a percentage pointby higher oil prices.

Graph 6

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GDP Inflation

200019981996

Europe – Growth and InflationYear-ended

200019981996

UK

Euro area

% %

UK(RPIX)

Euro area(core)

Euro area(headline)


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International Financial Markets

International financial markets have beenin something of a holding pattern in recentmonths as they assessed the implications ofincreases in official interest rates in virtuallyall developed countries over the previous6-12 months. Rises in official interest rateshave been in the order of 1-2 percentagepoints across countries, with most in the tophalf of this range.

The United States Federal Reserve hasraised the Fed funds target by 175 basispoints, to 6.50 per cent, in the currentmonetary tightening episode which began inJune last year (Graph 7). The first fiveincreases were each of 25 basis points, but thelatest increase, in May, was 50 basis points.This followed the release of data suggestingthat wage and inflationary pressures may bebuilding .

Among other English-speaking countries,the Bank of England has increased officialrates by 100 basis points in four steps to6 per cent, the Reserve Bank of New Zealandhas increased rates by 200 basis points to6.5 per cent, and the Bank of Canada hasincreased rates by 125 basis points to5.75 per cent, with the past four increasesimmediately following the US Fed (Table 3).

While economic expansions in thecontinental European economies are at a lessadvanced stage than those in theEnglish-speaking economies, monetaryauthorities there also have generally increasedinterest rates, though the levels remain belowthose in the latter countries. The EuropeanCentral Bank has increased official rates by175 basis points to 4.25 per cent, whileDenmark’s central bank has increased rates

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Policy Rates% %

1999M

2000M A N F M A N F1998

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Australia

US

UK

NZCanada

Sweden

Germany/Euro

F

Graph 7

Table 3: Policy Interest Rate IncreasesBasis points

April May June July August Cumulative Currentincrease level

since (%)mid 1999

US 50 175 6.50Canada 50 125 5.75Australia 25 25 25 150 6.25NZ 25 50 200 6.50UK 100 6.00Euro 25 50 175 4.25Denmark 25 60 185 4.70Sweden 85 3.75Switzerland 175 3.50Norway 25 50 25 8.25


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by 185 basis points to 4.7 per cent. TheSwedish central bank has increased policyrates by 85 basis points to 3.75 per cent, whilethe Swiss authorities have increased theirtarget band by 175 basis points to between3 and 4 per cent.

Japan remains an exception to the tighteningcycle. With economic conditions in Japanimproving in recent months, the Bank of Japanhad begun to prime markets for an end to itszero interest rate policy at its 17 July meetingbut, in the event, the collapse of a largeJapanese retailer, Sogo Co, prompted theBank to hold off its decision. Markets see thisas no more than a temporary delay.

Since the last round of official interest rateincreases around the world over May andJune, market interest rates in many countrieshave fallen as earlier inflationary fears havesubsided. In the US, yields on 10-year bondshave settled around 6 per cent compared witha peak of around 6.5 per cent. The yield onthe German 10-year bond has fallen fromaround 5.45 per cent to 5.20 per cent. UKyields have fallen by a similar amount. Themain exception to this global pattern has beenJapan, where 10-year bond yields haveremained remarkably stable, generally tradingin the range between 1.7 per cent and1.8 per cent so far this year (Graph 8).

As policy rates were increased in the US overthe first few months of 2000, share marketsbecame increasingly prone to volatility,

Share prices recovered for a time in June asmarkets began to anticipate a ‘soft landing’ ofthe US economy, but more recently shareprices have again been subject to weakness asprofit announcements by companies havegenerally disappointed. Broad-based shareindices in the US have now shown little netchange so far this year (Table 4).

Share markets in most other countries havefollowed a similar course, with those withrelatively higher weightings of technologystocks – such as Germany and Canada –having been more volatile (Graph 10).

Japanese share prices remain well belowtheir early 2000 peaks. Following sharp fallsin April and May which were part of theworld-wide correction at that time, theJapanese market has remained under pressureamid some increase in corporate bankruptciesand rising prospects of some increase ininterest rates.

The factors driving interest rates and sharemarkets in recent months have also had animpact on exchange rates among the threemajor currencies. The trade-weighted valueof the US dollar appreciated sharply over Apriland into May as inflationary concerns roseand markets anticipated a more aggressive

Graph 8

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Ten-year Bond Yields% %

Australia US

Japan

NZ

Canada

Germany

1999F M A N F

2000M A

culminating in a large correction over Apriland May (Graph 9). Markets with relativelyhigh weightings in the technology sector werethe hardest hit. The Nasdaq index fell by25 per cent over this period.

Graph 9

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US Share Price Indices1 January 1999 = 100

Dow Jones

1999F M A N F

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NASDAQ

Wilshire

IndexIndex


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monetary tightening by the Fed. It depreciatedfor a time as these concerns receded, but, morerecently, has tended to rise again (Graph 11).This cycle was most pronounced against theeuro (which fell to a record low against theUS dollar in May) but was also evident to adegree in the rate against the yen (Graph 12).

Most of the Asian economies with freelyfloating currencies have experienced someexchange rate falls against the US dollar inrecent months. This was particularly the casefor Thailand, Indonesia and the Philippinesand mainly seemed to reflect concerns byinternational investors about whether theirrecent pace of economic expansion could besustained. The falls were fairly modest (in theorder of 5 per cent) and well within thefluctuations that could be expected of floatingexchange rates. The earlier strong upwardpressure on the Korean won, which had been

resisted by the Bank of Korea throughintervention, also seems to have abated inrecent months.

Table 4: Changes in US Equity PricesPer cent

Jan 1999 Jan 2000 Current change from Current change fromto current to current 2000 peak 2000 trough

Wilshire 21 0 (24 Mar) –7 (14 Apr) 11Dow Jones 20 –5 (14 Jan) –6 (7 Mar) 12S&P 500 21 1 (24 Mar) –3 (5 Feb) 11NASDAQ 76 –5 (10 Mar) –24 (25 May) 22

Graph 10 Graph 11

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Graph 12

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US Dollar Exchange Rates

2000

Yen US$

Feb Mar Apr May Jun Jul AugJan

(LHS)

Yen per US$

US$ per Euro(RHS, inverted scale)


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Graph 13

The Australian economy continued to growstrongly in the first half of the year (Graph 13).Over the year to the March quarter, realoutput growth again exceeded 4 per cent, andindicators point to further strong growth inthe June quarter. In the past few quarters, thecomposition of growth has gradually shifted,with a slight slowdown in the pace ofconsumption growth offset by an increase inexport growth, in line with the strengtheningworld economy. The lower exchange rate,favourable domestic financial conditions andthe boost to household incomes from incometax cuts and increases in social benefitpayments should continue to support growthin the period ahead.

Domestic Economic Activity

The strength of growth in the March quarteras measured in the national accounts was atodds with some of the partial indicators whichhad suggested that a noticeable slowdown wasin train. However, it was consistent with anumber of underlying economic factorssupportive of growth. Robust householdincome growth bolstered by strongemployment growth, fast credit growth and ahigh level of household wealth haveunderpinned the strength in consumption.The ready availability of funding and the high

level of profits have contributed to a favourableenvironment for business. These factorsappear to have offset any dampening influencefrom the declines in business and consumerconfidence that occurred in the Marchquarter. More recently, as discussed below,the decline in consumer confidence has beenreversed.

The changes to the tax system have affectedsome parts of the economy prior to theirimplementation on 1 July. This has been mostevident in the housing sector, which wasoperating at full capacity in the March andJune quarters. The tax changes also influencedconsumption decisions with the purchase ofsome goods whose prices were expected toincrease on 1 July being brought forwardbefore that date, and other purchases whereprices were expected to fall – most notablymotor vehicles – being delayed. Someinvestment spending is likely to have beendelayed until the September quarter to takeadvantage of lower prices, though this hasbeen offset to some extent by businessesneeding to invest in systems in preparationfor the introduction of the goods and servicestax and the new business repor tingrequirements.

The coincidence of the effects arising fromthe changes to the tax system and the OlympicGames in September will make interpretingdevelopments in the economy, especially themonthly data, more difficult than usual overthe near term. In aggregate, the introductionof the GST is likely to have resulted in atransfer of private demand from theSeptember quarter to the June quarter, butthe Olympics should provide an offsettingboost to consumption (from ticket sales) andservice exports in the September quarter.

Household consumptionThe national accounts showed continued

growth in consumption spending, though ata slower pace, in the March quarter, after

GDP

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strong growth in the previous six months(Graph 14). This was in marked contrast tothe retail trade figures which showed a sharpdecline in spending in the March quarter. Itis difficult to understand why the retail tradefigures showed this result, but part of theanswer may be in the pattern of consumptionspending. There was reduced spending onretail goods, particularly sales of food, clothing

and footwear, and motor vehicles, which wasmore than offset by increased spending on avariety of services, particularly transport,recreation and culture, hotels and cafes andutilities.

According to the monthly retail trade survey,retail sales remained relatively subdued(especially for the smaller, more specialisedestablishments) in April and May but rose verystrongly in June. For the June quarter as awhole, sales increased in real terms by2.7 per cent. This increase was experiencedacross all states, with particularly stronggrowth in the ACT, New South Wales andWestern Australia (Table 5). Whiledevelopments in income and wealth have beensupportive of consumption spending, twoadditional factors are likely to havecontributed to the rise. Firstly, a number ofmajor retailers brought forward theirhalf-yearly clearance sales from July into June.Secondly, consumers became more aware ofthe likely price changes resulting from thechanges to the tax system through pricelistings such as those released by the ACCCin late May. The retail sales data for Junesuggest that consumers were, by then,generally well informed of the price changes,with large increases recorded in sales of goodsthat were expected to rise in price, such asclothing and footwear. Given the change intiming of the half-yearly sales and thepre-GST surge in spending, retail sales arelikely to have been temporarily weaker in July.

