Tag: RBA

Limits To Low Interest Rate Policy

In a recent speech, “Low Inflation in a World of Monetary Stimulus” RBA Deputy Governor Philip Lowe highlighted the impact of low interest rates. Significantly he observes that low interest rates are not translating into buoyant consumer spending. As a result, such monetary policy will not necessarily deliver the desired economic outcomes.

One area where low interest rates do appear to be having the broadly expected effect is on asset prices: global equity markets have been strong; property prices are again recording solid gains in some countries; and bond prices have increased substantially. However, for these increases in asset prices to boost the global economy, households and businesses need to respond by increasing their spending. While in the United States there are now some signs that this is happening, on the whole the response of private spending to higher asset prices has been muted.

Overall, looking at this experience, I find it difficult to escape the conclusion that changes in interest rates are not affecting decisions about spending and saving in the way they might once have done. Undoubtedly, low interest rates are helping to repair balance sheets by lowering debt-servicing costs and by pushing up asset prices. In so doing, they are helping lay the foundations for future growth in consumption and investment. But, while this repair process is taking place, consumption is weaker than it otherwise would be. In turn, subdued consumption growth is feeding through to a more subdued business climate and weaker investment.

Arguably, a similar dynamic has been playing out in government finances in a number of countries. After the financial crisis, many governments found themselves with debt levels that were very high. Like many households, they have responded by tightening their belts. Given the high levels of debt and ongoing imbalances between recurrent revenue and expenditure, few governments have seen the very low interest rates as an opportunity to support long-term infrastructure investment at low cost. Rather, much as households have done, governments have taken advantage of the lower debt-servicing costs to help shore up their finances.

He concludes that low interest rate monetary policies are unlikely to succeed.

Finally, stepping back from the short term, the low interest rates we are seeing globally and in Australia are a direct consequence of an elevated appetite for saving and a muted appetite for real investment in many economies. Monetary policy globally has responded to this reality in a way that a decade or so ago would have hardly seemed imaginable. In doing so it has helped the global economy through a very difficult period. But, at the end of the day, the solution to the problems caused by the disconnect between the desire to save and the desire to invest cannot lie with monetary policy. Instead, it lies in measures to improve the investment environment so that once again there is strong productive demand for the use of our societies’ savings.

Review of Card Payments In Australia

The RBA has issued a paper outlining the proposed scope of a review of card payments in Australia. Given the evolution of payments, the rise of new payment platforms, weaknesses in the current interchange arrangements, payment surcharging and changed economics in the payments value chain, this is timely. Submission on aspect of the Bank’s card payments reforms, should be provided by no later than 24 April 2015.

The RBA outlines a number of factors which indicate a review is needed:

  • Aspects of the interchange fee system and merchant surcharging practices have raised concerns, some of which were noted in the Board’s 2013 Annual Report and the Bank’s two submissions to the Financial System Inquiry (FSI).

  • There have been some significant changes to the regulation of card payments in other jurisdictions.

  • The completion in 2014 of the Bank’s third Consumer Use Survey and second Payment Costs Study have provided a useful evidence base for considering possible changes to policy.

  • The continuing growth in the role of cards in the payments system since the initial reforms underscores the need for an appropriate regulatory framework for such payments.

  • Interchange arrangements in the card systems will also affect the nature of new payment arrangements that are adopted by the payments industry. In particular, a more efficient and lower-cost new payment system might be hampered in its development to the extent that it had to match existing interchange payments to card issuing institutions to ensure the participation of banks in the new system.

  • The FSI has made recommendations directed at the Bank and its regulation of card payments, with particular focus on interchange fee regulation and surcharging.

The Payments System Board would be interested in hearing the views of stakeholders about the issues raised in the previous chapter and possible changes to the regulatory framework that might address those issues.

