Statement on Monetary Policy May 2015 (Edited overview)

Fill the gaps in this Statement on Monetary Policy May 2015 (Edited overview)

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Growth of Australia’s major trading partners was around its long-run average in 2014. It appears to have eased slightly in the early months of 2015. prices have been quite volatile over recent months, notably iron ore and oil prices, which have rebounded somewhat from recent lows. Even so, prices of Australia’s key commodity overall have declined since the beginning of 2015 and are well down on levels of a year ago. In large part, the declines reflect growth in the of commodities globally, although an easing of growth in China’s for some key commodities has also played a role. While there has been a further fall in Australia’s of trade, the Australian dollar has by around 3 per cent against the US dollar and in trade- terms since the previous Statement.

In China, economic has eased further. The Chinese property market remains a source of weakness in the economy and this is flowing through to weaker for steel and other construction-related products. Indicators for Japanese economic activity have been somewhat mixed early this year, though labour conditions remain tight and there are tentative signs that wage will rise, which is expected to underpin a pick-up in domestic price pressures. Economic growth in the rest of east Asia looks to have slowed a little in the March quarter. Growth in the US economy moderated in the March quarter, largely reflecting the temporary effects of disruptions related to severe weather and industrial action in west coast ports. Meanwhile, the US labour market has continued to improve and growth has picked up. Economic activity in the euro area is recovering at a gradual pace.

Despite slightly weaker-than-expected conditions early in 2015, growth of Australia’s major partners is expected to remain around its long-run average pace in 2015 and 2016. Growth will continue to be supported by very stimulatory monetary in most parts of the world. Core rates are below many central banks’ targets. The Federal Open Market Committee is not expected to start increasing the US policy rate until the second half of 2015.....

The available data suggest that the domestic economy continued to grow at a below- pace in the March quarter. Dwelling investment and resource exports appear to have continued growing strongly and there is evidence that the growth of household has been gaining some momentum over the past six months or so. However, investment in the sector is declining noticeably and non-mining business investment remains subdued. .....

Conditions in the established market remain strong, especially in Sydney and to a lesser extent in Melbourne. Outside these cities, however, housing price growth has declined. Forward-looking indicators, including building , suggest that dwelling investment overall will continue to grow strongly over coming quarters.....very low interest and increasing housing prices helped to support a pick-up in the growth of consumption over 2014. More recent retail sales data suggest that consumption growth maintained its pace into the early months of 2015. Measures of consumer remain a little below average.

Export volumes continue to increase, aided in the March quarter by the absence of substantial -related disruptions to mining and sg operations across the country. Re export volumes are expected to continue growing as new production capacity for iron ore and liquefied gas comes on line over 2015. However, the decline in commodity prices in recent quarters has put pressure on higher-cost in the iron and coal sectors. While the substantial declines recorded in mining investment have been much as expected, producers have responded to lower commodity prices with further -cutting. Some smaller, higher-cost producers of iron ore and coal in Australia have announced the curtailment of production, although the affected mines accounted for only a relatively small share of Australian production in 2014.

Non-mining business has remained subdued even though many of the conditions for a recovery have been in place for some time. Access to funding does not appear to be constraining business decisions; l rates on the outstanding stock of business (and housing) loans have continued to edge lower and business growth has been picking up. Also, surveys suggest that business conditions in the non-mining sector are close to average. However, forward-looking measures of business c remain a bit below average and non-residential building approvals are relatively subdued. Business liaison suggests that firms have spare and are still waiting to see a more substantial improvement in d conditions before they commit to major new investment projects. ...

There continues to be excess in the labour market, though the most recent labour data suggest that growth has increased over the past six months or more, to be above the rate of population growth. The p rate has picked up slightly, and the rate has been stable at about 6¼ per cent since mid 2014. Forward-looking indicators of demand, which had picked up somewhat over the past year, have been little changed over recent months and point to modest growth of employment over coming months.

Consumer price declined over the past year, reflecting substantial falls in f prices and the repeal of the price, although the recent rebound in fuel prices should add to inflation somewhat in the near term. Measures of inflation remained around ½–¾ per cent in the March quarter and 2¼–2½ per cent over the past year. Domestic cost pressures are generally well contained, partly because of the extended period of low growth of w, with the result that non-tradables inflation was about 1 percentage point below its decade average over the year to March. Consumer prices related to housing increased by marginally more than their historical average, driven by inflation in new dwelling costs, which in turn reflects the strength of dwelling . T inflation (excluding volatile items and tobacco) has picked up in response to the depreciation of the Australian dollar over the past two years or so.

Growth in the Australian is expected to continue at a below-average pace for a little longer than earlier anticipated and to pick up gradually to an above-average pace over 2016/17. The key forces shaping the outlook are much as they have been for some time. Recent data suggest that consumption growth has continued to pick up gradually, supported by very low rates and relatively strong population . Forward-looking indicators continue to suggest that dwelling will continue to grow strongly in the near term. The momentum building in household demand will, in time, provide some impetus to non-mining business investment, even though indicators of investment intentions suggest that non-mining business investment is not likely to pick up over coming quarters, as had been expected at the time of the February Statement. Export growth is also expected to continue making a substantial contribution to growth. Mining investment, consolidation and the falling of are expected to impart an offsetting restraint on growth over the next couple of years at least.