Graph 14

Table 5: Retail SalesPercentage change, 1998/99 prices

March quarter June quarter Year to June2000 2000 quarter 2000

New South Wales –1.1 3.4 4.5Victoria –3.1 2.1 2.8Queensland –0.6 1.8 5.1South Australia –1.3 2.2 6.4Western Australia –0.1 3.6 6.7Tasmania –1.6 –0.4 –0.7Northern Territory –0.6 2.9 6.0ACT 2.1 8.9 16.0Australia –1.4 2.7 4.7

Consumption

2000

Retail trade and consumptionYear-ended percentage change

%

Retail trade

0

3

6

0

3

6

60

80

100

120

60

80

100

120

Consumer sentimentLong-run average = 100

Consumption

19971994199119881985

%

IndexIndex


14

In contrast to the surge in retail sales in June,households tended to delay their purchasesof motor vehicles until after 30 June when theprice of cars was expected to fall and a numberof new models were launched on theAustralian market. Passenger motor vehicleregistrations fell by 13 per cent in the Junequarter and were 17 per cent lower than a yearearlier. Motor vehicle retailers and wholesalersacted to offset some of the expected downturnby offering discounted prices prior to 1 July.The motor industry’s expectation of strongersales in the second half of the year is evidentin the rapid growth of motor vehicle importsin the June quarter. This is consistent withindications of a strong rebound in sales in July.

The Westpac–Melbourne Institute index ofconsumer sentiment fell sharply in the earlymonths of the year reaching a trough in Maybelow its long-run average. The tightening inmonetary policy is likely to have contributedto this decline, but the available evidenceindicates that uncertainties about the taxpackage also had some effect. The MelbourneInstitute’s ‘Monitoring the GST’ surveyssuggested that around 70 per cent ofrespondents either expected no compensationor didn’t know whether they would receive

any compensation. The rebound in consumersentiment may have reflected the fact that theearly experience with the GST was lesstraumatic than most had expected.

Growth in household incomes hassupported consumption and should continueto do so in the period ahead, as employmentand wages continue to grow solidly. Incomeshave been boosted by the income tax cuts andincreases in social benefit payments deliveredon 1 July. The demutualisation of NRMA mayalso provide a small boost to householdspending, although the payment of the finalinstalment of the second Telstra float inNovember may have a negative short-termeffect on household cash flows.

In recent quarters, the increase in householdwealth has also contributed to the robust paceof consumption spending. Although grosshousehold wealth fell slightly in the Marchquarter, it remained 12 per cent higher thana year earlier, and 40 per cent higher thanthree years earlier (Table 6). The decline inwealth in the quarter primarily reflected fallsin dwelling prices in Sydney and Melbourne.Dwelling prices nonetheless remain at highlevels. They have increased over the past yearin all mainland state capitals and in the

Table 6: Household AssetsAs at March 2000

Level Share of Year-ended Average$b total assets growth annual

growth sinceMarch 1997

Per cent

Dwellings 1 602 55.6 13.6 13.2Consumer durables 122 4.2 4.3 3.3Financial assets 1 159 40.2 10.3 11.0of which:– Currency and deposits 247 8.6 2.0 4.8– Equities 226 7.8 14.1 24.8– Superannuation and life offices 606 21.0 14.1 11.2– Other 81 2.8 0.9 1.2Total assets 2 882 100.0 11.8 11.8

Sources: ABS; CBA/HIA Housing Reports


15

Graph 15non-metropolitan regions of all mainlandstates except Queensland.

Household sector financial assets increasedby 1.7 per cent in the March quarter, asomewhat slower rate than in previousquarters, as a reduction in the value of directequity holdings partially offset strong gainsin the value of funds held in superannuation.Valuation effects, largely due to falls in theprices of bank shares, reduced the value ofthe household sector’s directly owned shareportfolio by 1.4 per cent in the March quarter,but these shares have since rebounded invalue.

On the other side of the household balancesheet, the debt of the household sector hascontinued to grow rapidly, increasing by141/2 per cent over the year to March. Thishas primarily been driven by borrowing forhousing, but growth in personal credit has alsobeen strong. The rise in interest rates over thepast seven months has not yet had adiscernible impact on the borrowing of thehousehold sector, with strong credit growthcontinuing in the June quarter.

The tightening in monetary policy has,however, resulted in a rise in the interestpayments of the household sector from around6 per cent of household disposable income inthe first half of 1999, to around 71/4 per centin the March quarter (Graph 15). The interestrepayment burden on the household sector isnow higher than the previous peak in 1996,of 7 per cent of disposable income, reflectingthe rapid rise in household indebtedness. Thisis despite the fact that interest rates paid ondebt by households are substantially lowernow than in 1996. The interest repaymentburden is likely to have increased further inthe June quarter as household creditcontinued to increase at a faster pace thandisposable income, and mortgage rates rose.The extent to which this is impinging onhousehold cash flows is less clear. The practiceof holding total repayments (i.e. interest plusprincipal) steady while interest rates fell in1996 and 1997 appears to have beenwidespread. This built up a buffer of ‘excess’repayments which will have cushioned some

households from the direct effects of therecent interest rate increases.

Dwelling investmentWhile the growth in households’ spending

on retail goods eased early in the year,spending on dwellings increased significantly.Private dwelling investment grew by10 per cent in the March quarter and byalmost 14 per cent over the previous year, andnow accounts for over 6 per cent of GDP, thehighest in over twenty years (Graph 16).Although a large part of this activity probablyreflects the desire to complete constructionprior to the introduction of the GST, otherfactors have contributed to the strong demand

20

40

60

80

100

Household Debt and InterestPer cent of household disposable income

0

2

4

6

8

%%Debt Interest paid

200019931986Sources: ABS; RBA

2000199319861979

Graph 16

1

2

3

4

5

6

1

2

3

4

5

6

Private Dwelling InvestmentPer cent of GDP, current prices

2000

% %

19971994199119881985

New dwellings

Total


16

Graph 17for housing, notably the relatively high levelsof affordability throughout 1999. Morerecently, increases in house prices and interestrates have reduced home affordability.

Leading indicators of dwelling activitybegan to decline as the opportunity tocomplete work prior to the introduction ofthe GST diminished. Although the value ofloan approvals increased in May, the averagelevel of loan approvals for the three monthsto May was 11 per cent below the level in late1999. For owner-occupiers, the largestdeclines have been in approvals for newconstruction. In contrast, loans to investorsfor both new construction and existing houses(a sector likely to have been less affected bythe introduction of the GST) have continuedto grow at double-digit rates in year-endedterms. Building approvals have fallen sharplyin recent months to be nearly 40 per centbelow the January peak, although this followsa strong rise of 17 per cent over the previoussix months. The largest falls in buildingapprovals in recent months have been inQueensland, South Australia and Victoria. Itremains to be seen how much of the large fallin building approvals in June will be reversedfollowing the actual implementation of theGST and the availability of the First HomeOwners’ Scheme (discussed below).

Notwithstanding the unwinding of the effectof the GST on the housing industry, shortagesof labour and materials and the large amountof work yet to be done at the end of the Marchquarter means that a lot of pre-GST relatedwork will probably spill over into the secondhalf of 2000 (Graph 17). In addition, dwellingactivity in the second half of the year is likelyto be boosted by policies to assist first homebuyers. The most recent loan approvals datashowed a declining share of housingcommitments going to first home buyers inthe lead-up to the GST. Given the extra timetaken to complete work prior to theintroduction of the GST, there was anincentive for first home buyers to wait and beeligible for the Commonwealth Government’sgrant to first home buyers of $7 000. InNew South Wales, further savings for firsthome buyers of up to $5 000 in stamp duty

exemptions were available from 1 July.Despite the sharp fall in housing loan

approvals, growth in the stock of housingcredit has continued to accelerate. Housingcredit grew at an annual rate of just under19 per cent over the first half of 2000,compared with 161/4 per cent over the previoussix months. The divergence between housingcredit growth and loan approvals may partlyreflect lags between the purchase of a homeand final settlement. Repayments of principalcould also slow in the months immediatelyfollowing an increase in interest rates, ifborrowers who were making more than thecontractually required repayment chose tomaintain their total repayment as interest ratesrose, thereby allowing the amount of principalrepaid to fall.

In addition, the capacity constraints in thebuilding sector in the lead-up to theintroduction of the GST may have resultedin borrowers obtaining finance forconstruction well before the work wascompleted and paid for. Accordingly, asubstantial pool of undrawn commitmentsbuilt up over the last few months of 1999 andthe beginning of this year, peaking at a levelequivalent to just under 8 per cent of housingcredit. In recent months, the flow of loansactually advanced has risen sharply, whichmay reflect borrowers drawing down theirloans in order to finalise payments for theirdwellings. The stock of loan commitments not

2

3

4

5

6

7

8

2

3

4

5

6

7

8

Private Dwelling InvestmentCurrent prices, seasonally adjusted

2000

Work yet to be done

$b

Approved

$b

19981996199419921990


17

advanced still remains at very high levels,suggesting that housing credit growth is likelyto remain high over the next quarter asconstruction work begun before 1 July iscompleted and paid for.

The business sectorA favourable external environment,

continued strong growth in domestic demand,high profitability and the ready availability ofexternal funds have underpinned a positiveenvironment for the business sector. In theMarch quarter, strong growth in output wasparticularly evident in the construction,mining and agricultural sectors. Pre-GSTactivity boosted output in the constructionindustry and, given the large amount of workyet to be done in the residential sector, thisshould support activity in the industry in theperiod ahead. The addition of new supplycapacity in the oil industry, reflecting earlierinvestment, boosted growth in the miningsector in the March quarter. The strength wasnot confined to oil, with other areas of themining sector such as base metals alsoexperiencing strong growth in output throughthe year.

Profits continued to grow strongly in theMarch quarter, with the gross operatingsurplus of the corporate sector increasing byjust under 9 per cent, and by 113/4 per centover the year to the March quarter. As a shareof GDP, corporate profits reached 16 per centin the quarter (Graph 18), the highestrecorded ratio, although this has been boostedin recent years by privatisations and the trendtowards incorporation by small businesses.Strong profitability, low interest rates and adebt burden well below historical peaks haveall tended to hold down the interest burdenof the corporate sector: as a share of grossoperating surplus, net interest paid by thecorporate sector remains well below historicalaverages.