Some of the possible changes to the regulatory framework are along the lines of those suggested in the Final Report of the Financial System Inquiry (FSI). The Final Report endorsed the broad nature of the Bank’s reforms over the past decade or more. In particular, the Report stated that ‘the Inquiry believes interchange fee caps improve the efficiency of the payments system. Without interchange fee caps, price signals for customers are less clear and outcomes are less efficient because customers can be encouraged to use higher-cost payment methods’ (FSI 2014b, p 171). In addition, the Final Report stated that ‘the Inquiry agrees with the RBA that surcharging can improve the efficiency of the payments system by providing accurate price signals to customers’ (FSI 2014b, p 175).

However, the Final Report noted a few areas where the Inquiry believed the existing regulatory framework could be improved. These included lowering the existing interchange fee caps and broadening their application, and improving the accuracy of price signals in surcharging and the enforceability of mechanisms against excessive surcharging. The FSI Final Report took a holistic view of the card systems, just as the Bank’s earlier reforms have recognised the interlinkages between different aspects of the operations of the card systems. One example is that the Report’s recommendations on surcharging were linked to its recommendations on interchange fees. In particular, the surcharging recommendations reflect the idea that if it was possible to promote the availability of low-cost methods of payment for consumers and merchants, the case for merchants retaining the right to surcharge for those low-cost methods of payment would be reduced.

Specific Issues for Consultation

The Board is interested in the views of stakeholders on the following issues.

With respect to the regulation of interchange fees, the Board is interested in views on the following options:

  • Publishing thresholds for which payment system providers will be subject to interchange or related regulation, possibly based on transaction values and/or market shares. The FSI Final Report suggests that that this would give new entrants and existing providers greater certainty about how regulation will be applied and would enhance competitive neutrality between providers. Such thresholds could potentially apply to providers such as American Express, as well as other international schemes such as UnionPay, if they entered the domestic market. Thresholds might also be applied for surcharging regulation and could potentially apply to providers such as PayPal.
  • Broadening interchange fee caps to include other payments between schemes and issuers. There are a range of payments (such as marketing fees, sign-on fees, incentive fees and rebates) from schemes to issuers that are used in both three- and four-party schemes. These other payments can potentially be used to circumvent interchange caps: for example, a four-party scheme can increase fees charged to acquirers and use these funds to pay rebates to issuers, mimicking an interchange payment. Similarly, rebates or incentives paid by a network to an issuer in a companion card arrangement can achieve similar outcomes to an interchange fee. The FSI Final Report suggests that broadening the current interchange fee caps to apply on a broader functional basis would help prevent circumvention of interchange caps and enhance competitive neutrality in the case of companion card arrangements. Regulation of other incentive payments has already been implemented for debit cards in the United States, and is proposed for both debit and credit card schemes in the new EU payments regulation.
  • Making changes to the interchange benchmark system to reduce the upward ‘drift’ in average interchange rates inherent in the current three-year reset cycle. One option would be to shift to more frequent benchmark observance, such as annually or even quarterly. This would ensure that average interchange rates were much closer to the benchmark, though this might not have much effect on the tendency for the gap between the highest and lowest interchange rates to widen.
  • Lowering interchange caps. The FSI Final Report suggests that payments system efficiency could be enhanced by lowering interchange fee caps, with the benefits including lower product prices for all consumers as a result of lower merchant service fees, and less cross-subsidisation in the payments system.
  • Replacing weighted-average interchange caps with hard caps. The FSI Final Report notes that weighted-average caps allow schemes to set interchange schedules which imply relatively high payments costs for smaller merchants without market power and low costs for larger merchants. In addition, the widening in the range of interchange fees raises questions about the transparency of costs for many merchants. Furthermore, the current system of observance of the caps has meant that weighted-average interchange fees in the MasterCard and Visa systems have typically been above the caps. In the new European Union (EU) payments regulation previous settlements reached with MasterCard and Visa, constraining interchange fees for cross-border consumer credit card transactions to 30 basis points per transaction or a maximum weighted-average cap of 30 basis points respectively, will be replaced by a hard cap of 30 basis points on all credit card transactions.
  • Applying caps as the lesser of a fixed amount and a fixed percentage of transaction values. The FSI Final Report suggests that applying a fixed percentage cap for debit cards, in addition to a fixed-value cap, would ensure low interchange payments on low-value transactions which would promote merchant acceptance. The use of a dual percentage/value cap has also been proposed in the new EU payments regulation, where debit card interchange could be capped at the lower of 20 basis points or a fixed-value cap which member states may set at their own discretion. In the case of credit cards, the FSI Report notes that the introduction of a fixed-value cap would be a significant change and that a transition period might be warranted if it were adopted.
  • Including prepaid cards within the caps for debit cards. As noted above, there is a degree of ambiguity in how prepaid cards are dealt with under the interchange benchmarks. Accordingly, it would be helpful to clarify this in a review.
  • Allowing for ‘buying groups’ for smaller merchants to group together (subject to any competition law restrictions) to negotiate to receive the lower interchange rates that are accessible to larger merchants. This option might be considered in the event a future interchange system continued to generate large differences in the interchange rates faced by different types of merchants. A similar measure was part of a settlement between US merchants and MasterCard and Visa in 2012, although that agreement only requires that card companies meet with merchant buying groups, and not that card schemes must offer similar rates to merchant groups that bring similar transaction volumes.