The profile for GDP growth implies that there will be excess capacity in the labour for longer than previously thought. The rate is expected to rise gradually and peak a little later than envisaged in the February Statement, before gradually declining towards the end of the forecast period. W growth is not expected to increase much from its current low levels over the next two years or so. As a result, domestic labour cost pressures are likely to remain well contained and underlying is expected to be consistent with the inflation target throughout the forecast period.

.....Developments in China and their impact on commodity prices are also likely to affect the outlook for the [Australian] rate, which is another important consideration for the forecasts for the domestic economy. Further of the exchange rate seems both likely and necessary, particularly given the significant declines in key commodity prices, although increasingly divergent monetary policies in the major economies are also likely to have an important bearing on exchange rate developments.

Domestically, the forecasts embody a further gradual pick-up in consumption growth and decline in the s ratio. However, if households respond to changes in rates and asset prices to the same degree as they did prior to the global crisis, this would support higher c growth and imply a lower saving ratio than embodied in the forecasts. Alternatively, if households are less inclined to bring forward their consumption than has been factored into the forecasts, perhaps because they do not wish to increase their le, consumption growth would be weaker and the saving ratio higher than forecast.

Business investment remains a significant source of uncertainty. investment is expected to fall significantly, but the size of the fall and the impact of lower-than-expected prices remain uncertain. There are also significant risks to the forecasts for non-mining investment. While the latest capital expenditure survey implies a weaker profile for non-mining business over the next year than currently forecast, the first estimate of investment intentions for 2015/16 is subject to considerable uncertainty and the survey covers only about half of actual non-mining business investment. Moreover, many of the preconditions for a recovery in non-mining business investment are in place, so it is possible that the recovery could begin earlier or be stronger than currently forecast.

The adjustment to the decline in the terms of and investment over recent years has resulted in a rise in the rate and a pronounced decline in growth in the economy. The unemployment rate is expected to rise a little further from here, before it begins to decline. .....

The Reserve Bank Board reduced the rate by 25 points at its February meeting. At its March and April meetings, the Board kept the cash rate steady, but indicated that further easing may be appropriate. Over that period, incoming data have generally provided more confidence that growth in household expenditure is gaining some momentum, consistent with the forecasts presented in the February Statement. However, other information, including the forward-looking indicators of investment, suggested that overall growth will remain trend for longer than had previously been expected. Accordingly, the economy is likely to be operating with a degree of s c for some time yet and domestic cost pressures are expected to remain subdued and well contained.

The Board noted that although financial conditions are very a, the rate continues to offer less assistance than would normally be expected in achieving bd growth in the economy. It also noted that while housing price growth is very strong in Sydney, it has declined across much of the rest of the country, and there has been little change to the growth of housing credit in recent months. The Bank is working with other regulators to assess and contain risks that may arise from the housing market.

At its May meeting the Board judged that, under these circumstances, it was appropriate to reduce the cash rate by a further 25 basis points to provide some additional support to economic . This could be expected to reinforce recent encouraging trends in household demand and is consistent with achieving the inflation .

The Board will continue to assess the outlook and adjust policy as needed to foster sustainable growth in demand and inflation outcomes consistent with the inflation target over time.

Questions/tasks
1. Explain why commodity prices have fallen over the past year. Use a D/S to illustrate your response.
2. Provide a possible explanation for the rise in the AUD despite the continuing fall in the terms of trade.
3. Explain how a weaker Chinese property market can impact negative on Australian net export values.
4. Explain how a Federal Reserve decision to delay its long awaited tightening of monetary policy can impact on Australia’s exchange rate.
5. Outline a possible explanation for subdued non-mining investment in Australia during the early part of 2015.
6. Describe how adverse weather events in the past may have resulted in lower resource export volumes.
7. Explain why there has been an increase in iron ore production capacity over the past year and examine the implications for net exports (or the balance on trade) in a climate of falling commodity prices.
8. Explain what is meant by excess capacity in the labour market and outline the implications for wages and inflation.
9. Explain why fuel and electricity prices fell over the past year and examine the implications for headline and underlying inflation rates.
10. Describe why a depreciation of the AUD has caused tradables inflation to increase relative to non-tradables inflation.
11. Define fiscal consolidation and outline why it is likely to restrain economic growth into the future.
12. Describe the relationship between excess capacity in the labour market and the unemployment rate.
13. Explain why further depreciation of the AUD is likely and necessary.
14. Explain why the ‘saving ratio’ is expected to fall in the period ahead and examine the implications for AD and economic growth.
15. Explain why households might be unwilling to increase their ‘leverage’ and consumption during a period of record low borrowing costs.
16. Explain why the fall in the terms of trade has resulted in:
a. a fall in mining investment
b. a rise in the unemployment rate
c. slower wages growth
17. Briefly describe why the RBA Board decided to reduce the cash rate to 2.00% in May 2015.
18. ‘The RBA is less likely to have loosened monetary policy in May 2015 if the exchange rate had fallen to approximately USD0.75’. Discuss