In addition to the internal funds generatedby strong profit results, businesses have ampleaccess to external sources of funding. Businesscredit has accelerated in recent months,growing at an annual rate just under13 per cent over the first half of 2000,

compared with 43/4 per cent over the previoussix months. Both fixed and revolving creditincreased, with promissory notes particularlystrong for much of this period. The strengthin intermediated business borrowinghas been reinforced by a high level ofnon-intermediated debt raisings. Althoughsome share market floats were cancelled orpostponed following the decline in shareprices earlier in the year, the subsequentrebound in prices should limit any weaknessin equity raisings.

Despite these favourable conditions,businesses repor ted a deterioration insentiment early in the year which continuedinto the June quarter, according to the NABQuarterly Business Survey (Graph 19). Thisreflected a combination of concerns about theimplementation of the tax changes, the impactof higher oil prices on profit margins, as wellas higher interest rates. While the deteriorationwas reported by firms of all sizes, small firmsreported the weakest conditions. The miningindustry was a notable exception to the fall inbusiness conditions, reflecting the favourablecombination of rising commodity pricesand strong external demand.

While data for retail sales reported a declinein the March quarter, there was also a largerun-down in business inventories at this timeas measured by the ABS, particularly in theretail sector. This juxtaposition of events issurprising, given the strong growth in imports

Graph 18

Corporate Sector*

2000

%

* GOS adjusted for privatisations

GOS beforeinterest

5

8

11

14

17

0

10

20

30

40

%

GOS afterinterest

Interestpaid

1995199019852000199519901985

Per cent of GOSPer cent of GDP


18

Graph 20Graph 19

in the quarter and the business surveys whichindicated that inventories increased in theMarch quarter.

The decline in business sentiment did nothinder strong growth in business investmentin the March quarter. This rise in investmentlargely reflected a solid rise in spending onmachinery and equipment (Graph 20). Whilethe quarterly investment outcomes recordedin the national accounts have been volatile,throughout 1999/2000, successive surveys ofcapital expenditure by the ABS indicatedhigher expected investment spending for theyear as a whole. Strength in recent quartershas been evident in the communications,finance and property, and business servicessectors. Investment in the manufacturing,retail, wholesale, and transport and storagesectors has been either steady or falling.

It is difficult to discern a clear picture ofinvestment intentions in 2000/01, because itis unclear the extent to which businesses havetaken account of the lower prices for manyinvestment goods resulting from thereplacement of wholesale taxes with the GSTon 1 July. (Firms were asked by the ABS toreport their investment intentions net of theGST.) According to the ABS CapitalExpenditure Survey, firms expect to increasespending on machinery and equipmentinvestment in nominal terms by only

11/2 per cent in 2000/01, once averagerealisation ratios are applied. Assuming thatbusinesses did indeed take account of thelower prices on investment goods after 1 July,this implies that there is likely to be strongerreal growth in investment in plant andequipment in 2000/01. As a share of GDP,investment is around average levels, suggestingthere is scope for it to grow as the economycontinues to expand.

The non-residential building component ofbuildings and structures investment also rosestrongly in the March quarter, although thiswas not enough to offset a large fall inengineering construction. Expenditure onengineering construction has been particularlyweak since the beginning of 1999 and is nearlyone-quarter lower than the level a year earlier.The immediate outlook for non-residentialbuilding work has improved slightly, withbuilding approvals picking up from the troughreached late last year. Increased pressure onoffice rentals, particularly in Sydney andMelbourne, points to some scope for futuregrowth in new office projects. According to

-45

-30

-15

0

15

30

-45

-30

-15

0

15

30

Business ConditionsNet balance*

2000

%

All otherindustries

Mining

%

19981996199419921990* Deviation from long-run average. Expected business

conditions next quarterSource: NAB Quarterly Survey

0

2

4

6

8

10

12

14

16

18

0

2

4

6

8

10

12

14

16

18

Business Investment1997/98 prices

$b $b

Total

Machinery andequipment

Buildings andstructures

Other

200019981996199419921990


19

the Access Property Monitor, growth inbuilding work is projected to occur in the retailand wholesale sectors. By contrast, the valueof building projects in the hospitality sector(hotels and resorts) is expected to fall.

The estimates of intangible investment(which comprises computer software,minerals exploration and artistic originals)and livestock investment continued to growstrongly in the March quarter, to be just over20 per cent higher than a year earlier. Someof the strength in the first half of 2000probably relates to businesses purchasingsoftware to assist with the new taxarrangements and the associated change inbusiness reporting requirements. Somepurchases may also have been brought forwardas software prices were expected to increasefrom 1 July. Mineral exploration expenditurehas continued to decline. Expenditure in theMarch quarter was around half the peak levelof expenditure recorded in 1997, with areduction in gold exploration accounting formost of the fall.

The labour marketFollowing a pick-up in the second half of

1999, employment growth remained at anabove-average rate in the first half of 2000.Employment increased by 285,000, or31/4 per cent, over the year to the June quarter,substantially faster than the rate of growthprevailing for most of the previous four years;almost three-quarters of the increase was infull-time employment. The recent strength inemployment growth contributed to a furtherdecline in the unemployment rate to63/4 per cent in the June quarter, comparedwith almost 71/2 per cent a year ago(Graph 21). The participation rate continuedto rise in the first half of the year, reflectingthe strengthening labour market and buoyanteconomic activity generally, reaching633/4 per cent in the June quarter. The femaleparticipation rate has risen more sharply thanthe male equivalent over the past year.

Strong employment growth over the pastyear has occurred in most states and hascontributed to falls in unemployment rates inevery state (Table 7). The recent strength in

national employment growth has beenunderpinned by increases in employmentgrowth in NSW and Victoria, partly drivenby the rapid growth in residential housinginvestment in those states. Employmentgrowth over the year to the June quarter was3.3 per cent in both state capitals andnon-metropolitan areas. In the June quarter,the unemployment rate in the capital citieswas 6.1 per cent, almost a percentage pointlower than a year earlier. The unemploymentrate in non-metropolitan areas has fallen moremodestly, to 8.1 per cent, associated with alarger rise in labour force participation innon-metropolitan areas.

The pick-up in employment growth andrelatively stable output growth over the pastyear has resulted in a fall in measured labourproductivity growth. In terms of output perhour worked, year-ended productivity growthhas eased to about 13/4 per cent, down fromthe average of 31/4 per cent prevailing in theprevious three years. Abstracting fromshort-term fluctuations, productivity growthremains relatively robust, with gains in the

Graph 21

%

Employment

Labour Force

1 1

62

63

64

6

8

10

199919981995 1996 1997

Contributions to quarterly growth

%

%%

Part-time

Full-time

%pts

%pts

00

2000

Year-ended percentage change

Participation rate(LHS)

Unemployment rate(RHS)

2

4

2

4


20

Graph 22current expansion spread across mostindustries.

While a high level of job vacancies continuesto indicate strong employment growth in thenear term, information on employmentintentions from the major business surveys hasbeen weaker recently (Graph 22). The ABSjob vacancies series, which surveys employers,recorded a new high in May, with the recentrise concentrated in the public sector and inVictoria. The newspaper-based jobadvertisements series published by both theANZ Bank and the Department ofEmployment, Workplace Relations and SmallBusiness have softened recently, with bothseries falling over the past three months,though they remain at high levels.Employment intentions reported in the NABbusiness survey and the ACCI-Westpac surveyof manufacturers have fallen below their peaksrecorded in mid 1999, with the NAB businesssurvey recording its lowest level ofemployment intentions in two years.Forward-looking indicators of labour demandin the construction sector suggest a significantdecline from current levels, in line with theexpected decline in construction activity notedabove. The major business surveys suggest that

Table 7: Labour Market Conditions by State

NSW VIC QLD SA WA TAS Australia

Employment growth– Year to June quarter 2000 4.3 3.4 2.3 2.2 3.0 1.5 3.3Unemployment rate(a)

– June quarter 1999 6.6 7.7 8.1 8.5 6.9 10.0 7.4– June quarter 2000 5.8 6.7 7.8 8.3 6.4 9.5 6.7

(a) Seasonally adjusted by the RBA

Indicators of Labour Demand

2000

Job vacanciesSeptember quarter 1990 = 100

Index

* NAB Survey, deviation of net balance from long-run average

ABS

100

150

200

100

150

200

-4

-2

0

2

4

-36

-24

-12

0

12

Index

%%

ANZ Bank

19981996199419921990

Employmentintentions *

Employment(LHS, year-ended change)

(RHS)

the difficulty firms face in finding suitablelabour has eased slightly in the past six monthsbut remains at relatively high levels.


21

Balance of Payments

Export revenues have continued to growrapidly due to stronger world demand, thedepreciation of the Australian dollar andfirmer commodity prices (Graph 23). Thesegains in the value of exports have been to mostmajor destinations, with the growth of exportsto East Asia being particularly pronounced(Graph 24). The strong increase in exportreceipts, however, has been matched by solidgrowth in the value of imports. This reflectsthe continuing strength in domestic demandand, in the most recent period, stronger

import prices. As a result, the trade deficit hasremained at around 2 per cent of GDP forthe last three quarters, although it has declinedfrom the peak reached in the middle of 1999.

Most major categories of export earningshave increased strongly over the past year(Graph 25). The value of resource exports(excluding re-exported gold) increased by over40 per cent over the past year, with thisstrength reflecting a combination of strongervolumes and prices. Exports of oil, gas andpetroleum products accounted for asubstantial portion of the rise, due to sharpincreases in the price of crude oil andsignificant expansions in production capacity.Other major resource exports, like metal oresand processed metals, also benefited fromcapacity expansions, higher prices and thecontinued improvement in trading partnergrowth, particularly in East Asia. Steamingcoal exports, after a period of weaknessthrough late 1998 and 1999, have recoveredin the first half of 2000, particularly to SouthKorea and Taiwan.