With respect to surcharging, the Board is interested in views on the following options:

  • A tiered surcharging system, perhaps along the lines of the FSI recommendations. The FSI Final Report suggests that a three-tier approach would be likely to reduce cases of excessive surcharging by providing merchants with clearer surcharging limits that will reduce problems with enforcement in the current system. Alternatively, other variants of a tiered system might be appropriate. The FSI Final Report proposal would include:
    – Allowing low-cost system providers to prevent merchants from surcharging, to encourage consumers to use low-cost payment methods. The Final Report suggests that systems would qualify as low-cost if their interchange fees were below the caps for debit systems (or if three-party systems were equivalently low-cost in terms of merchant service fees). Given the widespread holding of debit cards, this would imply that essentially all consumers would be able to make card payments (presumably including in the online environment) without being surcharged.
    – Allowing medium-cost providers to limit surcharges to limits set by the Board. The Final Report suggests that schemes would qualify as medium-cost if their interchange fees were below credit card interchange fee caps (and three-party systems could qualify if their merchant service fees were equivalent to those of other medium-cost providers). The limit set by the Board might be based on average card acceptance costs. Such limits would be published, which would ensure that it was immediately observable to card schemes, consumers and others if a merchant was surcharging excessively – this would enhance the enforceability of such limits.
    – Allowing high-cost providers to limit surcharges to the reasonable cost of acceptance. Such providers would also be required to disclose that they were high-cost providers so that their customers would understand why they were likely to be surcharged. The reasonable cost of card acceptance would be based on the costs of the particular merchant, meaning that there would remain scope for dispute over whether a merchant was surcharging excessively.
  •  Targeted changes to reduce particular cases of excessive surcharging. The two industries where concerns about surcharging are most vocal are the taxi and airline industries. Surcharging in the taxi industry is becoming the focus of most state taxi regulators. In the case of the airlines, the current fixed-dollar surcharges would appear to be well above the reasonable cost of card acceptance for low-value fares, given that the costs associated with credit cards are typically mostly ad valorem or percentage-based. Accordingly, a simple measure might be to modify the Bank’s surcharging Standard or Guidance Note to allow schemes to cap any surcharges that are not percentage-based at some low fixed-dollar amount. This could result in a significant reduction in surcharges payable on lower-value fares. It is possible that a change such as this, which would be largely independent of potential other changes to the regulatory framework, could be made relatively quickly.
  • Any other changes to enforcement procedures and disclosure practices. Where merchants wish to surcharge for particular high-cost payment instruments it is important that any charge should be properly disclosed up front and that there is at least one non-surcharged method of payment that is generally available to consumers. The Board is interested in stakeholder views regarding the extent to which these requirements are met by merchants and also in more general views as to mechanisms by which excessive surcharging or incomplete disclosure of surcharges might be addressed.