The growth in rural exports in the first halfof the year resulted from strength in the exportof wool products and other rural goods(particularly canola). These volume gains weredriven by record levels of farm production,

Graph 23

Graph 24 Graph 25

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

2

3

4

5

6

7

8

9

2

3

4

5

6

7

8

9

Merchandise Exports by Destination*Seasonally adjusted, current prices

2000

$b

(excluding Japan)East Asia

19981996199419921990

Japan

Europe & US

NZ, Middle East,Pacific, South Asia

$b

*Excludes re-exported gold and frigates

Value of Exports*

4

5

6

7

3

4

5

6

5

6

7

9

11

13

$b $b

$b $b

2000

Rural Resources

Services Manufactures

19981996 200019981996* Estimates for June quarter 2000; data excludes RBA gold

transactions, re-exported gold and frigates

1994


22

and were supported by stronger prices,particularly for meat and wool products.

According to the Australian Bureau ofAgricultural and Resource Economics(ABARE), the total area planted to wintercrops is forecast to be a record 19.2 millionhectares in 2000/01, following good plantingrains across most grain-growing areas in theeastern states. Total meat production isforecast to fall slightly in 2000/01 as cattle herdrebuilding continues, though live cattleexports are expected to increase, reflecting afurther improvement in Asian demand. Woolproduction is expected to fall slightly. Overall,ABARE expects the volume of farmproduction in 2000/01 to at least match therecord levels achieved in 1999/00, and this willsupport rural export volumes over the yearahead.

Manufactured export earnings againincreased strongly in the June quarter, andwere 19 per cent higher than in thecorresponding period last year. As has beenthe case since the middle of 1999, much ofthe growth has been recorded in exportsof transport equipment. Growth inmanufactured exports to the European Union,the United States, the Middle East, andrecoveries in demand from non-Japan Asia,have underpinned this strength.

Service exports increased moderately in thefirst half of 2000. After a slight fall in theMarch quarter, tourism revenues reboundedstrongly in the June quarter as arrivals fromJapan, the United Kingdom and New Zealandall increased solidly. Export earnings relatedto sponsorships, royalties and tourism areexpected to rise substantially in the Septemberquarter due to the staging of the Olympics inSydney. Travel exports may also be boostedin coming periods if the exchange rate remainsaround current levels.

The value of imports of goods and servicesrose again in the June quarter, to be around20 per cent higher than a year earlier.However, the strength in the June quarter, incontrast to previous quarters, is largely dueto higher import prices, rather than continuedgrowth in import volumes. Indeed, in volumeterms, headline imports of goods and services

appear to have remained flat in the Junequarter, following very strong growth in theMarch quarter. Over the past year, the volumeof imports in both headline and underlyingterms has risen by a little over 10 per cent,reflecting the continuing strength in domesticdemand.

Capital imports were weaker in the Junequarter, although this softening in demandfollowed exceptional strength in the Marchquarter. Imports of major capital equipment,such as machinery, computers andtelecommunications equipment, remain atvery high levels. Consumption importvolumes remained firm, with growth in excessof 12 per cent over the past twelve months.Imports of motor vehicles increasednoticeably in the June quarter as retailers andwholesalers stockpiled cars in anticipation ofstronger demand in the second half of the year.While the growth of underlying intermediateimports has moderated from the exceptionallystrong growth observed in the latter half of1999, it continues to grow in line with thepace of growth of the domestic economy.Service import volumes have increased by9 per cent over the past year.

Net foreign liabilities rose by 1 per cent inthe March quarter to $383 billion, or61 per cent of GDP. Net foreign debt rose to41 per cent of GDP, on account of bothincreased foreign borrowings and valuationeffects flowing from the depreciation in theA$ in the quarter. These valuation effects,however, also resulted in a decline in netforeign equity liabilities in the quarter. Thenet income deficit widened to $4.7 billion inthe March quarter, with increased incomeinflows due to higher returns on equityinvestments abroad partially offsetting growthin outflows. The ratio of net income paymentsto exports remains around 16 per cent.

Commodity pricesCommodity prices generally moved higher

again during the June quarter, reflectingstronger world demand and a recovery in ruralprices. Base metal prices, which rose stronglyin the second half of 1999, have fallen a littleover the first half of this year.


23

The price of oil rose by around US$5 perbarrel over the June quarter, with the price ofWest Texas Intermediate crude oil tradingabove US$30 per barrel for much of June(Graph 26). The rise reflected a growingrealisation that the first increase in OPECproduction quotas, which were negotiated inMarch, might not match increases in worlddemand. In late June, OPEC membersdecided to increase their crude oil outputquotas further from 1 July. However, incontrast to the reaction following the Marchoutput increase, the oil price did not fallsharply following this announcement, as themarket judged the increase was again likelyto be insufficient to exceed projected increasesin global demand. Subsequent statementshave seen some OPEC member countriescanvassing the possibility of further quotaincreases, placing downward pressure onprices since early July. However, suchsuggestions have elicited a mixed responsefrom other member countries, and, to date,no official increase in OPEC productiontargets has been agreed.

In SDR terms, the Bank’s index ofcommodity prices increased again in the Junequarter, to be about 7 per cent higher than ayear earlier (Graph 27). Continued stronggains in rural commodity prices underpinnedthe strength in the June quarter, while the basemetals index fell for the first time since early1999.

The price of every component of the ruralindex rose in the quarter, in both domesticand foreign currency terms, with sugar,cotton, and wool prices exhibiting particularstrength. The sugar price increased by morethan one-third on expectations of lower outputfrom Brazil, the world’s largest producer, andbuying interest from Asia (particularly thePhilippines). Cotton prices also experienceda second consecutive quarter of very stronggains, on forecasts that world demand wouldsubstantially exceed supply next year. Inforeign currency terms, wool prices gainedover 7 per cent in the quarter, due to risingdemand for the finer wools. Wheat pricesincreased by almost 5 per cent in the quarter,staging strong gains early in the period on fearsthat dry weather in several large producercountries (in particular the US) would resultin lower world supply. An unexpectedly largepurchase from a major importer (Egypt) alsopushed prices higher.

The non-rural index of commodity prices(excluding base metals) remained unchangedin the quarter. Although the 4–5 per cent fallsin negotiated contract prices for steaming and

Graph 26

Graph 27

0

10

20

30

40

0

10

20

30

40

Oil Prices

2000

US$/barrel

Current prices

US$/barrel

1970 prices

1990198019701960

Commodity Prices1994/95 = 100

2000

90

95

100

105

110

90

95

100

105

110

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)


24

coking coal came into effect on 1 April, therewas a recovery in the spot market for thesecommodities in the quarter. Iron ore contractprices rose by between 4 and 6 per cent inthe quarter. Despite some gains towards theend of the June quarter, the price of gold fellmarginally due to lacklustre demand.

Base metal prices fell by close to 5 per centin the June quarter, but remain around20 per cent higher over the year. Aluminium,

lead and copper prices all fell, dragged downby concerns that the US economy is slowing.Nickel prices increased slightly in the quarter,but were volatile; after reaching a peak in midMay, the resolution of labour disputes at majorCanadian producers saw prices fall sharplythrough late May and June before stabilisingin early July.


25

Domestic Financial Markets

Australian dollarThe behaviour of the Australian dollar so

far in 2000 can be divided into a number ofphases. The first few months of the year,through to the second half of April, were aperiod of unilateral Australian dollar weakness(Graph 28). The trade-weighted index fell bya similar amount to the rate against theUS dollar.

From late April and into May, the currencycontinued to fall against the US dollar, butthis was mainly a reflection of US dollarstrength. The Australian dollar was steadierin trade-weighted terms and, indeed, it roseagainst some currencies, including the euro,during this period.

The initial recovery in the Australian dollarin early June continued to be mainly a mirrorimage of US dollar movements (i.e. thereversal of the US dollar strength). As such itwas less pronounced in trade-weighted terms.Following the release of National Accountsdata, however, which were a good dealstronger than expected and prompted manyanalysts to conclude that their earlierassessments of a slowing in the economy hadbeen overstated, the exchange rate movedhigher against all currencies.

More recently, the currency has fallensomewhat again. For a time, this wasassociated with the weakness in some Asiancurrencies, both because markets seeAustralia’s prospects as being closely tied tothose of Asia and because some investors soldinto the Australian market as a proxy for theless liquid Asian currency markets.Subsequently, it became mainly a reflectionof re-emerging US dollar strength. As such,the fall in the Australian dollar’s rate againstthe latter currency again became morepronounced than the fall in the trade-weightedindex.

The market responded to the Augustmonetary announcement with a small rise in

the exchange rate. Nonetheless, it remains ata relatively low level. At around US58 cents,it is 10 per cent below its average level for1999. The trade-weighted index is about7 per cent below its 1999 average.

The Bank has not undertaken anyoperations in the foreign exchange market inrecent months to influence the currency.

Market interest ratesAfter the four increases in official interest

rates between November 1999 and May 2000,short-term market interest rates fell for a timeas markets became more comfortable with theoutlook for inflation. This was similar to theexperience in many other countries. Morerecently, however, Australian short-term yieldsmoved up again in response to the run ofeconomic news, particularly that on inflation(Graph 29). A significant probability of anAugust tightening had been priced into marketyields in the days before its announcement,and it was followed by only a modest furtherrise in yields. As of early August, the yield on90-day bank bills was 6.4 per cent.

As has been a feature of recent years, yieldson long-term government bonds in Australia

Graph 28

l l l l l l0.56

0.57

0.58

0.59

0.60

0.61

0.62

0.63

0.64

0.65

49

50

51

52

53

54

55

56

57

Australian Dollar

2000

US$ Index

Feb Mar Apr Jun Jul AugMay

TWI(RHS)

US$ per A$(LHS)


26

have continued to move broadly in line withthose in the United States (Graph 30). Bondyields here and in the US peaked in early 2000and have since fallen. In Australia, the peakin the 10-year yield was 7.25 per cent, and thecurrent level is 6.1 per cent. This fall has beenlarger than the fall in the United States so thatthe spread between 10-year yields in thetwo countries has narrowed from about60 basis points to about 20 basis points.

For a period in early May, bond yields inAustralia had moved below those in theUnited States, i.e. the differential had becomenegative. The only other time this hadhappened was in mid 1998, when there wereconcerns about the outlook for the Australian

economy due to the expected impact of theAsian crisis. In the more recent episode, itlargely reflected expectations that thetightening cycle in the United States wouldbe noticeably more pronounced than inAustralia.

As in a number of other countries, bondissuance in Australia in recent years has shiftedaway from the public sector toward the privatesector. With $74 billion of non-governmentbonds outstanding, this sector is now largerthan the market for CommonwealthGovernment securities (Graph 31).

Graph 29

Graph 30

This points to the need to look atmovements in interest rates beyond those ongovernment securities. The recent fall incorporate yields has been a little less than thatin government yields. For ‘A’ rated corporates,the spread over government bonds ofcomparable maturity is currently about100 basis points, which is noticeably widerthan a couple of years ago (Graph 32).

The repricing of credit risk has been evidentin several countries, although these shifts aremore prominent in the United States andUnited Kingdom than in other countries, ascan be seen in the spread between yields ongovernment bonds and yields in swap markets(Graph 33). The 10-year swap spread in theUnited States, for example, has increasedin 2000 by about 50 basis points, to a level

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

Australian Short-term Interest Rates%

Cash rate

%

90-day billyield

1999 2000F M A N F M A

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

Ten-year Bond Yields%

US

%

Australia

1997 1998 1999 2000MDSJMDSJM DSJM J DS

Graph 31

0

20

40

60

80

0

20

40

60

80

Domestic Bonds OutstandingMonthly

1990

$b

*Excluding the Commonwealth Government's own holdings

CommonwealthGovernment*

State government

Non-government

$b

1992 1994 1996 1998 2000


27

higher than at the time of disruptions inmarkets during the LTCM crisis in 1998.

Some commentators have attributed thewidening in spreads to the reduced supply ofgovernment paper, but this does not appearto be the entire story. The reduction in publicsector debt has been larger in Australia thanin the United States (and elsewhere) and theshort-term outlook is for this to continue. Yetspreads in Australia have not increased asmuch. The diminution of supply ofgovernment bonds therefore seems, at best,to be a partial explanation of rising creditspreads (Table 8).

Other factors may have been a degree ofilliquidity in the swap market in the face of

large increases in private sector bond issuanceand rising interest rates. Rising interest ratesare likely to result in investors projecting aheadto slower economic growth and the possibilityof higher default rates. These concerns mightrecently have been exacerbated by changes inthe pattern of corporate financing: in countriesin which the swap spread has increased themost – the US and UK – growth in privatesector bond issuance has been relatively large,while net equity issuance has been low (oreven negative as in the United States). Thisswitch from raising funds in equity marketsto bond markets would, other things equal,also tend to raise concerns about creditquality, as corporate leverage would tend to

Graph 32 Graph 33

l l l l l l l l l l3

4

5

6

7

8

3

4

5

6

7

8

Australian Bond Yields

M

%

Source: UBS Warburg Australia Ltd

Corporatebond yield

%

Government bond yield

J S D M J S D M J S1998 1999 2000

l l l l l l l l l l0

25

50

75

100

125

0

25

50

75

100

125

Ten-year Swap Spreads

M

BpsUS

Bps

UK

Australia

Canada

Europe

J S D M J S D M J S1998 1999 2000

Source: Bloomberg

Table 8: New Financing1997–1999

Net debt issuanceNet equity Change in swap

raising spread

Public(a) Private

Cumulative change, per cent of GDP Basis points

United States –2 27 –6 70Euro area 6 5 na 30United Kingdom 1 16 3 85Canada 1 6 6 15Australia –8 13 13(b) 15

(a) Central government

(b) Excluding privatisations


28

rise. By contrast, while private-sector bondissuance has been high in Australia and, to alesser extent, Canada, new equity has beenequally high.

Intermediaries’ interest ratesBanks raised interest rates on most

categories of variable-rate loans by a similaramount to the rises in the cash rate betweenNovember 1999 and May 2000 (Table 9).Some business overdraft rates had risen byslightly more than this. Those banks which sofar have announced changes to interest ratesfollowing the tightening in early August have

also matched the rise in the cash rate. Inaddition, some banks have announcedincreases in interest rates on selected lendingproducts of between 1 and 15 basis points torecover the added cost of inputs which attractthe GST. (Financial services are ‘input-taxed’,meaning that financial service providerscannot claim a tax credit for these costs.)

The level of intermediaries’ interest ratesfor households and small businessesremains historically low – in particular,notwithstanding the fact that the cash rateexceeds by 1.5 percentage points its level atthe previous cyclical trough in 1993/94, rates

Table 9: Major Banks’ Indicator Loan RatesPer cent

Change between Level Cyclical lowend October 1999 as at in 1993/94

and July 2000 July 2000

HouseholdHousing

Standard variable 1.25 7.80(a) 8.75Basic 1.30 7.25 na

PersonalResidential-secured overdraft 1.30 7.95 9.75Credit card(b) 1.15 16.45 14.35

Memo Item:Mortgage managers’ rate 1.35 7.55 7.70

BusinessSmall business

Residential-secured– Overdraft 1.40 8.35 na– Term 1.30 7.95 naOther(c)

– Overdraft 1.45 8.90 9.30– Term 1.35 8.40 na

Large business– Overdraft 1.40 9.35 9.00– Term 1.35 9.25 na

Cash Rate 1.25 6.00 4.75

(a) By 9 August, the major banks had each announced an increase in mortgage rates of 0.25 of a percentage pointfollowing the tightening of 2 August. The average level of this rate was 8.05 per cent.

(b) With interest-free period.

(c) Both secured by other assets and unsecured.


29

paid by borrowers, especially for housing,typically remain below their level at that time.

Mortgage managers have, on average, raisedtheir housing interest rates by more than banksbecause they fund their lending in wholesalemarkets, whereas banks also draw on alow-cost supply of retail deposits: since moneymarket interest rates over the past year havetended to trade significantly above the cashrate, mortgage managers’ margins have beensqueezed.

The pattern of increases in credit card rateshas varied from bank to bank. While theaverage increase by the major banks sinceend October is a little smaller than the rise inthe cash rate, banks did not lower credit cardrates by as much as the cut in the cash rateduring the previous easing phase. On thewhole, margins on credit card lending havetended to widen since the mid 1990s.

The flagship small business rate – onresidentially secured term loans – has beenincreased in line with the cash rate. Rises inother indicator rates on loans to smallbusinesses have, on average, tended to belarger than this as some banks have raisedsome rates independent of monetary policymoves (including by some banks to recoupthe costs of the GST). Measured across allloan products, and taking into accountchanges in customer risk margins, however,it seems that interest rates paid on average bysmall businesses have increased by a little lessthan the rise in interest rates directly due tothe tightening of monetary policy. This isbecause small businesses lending has beenmigrating to low-interest rate loan products,such as residentially secured loans.

Interest rates on new fixed-rate loans havefallen over recent months, reflecting falls inyields in capital markets in which these loansare funded (Graph 34). Banks’ 3-year fixedhousing lending rates have fallen by an averageof 35 basis points, from their peak earlier inthe year, to 7.60 per cent. The correspondingindicator rate for small businesses has fallenby 55 basis points from its peak, to8.20 per cent. Fixed-rate loans for housinghave fallen by less than those for smallbusinesses since they had also risen by less

during the phase of rising yields in capitalmarkets in 1999.

The increases in banks’ retail deposit ratessince last year have, in most cases, been smallerthan the rise in the cash rate (and lendingrates), especially for transaction accounts andaccounts with small balances. (Some depositrates were also reduced to cover rises in costsof banks’ inputs associated with theintroduction of the GST.)

Financial aggregatesCredit growth remains strong and has

picked up noticeably in recent months, drivenby an acceleration in both business andhousing credit (Table 10). Credit outstandingincreased at an annual rate of more than15 per cent over the first half of this year, andby just over 13 per cent over the year to June.Growth in housing credit has beenconsistently strong for an extended period,and has picked up further in the first half ofthis year, with much of the strengthconcentrated in borrowing to purchaseinvestment properties. Business credit growth,in contrast, was quite weak around the middleof 1999, but in recent months has recoveredto reach an annualised rate of around13 per cent over the first half of 2000. Whilegrowth in personal credit has slowed a little,it remains robust. Within personal credit,revolving finance such as credit cards andoverdrafts have continued to be stronger thantraditional fixed-term loans.

Graph 34

4

5

6

7

8

9

10

11

12

4

5

6

7

8

9

10

11

12

Interest Rates3-year fixed

%

Housing

Small business

Swap rate

%

1996 1998 20001994


30

Margin lending by banks and brokers grewby 3.6 per cent in the June quarter, somewhatslower than the increase of around 10 per centin each of the previous three quarters. Theearlier large rises reflected the second trancheof the privatisation of Telstra and strongactivity in the share market by retail investors.With the market being more subdued of late,demand for margin loans has increased lessquickly. Margin lending now stands at$6.5 billion, and accounts for approximately9 per cent of non-housing personal creditoutstanding.

Growth in the deposit aggregates has pickedup from a slower period in the latter half of1999. Both M3 and broad money registeredrobust growth in the three months to June,and annualised growth over the first half of2000 was over 10 per cent. This compares withannual growth rates of around 4 per cent overthe six months to December 1999. Thepick-up in current (cheque-linked) depositshas been particularly marked. In contrast,abstracting from the increased circulation ofcash around the end of last year, annualgrowth in currency has been relatively stableat around 7–8 per cent for a number of years.

The financial aggregates are likely tobecome somewhat more volatile in comingmonths, due to a change to reportingarrangements that will remove some of the

smoothing effect generated by averaging datawithin individual months. Analysis of trendsin credit growth will therefore need to takeaccount of a greater degree of noise in theseries in the future.