The Board is also interested in views on some other possible regulatory changes that could improve the way that market forces operate in the cards system:

  • Strengthened transparency over the cost of payments to merchants and cardholders. To the extent that there continued to be large differences in interchange rates on cards from a particular system, it would seem important for merchants to know the cost of accepting a card at the time of the transaction, so they can make informed decisions regarding acceptance or surcharging. Greater transparency would also be important for consumers to enhance their understanding of whether they are using a low-cost card or a high-cost card that may be surcharged. Measures to improve transparency could include:
    – Ensuring that debit and credit cards are more readily identifiable by merchants electronically.
    – Requiring, as in the new EU payments regulation, that categories of cards with different interchange fees should be identifiable both visually and electronically, so that consumers and merchants are aware when a high-cost card is being used.
    – Requiring, as in the EU payments regulation, that acquirers must offer merchants pricing and billing that separately shows the interchange fee and merchant service charges that apply to each brand and category of cards. While many Australian merchants are now subject to ‘interchange-plus’ pricing for each scheme, others are still subject to blended rates, including between debit and credit, and some merchant statements do not promote a good understanding of card costs borne by merchants.
  • Further easing of ‘honour-all-cards’ rules to allow merchants to decline to accept cards with high interchange fees. The current restrictions on honour-all-cards rules allow merchants to make separate acceptance decisions on debit versus credit, but could be extended to allow merchants the freedom to decline high-cost cards within a particular scheme.
  • Facilitation of differential surcharging by merchants. To the extent that the acquiring market was not providing the ability for merchants to surcharge differentially based on the nature of the card, it might be desirable to explore measures that would require card schemes and acquirers to provide merchants with such ability to differentiate. This might be supplemented, as in the EU proposal, with controls on scheme rules or contractual terms that prevent merchants from informing consumers about the cost of interchange fees or merchant service charges: this would mean that Australian merchants could not be prevented from informing customers of their cost of card acceptance if they wished to justify their surcharging policies.
  • Ensuring that merchants have the ability to choose to route their transactions via lower-cost networks or processors. This might involve requiring, as is the case for debit cards in the United States, that acquirers must route transactions through the network which the merchant has nominated as their preferred option among those networks available on a card. This could provide some offset to the tendency for competition between schemes to drive interchange fees higher. A stronger option, as will be required in the EU payments regulation currently being considered, would be that the scheme activities and processing infrastructure of card networks are legally separated, so as to facilitate competition in the market for processing transactions.
  • Clarifying arrangements for competing payment options within a single device or application. One option might be along the lines of the proposed EU payments regulation concerning ‘cobadging’ and choice of payment application. Regulatory measures might include restrictions on scheme rules that prevent the inclusion of other payment brands or payment applications on a device (e.g. mobile phone) or that may prevent different payment options being included within a payment application. The proposed EU payments regulation also requires that security standards or technical specifications, and arrangements for routing transactions, should be applied in a non-discriminatory manner when handling two or more different payment brands or applications on a single device. Similarly, providers of payment services might be required to allow merchants or cardholders the option of specifying their own preferences regarding the priority of different networks or payment methods, both on co-badged devices and in mobile wallet applications.

Finally, the Board is also interested in stakeholder views on the appropriate regulatory arrangements for prepaid cards.

General Issues for Consultation

The Board expects that stakeholders may wish to raise other issues concerning card payments and their role in the broader retail payments system. Accordingly, it encourages stakeholders to suggest any additional measures that the Bank should consider in a review of the regulatory framework. The Board will also take account of any relevant responses to the Government’s current consultation on the recommendations in the Final Report of the Financial System Inquiry.

The Board recognises that some of the possible regulatory changes discussed above (e.g. changes to the interchange fee caps) could imply significant changes to business models in the cards industry while other possible changes (e.g. to improve the transparency of costs to merchants) could imply significant systems changes by schemes and acquirers. It will be mindful of these issues as the Review proceeds. However, the Board notes its concerns about the existing cards model which results in most merchants facing significant variability in the cost of card transactions within the four-party schemes, while having no visibility over these costs at the time of the transaction. Similarly, merchants have limited or no ability to respond to these differences by charging differentially or declining to accept high-cost cards. Accordingly, the Board encourages stakeholders to suggest measures that could address its concerns in ways that would minimise adjustment costs for the payments industry.