Managed fundsGrowth in funds under management slowed

to 3 per cent in the March quarter, from5.3 per cent in the December quarter, and was15 per cent over the year to the March quarter.The increase in the value of assets during thelatest quarter was mainly driven by stronggrowth in the value of equities and units intrusts, and overseas assets (Table 11). Withdomestic share prices relatively flat over theMarch quarter, the increase in equities andunits in trusts suggests net inflows to this assetclass. Similarly, the growth in overseas assetsin the quarter probably reflected valuationeffects flowing from the depreciation of theexchange rate in the quarter or net inflows tothis asset class; the mixed performance ofoverseas equity markets during this periodimplies that valuation effects flowing fromincreases in equity prices would have beensmall. Institutions with high exposure tooverseas assets, particularly superannuationfunds and public unit trusts, recorded thelargest asset gains in the quarter.

Table 10: Financial AggregatesSeasonally adjusted annualised growth rates, per cent

Year to Six months to:June 2000

December 1999 June 2000

Total credit 13.1 10.8 15.4– Personal 17.5 20.1 15.0– Housing 17.5 16.2 18.7– Business 8.7 4.7 12.8Currency 7.1 8.1 6.1M3 7.5 4.9 10.1Broad money 7.3 3.7 11.1


31

Share marketShare prices in Australia softened early in

the June quarter, in line with USdevelopments. Since then, however, theAustralian market has done better than its UScounterpart and prices attained a record highin July. The ASX 200 index is about12 per cent above its low point in the Junequarter, and its level a year ago.

The industrial and resource sectors haveboth shown relatively small increases over thepast year; stocks of financial companies areup by 15 per cent (Graph 35).

Table 11: Managed Funds by InstrumentAs at March 2000

Percentage change Per cent of total

March 2000 Year to March 2000

Cash & deposits –0.9 9.4 7Loans & placements 5.1 23.0 5Short-term securities –0.8 0.8 10Long-term securities 0.1 0.0 13Equities & units in trusts 2.8 15.1 30Land & buildings 4.8 16.5 11Assets overseas 6.9 36.4 21Other assets 4.2 14.0 3Total 3.0 15.0 100

Graph 35

Australian Share PricesLog scale, end December 1995 = 100

Banks and insurance

Index

S DM J S DM J S D

200

140

65

45

1997 1998 1999

Other industrials

Other resources

Gold

Index

200

140

65

45

M J2000

3030M J S

100100


32

Inflation Trends and Prospects

Recent developments in inflation

Consumer prices

Measures of consumer price inflationcontinue to increase. The Consumer PriceIndex (CPI) increased by 0.8 per cent in theJune quarter 2000 and by 3.2 per cent overthe year (Graph 36). Measures of underlyinginflation, which are less sensitive tomovements in the volatile components of theCPI, indicate that inflation has graduallyincreased to around 21/2 per cent from itsrecent trough of around 11/2 per cent(Graph 37). While some of the rise in inflationover the past year or so reflects increases inthe price of oil and tax-related increases inthe cost of insurance, house purchase andcigarettes and tobacco, the pick-up in inflationhas been quite broadly based (Table 12).

Retail petrol prices increased by 3.2 per centin the June quarter, reflecting a combinationof higher world prices of oil over the pastsix months as well as the influence of a lowerexchange rate. Together, these two factors ledto an increase in the Australian dollar price ofcrude oil of around 7 per cent in the Junequarter. Over the past year, retail petrol priceshave risen by 22 per cent, contributing

Graph 36

Graph 37

0.9 percentage points to the increase in theCPI over that time. In recent weeks, the priceof crude oil has fluctuated around a level closeto the June quarter average. Assuming thatthe exchange rate remains around its currentlevel, this would imply little further change inpetrol prices at the pump in the Septemberquarter (Graph 38).

The large rise in the house purchasecomponent of the CPI over the past year hascontributed to the increase in the CPI and to

Graph 38

0

1

2

3

4

0

1

2

3

4

Measures of Underlying InflationYear-ended

2000

%

Trimmed mean

Weightedmedian

Private-sectorgoods and services

%

1998199619941992

Treasuryunderlying CPI

60

65

70

75

80

7

12

17

22

27

Petrol and Crude Oil PricesCents per litre (A$)

Cents Cents

Crude oil prices(RHS)

Retail petrol prices(LHS)

200019981996

*

1997 19991995* Average crude oil price for August to date

-1

0

1

2

3

4

-1

0

1

2

3

4

CPI Inflation*

2000

%

Quarterly

Year-ended

1998199619941992

%

* Excluding interest charges prior to September quarter 1998


33

most measures of underlying inflation. Thecost of house purchase increased by0.4 per cent in the June quarter and by 7.5 percent over the year to the June quarter. Theincrease over the past year has reflected thestrength of housing activity and the emergenceof capacity constraints in the industry, asdiscussed above in the chapter on ‘DomesticEconomic Activity’. The strength in thehousing industry has been supported byunderlying demand factors, notably thegrowth of incomes and the relatively low costof housing credit, but it has also partlyreflected the desire to complete work beforethe introduction of the GST.

A range of other prices are likely to havebeen affected by the changes to the tax systembefore the introduction of the GST on 1 July,though in ways that are difficult to measureprecisely. The payment of GST on insurancepremiums has boosted those components ofCPI inflation over the past year; the methodof measurement based on premiums net ofclaims means that the recorded price ofinsurance in the CPI has increased by morethan the GST rate. Working in the otherdirection, the reduction in the top wholesalesales tax rate on some items last year, such astelevisions and VCRs, had a small offsettingeffect. Motor vehicle prices also appear to have

been lower than otherwise, rising by only1/2 per cent over the past six months despitethe exchange rate depreciation, reflectingdiscounting ahead of the introduction of theGST in an attempt to smooth sales.

Private-sector services prices have increasedat a consistently faster pace than private-sectorgoods prices for most of the past six years(Graph 39). While this pattern has continuedover the past year, much of the discrepancyin recent quarters is accounted for by thecontribution of GST-related increases in thecost of insurance to private-sector services

Table 12: Measures of Consumer PricesPercentage change

Quarterly Year ended

March June March Junequarter quarter quarter quarter

2000 2000 2000 2000

Headline CPI 0.9 0.8 2.8 3.2– Tradeable component 0.5 1.0 1.8 2.0– Non-tradeable component 1.3 0.7 3.8 4.2CPI excluding volatile items 0.7 0.6 2.2 2.6Private-sector goods and services 0.5 0.6 2.2 2.4Weighted median(a) 0.7 0.4 2.5 2.4Trimmed mean(a) 0.7 0.6 2.5 2.7

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

Graph 39

0

1

2

3

4

0

1

2

3

4

Private-sector PricesYear-ended percentage change

2000

% %

Services

Total

Goods

1998199619941992


34

prices. Excluding insurance, private-sectorservices prices rose by 0.5 per cent in the Junequarter and by 2.5 per cent over the year.

Over the past year, the price of tradeablescontinued to grow more slowly than that ofnon-tradeables. The 1 per cent increase in theprice of tradeables in the June quarterreflected a large increase in petrol prices, butalso higher prices for fresh vegetables andoverseas travel and accommodation, with thelatter increase, in part, due to seasonal factors.Abstracting from the effect of oil, tradeablesprices increased by 0.8 per cent in the Junequarter and by 0.2 per cent over the past year.However, the recent weakness of the exchangerate is likely to result in larger increases in theprice of tradeables over the coming year (seebelow). The price of non-tradeables rose by alittle over 4 per cent over the past year; thiscomponent comprises mainly services andincludes the cost of house purchase.

The exchange rate and inflation

In import-weighted terms, the Australiandollar has depreciated by around 51/2 per centsince the beginning of the year. The lowerexchange rate contributed to the sharpincrease in the wholesale price ofmanufactured goods in the June quarter, forexample, in meat products and petrol. Somepass-through of these wholesale priceincreases to retail prices is apparent in the Junequarter. However, the recent rise inmanufacturing wholesale prices, excludingpetrol, is likely to be seen more fully in retailgoods prices in coming quarters.

The overall effect of the currencydepreciation on inflation is subject toconsiderable uncertainty. The depreciation ofthe Australian dollar during the Asian crisishad little discernible effect on final consumerprices over the subsequent couple of years.However, a number of factors suggest that thedepreciation of the currency over the courseof this year is more likely to be passed throughto final consumer prices. Conditions in theeconomy are tighter now than in the aftermathof the Asian crisis, the deflationary impulsefrom Asian producers is no longer present andworld commodity prices are rising.

Recent movements in the exchange ratehave also been reflected in indexes of tradeprices; the export price index rose by morethan 16 per cent over the past year, with higherprices for base metals, chemicals, andpetroleum aided by higher world prices andincreased demand. Prices of importedconsumption goods at the docks increased byalmost 4 per cent in the June quarter, after avery modest rise in the March quarter, andhave now regained their level of nearly twoyears ago.

Producer prices

A wide range of producer prices increasedsharply in the June quarter (Table 13).Although some specific factors havecontributed considerably to these increases,most notably the rise in oil prices and the

Table 13: Producer and Trade PricesPercentage change

JuneYear to

quarterJune

quarter

Producer prices bystage of productionPreliminary commodities 3.3 8.3Intermediate commodities 2.5 6.7Final commodities 1.8 5.0

ManufacturingInput prices 4.8 16.4– Domestic 4.5 19.0– Imported 5.5 13.0Final prices 1.9 7.3– Excluding petroleum 1.4 4.7

ConstructionMaterials used in 1.4 5.3house buildingMaterials used in 0.9 1.7other buildingServicesTransport and storage 0.8 1.6Property and business 2.0 6.3servicesMerchandise tradeExport prices 6.2 16.7Import prices 5.5 9.3


35

depreciation of the exchange rate, the pick-upin producer price inflation has been broadlybased.

Both domestic and imported manufacturinginput prices increased strongly in the Junequarter, largely reflecting the continued risein the world price of oil and the 10 per centdepreciation of the exchange rate over the pastyear. Excluding oil, the domestic componentincreased by around 1 per cent in the Junequarter, driven by rises in utilities and metalore prices, while the non-oil-related prices ofimported inputs rose by a similar amount. Asa consequence, inflation in manufacturingoutput prices also picked up in the Junequarter. Although prices of petroleum andbasic metal products have contributed closeto two-thirds of the overall increase in thisseries over the past year, in recent quartersthere has been an intensification of upstreamprice pressures across most components(Graph 40).

Strong demand in the housing sector fuelledincreases in building materials prices in theJune quarter, with the increase mostnoticeable in Sydney. Property and businessservices prices rose strongly for the fifthsuccessive quarter. Growth in other buildingmaterials prices also picked up in the Junequarter, but the rise in this series over the pastyear has been more subdued than that in thehouse-building series, due to the slower paceof activity in the non-residential constructionsector.

A new ABS publication, Stage of ProductionProducer Pr ice Indexes, presents anarrangement of existing producer priceindexes at three stages of production –preliminary, intermediate and final. Theseindexes confirm that there have been strongincreases in prices at all stages of production.At the final stage, producer prices ofconsumption goods and services increased by5 per cent over the year to the June quarter,with higher wholesale petrol and food pricesbeing the main contributors. Final producerprices of capital goods have increased due tothe higher price of project home prices andexchange-rate induced increases in the priceof imports, such as industrial machinery andcomputer equipment.

Labour costsIndicators of wage growth have shown

divergent movements recently (Table 14). TheWage Cost Index (WCI) for total hours(excluding bonuses), an indicator ofmovements in average wage rates, increasedby 2.8 per cent over the year to the Marchquarter 2000, which is close to the previousreadings for this indicator (Graph 41).

Graph 40

Table 14: Indicators of Labour CostsYear-ended percentage change

Dec Mar June1999 2000 2000

Wage Cost Index(a)

Private 2.8 2.9Public 3.5 2.5Total 3.0 2.8

Average weekly earnings surveyAWOTE 3.0 4.1 4.5AWE 1.6 2.8 4.0

Executive remunerationBase salaries 4.6 4.6 4.5

New federal enterprise agreements(b)

Private 3.5 3.6Public 3.1 3.2Total 3.4 3.4

(a) Total pay excluding bonuses

(b) Average annualised increase

0

1

2

3

4

0

1

2

3

4

Final Manufacturing PricesYear-ended percentage change

% %

20001998199619941992

Final manufacturingprices*

Private-sectorgoods in CPI

* Excludes petroleum, basic metals and chemicals


36

Enterprise bargaining outcomes in the earlypart of the year also suggested little change inthe rate of wage growth; new federal enterpriseagreements in the March quarter yielded anaverage annualised increase of 3.4 per cent,unchanged from the previous quarter. In atrend that has been evident for a couple ofyears, replacement agreements in the Marchquarter provided for slightly lower wageincreases than the expiring agreements.

difficult to gauge. The NAB survey indicatesthat the growth of labour costs has picked upover the year to June, though the rate of growthin this series is still quite low. Looking forward,the survey also suggests that businesses expecta modest pick-up in growth of labour costs inthe September quarter. Both the NAB andthe ACCI-Westpac surveys point to higherexpectations for wage increases underenterprise agreements. These results may havebeen influenced by prospects for the wagecampaign in the Victorian manufacturingsector, which has recently commenced.Preliminary negotiations between unions andsome Victorian manufacturers suggest thatnew agreements may provide for wageincreases slightly higher than those yieldedin current agreements. Manufacturingunions are likely to attempt to pursue anindustry-wide agreement for other Australianmanufacturers in July 2001. In theconstruction sector, negotiations betweenunions and employers are now more or lesscomplete. The new agreements have providedfor wage increases that are slightly less thanthose specified in the expiring agreements.

The effect of GST-related clauses inenterprise agreements represents a source ofuncertainty in the wages outlook. A numberof enterprise agreements incorporate clausesthat seek either additional compensation forCPI movements in excess of a benchmark orthe ability to review wage increases should theeffect of the GST on the price level exceedexpectations. At present, however, only a smallproportion of enterprise agreements containa clause of this nature, or clauses that directlylink wage increases to movements in the CPI.

Inflation expectationsSurvey-based measures of inflation

expectations have shown divergent trends inrecent months. The introduction of the newtax system has complicated the inflationoutlook, while higher oil prices and the lowerexchange rate have tended to push up inflationexpectations.

Inflation expectations of consumers, asmeasured by the Melbourne Institute, fellsharply from above 7 per cent in the months

In contrast, the survey of average weeklyearnings has recorded a pick-up in growth inaverage weekly ordinary-time earnings(AWOTE) in recent quarters. Preliminaryestimates suggest that AWOTE increased by4.5 per cent over the year to May, up fromthe low point of 2.1 per cent reached in theSeptember quarter last year. Being a measureof the wage bill rather than wage rates, thisseries is susceptible to shifts in the compositionof employment. The effect of suchcompositional shifts, and the volatility of theseries more generally over recent years, makethe survey difficult to interpret. It is possible,against a background of increasing inflationand a strengthening labour market, that thesurvey is signalling some pick-up in underlyingwage pressures, but at this stage the extent ofany such pick-up is difficult to assess.

Recent business surveys have pointed tosome upward pressure on wage growthalthough, again, the extent of such pressure is

Graph 41

-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*


37

preceding the introduction of the GST to4.6 per cent in July, around the levels recordeda year ago (Graph 42). The proportion ofrespondents expecting inflation to be10 per cent or above almost halved in July,following a few months when over one-thirdof survey respondents had such anexpectation. Currently, more than one-thirdof respondents expect inflation over the nextyear to be 2–3 per cent or lower.

indicate that businesses now expect the GSTto add less to product prices by the end ofthis year than they had expected six monthsago. The June quarter ACCI-Westpac surveyof manufacturers suggests that price pressuresare picking up noticeably in that sector, withthe net balance of manufacturing firmsincreasing prices remaining at a high level.Medium-term inflation expectations ofbusinesses, as reported in the quarterly NABsurvey, have increased over the past year. Aclear, although gradual, shift has occurred inrespondents’ medium-term inflationexpectations, with the share of respondentsexpecting inflation to be less than 3 per centper annum declining steadily since early lastyear.

Inflation forecasts of private-sectoreconomists for the year to June 2001 continueto edge upwards (Table 15). The medianinflation forecast of private-sector economistsfor the year to June 2001, as surveyed by theBank following the release of the June quarterCPI, has increased to 5.5 per cent from5.3 per cent in the March survey. The medianestimate of the effect of the tax package onthe CPI over the year to June 2001 remainsat around 23/4 per cent (in line with theGovernment’s estimate). Hence, excluding theGST, the median forecast has moved up to2.8 per cent. The first reading of the medianforecast of inflation for the year to June 2002is around 2.3 per cent.

Business surveys have reported expectationsof rising inflation in the near term. Followinga pick-up in actual price increases over thepast year, the June quarter NAB surveyreported an increase in inflation expectationsin both the short and medium term(Graph 43). Inflation in actual purchase costsand overheads has also risen in recentquarters, and is expected to rise further in theSeptember quarter. The year-ended inflationrates discernible from the NAB survey remainquite modest, despite the expectations for theSeptember quarter covering the introductionof the GST. Responses to a special question

Graph 43

Graph 42

Inflation ExpectationsConsumers

Year-ahead inflation

%

2

4

6

8

2

4

6

8

0

25

50

75

0

25

50

75

20001998199619941992

%

%% Business Medium-term inflation

(per cent of respondents in each category)

Less than 3%

3% to less than 4%

4% or more

Sources: Melbourne Institute; National Australia Bank

0.0

0.5

1.0

1.5

0.0

0.5

1.0

1.5

NAB SurveyFor the quarter

2000

Purchase costs%

Expected

Final product prices %

19961992200019961992

Actual


38

Trade union officials, as surveyed by theAustralian Centre for Industrial RelationsResearch and Training (ACIRRT), haverevised up their forecasts of inflation for theyear to June 2001 in recent quarters, reflectingthe incorporation of the effect of the GST onprices by more respondents. They expectinflation to remain high in the following year,despite the dropping out of the GST effecton the annual inflation rate.

Longer-term inflation expectations offinancial market participants, measured by thedifference between nominal and indexed10-year bond yields, have remained relativelystable over the past few months. After reachinga peak of 33/4 per cent in mid January, theimplied 10-year inflation expectation fellsharply in the first quarter of the year to arange between 23/4–3 per cent, where it hasremained.

Inflation outlookInflation pressures have been gradually

strengthening, with all measures of inflationnow significantly higher than they were a yearago. The CPI increase of 3.2 per cent over theyear to the June quarter was slightly abovethe Bank’s target. This was the first time thetarget has been exceeded since the mid 1990s,but temporary deviations of this nature areallowable in Australia’s flexible inflationtargeting policy. Measures of core inflation

have shown a more gradual, but still quiteclear, increase to be running at around21/2 per cent over the latest year, comparedwith rates of around 11/2 per cent at the recenttrough.

Economy-wide demand conditions, as wellas changes in the international priceenvironment, are important forces underlyingthe shift in inflation. At the same time, anumber of particular factors which have alsocontributed to recent inflation developmentswill probably prove to have been of atemporary nature. The most important ofthese has been the increase in internationaloil prices. This has been reinforced by therecent depreciation of the Australian dollar,such that the combined effect has been anincrease in crude oil prices in Australian dollarterms of around 70 per cent over the past year.As a result, petrol prices at the pumps havecontributed significantly to CPI inflation overthe year and, to a lesser extent, have probablyalso contributed to some of the pick-up inunderlying inflation measures. Other specificfactors to have contributed to the CPI increaseover the past year have been large increases ininsurance and tobacco prices, much of whichwere tax-related, and house purchase prices,which have been partly driven by strength inhousing demand attempting to avoid the GST(and accommodated by easy creditavailability).

Table 15: Median Inflation ForecastsPer cent

Year to June 2001 Year to June 2002

Month of February May August Augustsurvey 2000 2000 2000 2000

Market economists(a)

CPI 5.2 5.3 5.5 2.3– Excluding GST 2.5 2.6 2.8 2.4Union officials(b)

‘Inflation’ 3.5 4.8 5.3 4.2

(a) RBA survey of financial market economists

(b) ACIRRT survey of trade union officials


39

But while these factors are unlikely tocontinue contributing to inflation to the samedegree as they have done over the past year, anumber of other sources of inflationarypressure remain in place and may strengthenfurther. Important near-term influences onprices will be the significant increases inproduction costs that have occurred recently,arising from higher fuel prices, increases in arange of other commodity prices and the effectof the lower exchange rate on prices ofimported inputs. These increases in costs arelikely to represent a source of upward pressureon consumer prices in the near future. Thelower level of the exchange rate, if sustained,is also likely to generate direct upwardpressure on prices of imported andimport-competing consumer goods.

Of greater importance looking further aheadis the more general influence of economy-widedemand pressures. The economy is now at anadvanced stage of its current expansion andhas continued to show greater strength thanhad been generally expected, with real GDPgrowing at an average annual rate of more than41/2 per cent, and domestic final demand atover 5 per cent, for the past three years.Growth at this pace has exceeded the rate ofgrowth of the economy’s productive potential,generating declining unemployment andrising levels of capacity utilisation, and is likelyto have contributed to the upstream pricepressures described above. While someslowing in the pace of growth in some sectors –such as housing – is likely in the period ahead,there are few signs at present that any slowingin aggregate demand is likely to be particularlypronounced. Overall growth is likely to be atleast as high as the economy’s long-runpotential growth rate.

Wage developments remain an importantsource of uncertainty in assessing the inflationoutlook. Over recent years, growth in wageshas been quite moderate, and in most of theavailable data, this continued to be the casein the early part of 2000. Growth in the WageCost Index for the year to the March quarterremained low, and enterprise bargaining datafor the March quarter showed no change inthe average negotiated increase. Average

weekly earnings data for May showed a sharpincrease in ordinary-time earnings growth,although the quality of this series as anindicator of wage growth over the short termis poor. With output growth likely to remainstrong, labour market conditions will probablytighten further. Since wage claims could alsobe expected to be responsive to the increasein underlying price inflation already observed,wages growth is likely to pick up in the periodahead, though the extent to which this mayalready be occurring is difficult to assess.

The June quarter represents the last CPIfigure for some time for which the annualincrease will not be heavily affected by theimplementation of the GST and related taxchanges. Preliminary indications are that theimplementation of the tax changes on 1 Julyproceeded smoothly and that the net taxeffects on prices were broadly in line with (orpossibly slightly lower than) those suggestedby prior estimates. Nonetheless, the CPI willshow a sharp upward movement in theSeptember quarter and, in year-ended terms,the CPI increase will remain well above thetarget until the June quarter 2001. For aperiod after that, in the second half of 2001,the annual figure may then be held down bylagged effects of some indirect tax reductions.Hence, it will be some time before the CPIwill provide a completely unambiguousreading of the annual inflation rate unaffectedby the tax changes. Moreover, standardmeasures of underlying inflation will also beaffected by the tax changes during this period(see Box).

As has been stated on a number of occasions,the Bank intends to abstract from theprice-level effect of the tax changes and willseek to ensure that ongoing inflation remainsconsistent with the target once the tax changeshave been absorbed. Given the uncertaintiesas to the exact size and timing of the tax effects,this will require careful judgments to be madeas to the contributions of tax effects andongoing inflationary pressures to CPIoutcomes in the coming quarters.

The Bank’s current assessment is thatinflation as measured by either the CPI orunderlying measures is likely to be in the upper


40

part of the 2–3 per cent target zone, once thesetemporary tax effects have passed out of thecalculation. This assessment is based on anevaluation of the recent trends in core inflationand likely developments in demandconditions, and takes into account thedampening influence of the monetary policyadjustments since November 1999. Theassessment depends importantly on theassumption that there will be no significantsecond-round wage and price effects arisingfrom the tax changes and that the tax-relatedincrease in the price level does not generatean upward shift in ongoing inflationexpectations. While this remains a source ofrisk, developments so far have been broadlyconsistent with this assumption. There havebeen few signs of excessive price increases inresponse to the tax changes, or of widespreadGST-related wage claims.

The risk of a more substantial and sustainedpick-up in inflation would be heightened if

the economy were to expand significantlymore quickly than currently envisaged. Risksworking in the opposite direction can beidentified as well. A weaker globalenvironment could dampen demand pressuresin the period ahead, although that appears tohave become less likely recently. Stronggrowth in productivity may continue torestrain growth in unit labour costs to a greaterextent than expected, though productivitygrowth in the past year has been below thatin the preceding few years. Finally, were theexchange rate to rise significantly from itsrecent low levels, that would also help todampen inflation pressures both directly andindirectly. The balance of risks around thecentral forecast appears at present to be suchthat it is more likely that inflation will exceedthe forecast, and therefore exceed the target,than that it will fall below it. R

9 August 2000


41

The introduction of the major elementsof the new tax system in July will lead totemporarily higher CPI inflation in theSeptember quarter 2000, followed by aperiod of time during which reductions invarious taxes flowing through to prices willreduce measured inflation. Once the effectsof the tax changes on prices have flowedthrough, inflation is expected to return torates consistent with the Bank’s target, butthere will be a permanent effect on the levelof the CPI relative to the path that it wouldotherwise have followed.1 Measures ofunderlying inflation, which are designed toabstract from the volatility inherent in theCPI, cannot remove the effects of thewide-ranging changes to prices associatedwith the tax changes. Consequently, allpublished measures of inflation are expectedto increase temporarily in the Septemberquarter.

Underlying inflation measures, which,along with the CPI, tend to produce similaraverage inflation rates over a run of years,fall into two broad categories (Table 1).2 Thefirst two underlying measures in the tableare exclusion-based, with prices that eitherhave a high average volatility, or which are

not market-determined, permanentlyexcluded from the CPI basket. The other twomeasures are based on statistical criteria,which are designed to limit the influence ofextreme price changes irrespective of thesource. These measures are calculated byexcluding a proportion of extreme pricechanges, but unlike the exclusion-basedmeasures, no judgement needs to be madeabout which particular items to exclude eachperiod. However, judgement is required asto what proportion of price changes toexclude; the trimmed mean excludes a fixedproportion of items (by weight) at theextremes of the distribution of price changes,while the weighted median excludes all butthe middle price change in each period.

The tax changes will not necessarily affectthe CPI and underlying measures of inflationto the same extent. For the CPI excludingvolatile items, the effect of the tax changescan be expected to be slightly larger than forthe CPI, as the prices of the excluded items– namely fresh fruit and vegetables andautomotive fuel – are not expected to besignificantly affected by the tax changes. Thenet tax effect on the private-sector goods andservices measure may be somewhat larger,

Box: Underlying Inflation and Taxation Changes

Table 1: Measures of Inflation

Average since mid 1993 Year to June 2000

CPI 2.1 3.2Underlying measures:

CPI excluding volatile items(a) 2.3 2.6Private-sector goods and services 2.2 2.4Weighted median 2.1 2.4Trimmed mean 2.1 2.7

(a) CPI excluding fresh fruit and vegetables and automotive fuel.

1. Statement 3 in Budget Paper No 1, 2000-01 Budget Papers presents estimates by the Commonwealth Treasuryof the effect of the new tax system on prices.

2. See ‘Measuring 'Underlying' Inflation’, Reserve Bank of Australia Bulletin, August 1994 for more details on theconcept of underlying inflation and the definitions used here.


42

since a greater proportion of the CPI basketis excluded, for which the net price effect ofthe tax changes is also expected to benegligible. In the case of the two statisticallybased measures of underlying inflation, theexpected relative impact of the tax changesis less clear. Although we have some idea ofthe distribution of tax-related price changesacross different items of the CPI, this is notsufficient to determine whether the effectson the median and trimmed mean measuresof inflation will be greater or less than thetotal effect on CPI inflation. It is thedistribution of overall price changes in theCPI basket – the combination of tax-relatedprice changes and persistent inflation – thatwill determine the precise effect on themedian and trimmed mean.

Since all published measures of inflationwill be affected by the tax changes, the ABSproposes to calculate a ‘constant tax ratemeasure’ for the September quarter CPI. InNovember, the ABS intends to publish theproportion of the change in the Septemberquarter CPI attributable to changes in taxrates between the June and Septemberquarters 2000. The constant tax rate measurecan abstract only from the first-round effectsof tax changes on prices, arising mainly fromthe introduction of GST and the removal ofWST on final goods.3 Accordingly, thisapproach will provide an upper limit of the

first-quarter price effect of the tax changes,because it does not take into account thedownward influence on prices from reducedtransport costs and the removal of WST atintermediate stages of production. However,these second-round effects are not expectedto be fully passed through to retail prices inthe September quarter, thereby reducing thedegree of overestimation. Additionaluncertainty in these calculations arises fromthe assumption that a 10 per cent GST hasthe same effect on the retail price as a10 per cent WST, even though the WST islevied at an earlier stage of production andtherefore represents a smaller amount of taxfor a given tax rate. This provides a possiblesource of offsetting downward bias in theestimate of the net tax effect.

As has been noted in the Bank’s policystatements, the Bank will seek to lookthrough the wide-ranging, but temporary,effects of the tax changes on the publishedmeasures of inflation. Monetary policy willbe based on assessments of developmentsin ‘ongoing’ inflation – that is, inflation netof the effects of changes to the tax system.Thus, the conduct of monetary policy incoming quarters will require carefulinterpretation of the data on pricedevelopments and assessment of the variousestimates of the net tax effect on prices thatare available.

3. See Price Indexes and The New Tax System, ABS Cat No 6425.0 for further details.

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