During the 2007–08 Review, the Board and the Bank spent a considerable amount of time exploring a non-regulatory approach whereby voluntary undertakings from schemes in relation to interchange fees could serve in place of formal regulation. As noted above, ultimately industry participants were unable to arrive at arrangements that the Board considered were in the public interest. International experience also suggests that non-regulatory solutions have been difficult to achieve. Furthermore, the option of removing interchange fee caps was touched on in the Interim Report of the FSI (FSI 2014a, p 2-31) but not endorsed by the Final Report (FSI 2014b). The Board sees challenges in a nonregulatory approach, but would nonetheless be interested in stakeholder views on approaches that could result in a sustainable framework that met the Board’s concerns and were in the interests of competition and efficiency in the Australian payments system.

Finally, while it is important that any changes to the regulatory system should occur in a way that recognises all the interdependencies, the Board is interested in views about whether there are particular targeted changes, for example to the surcharging framework, that could usefully occur ahead of any more general package of reforms.

RBA – No Rate Change Today

At its meeting today, the Board decided to leave the cash rate unchanged at 2.25 per cent.

Growth in the global economy continued at a moderate pace in 2014. A similar performance is expected by most observers in 2015, with the US economy continuing to strengthen, even as China’s growth slows a little from last year’s outcome.

Commodity prices have declined over the past year, in some cases sharply. The price of oil in particular has fallen significantly. These trends appear to reflect a combination of lower growth in demand and, more importantly, significant increases in supply. The much lower levels of energy prices will act to strengthen global output and temporarily to lower CPI inflation rates.

Financial conditions are very accommodative globally, with long-term borrowing rates for several major sovereigns at all-time lows over recent months. Some risk spreads have widened a little but overall financing costs for creditworthy borrowers remain remarkably low.

In Australia the available information suggests that growth is continuing at a below-trend pace, with domestic demand growth overall quite weak. As a result, the unemployment rate has gradually moved higher over the past year. The economy is likely to be operating with a degree of spare capacity for some time yet. With growth in labour costs subdued, it appears likely that inflation will remain consistent with the target over the next one to two years, even with a lower exchange rate.

Credit is recording moderate growth overall, with stronger growth in lending to investors in housing assets. Dwelling prices continue to rise strongly in Sydney, though trends have been more varied in a number of other cities over recent months. The Bank is working with other regulators to assess and contain risks that may arise from the housing market. In other asset markets, prices for equities and commercial property have risen, in part as a result of declining long-term interest rates.

The Australian dollar has declined noticeably against a rising US dollar, though less so against a basket of currencies. It remains above most estimates of its fundamental value, particularly given the significant declines in key commodity prices. A lower exchange rate is likely to be needed to achieve balanced growth in the economy.

At today’s meeting the Board judged that, having eased monetary policy at the previous meeting, it was appropriate to hold interest rates steady for the time being. Further easing of policy may be appropriate over the period ahead, in order to foster sustainable growth in demand and inflation consistent with the target. The Board will further assess the case for such action at forthcoming meetings.

Home Lending Up To $1.43 Trillion

Latest data from the RBA shows that home lending is worth $1.43 trillion, to end January. In the month, lending rose $8.5 billion, or 0.6%. However, investment home lending grew at 0.8%, whilst owner occupied lending grew at 0.49%. Investment lending was at a record 34.3% of total housing.

HousingAggregatesJan2015More broadly, total lending was up 0.6% from last month, and 6.2% year on year. The share of lending to business continued to fall as a share of total lending, now down to one third of all funds borrowed. This needs to be lifted if sustainable growth is to be delivered. Banks are biased toward ever more home lending, thanks to lower losses and advantaged capital requirements.

CreditAggregatesJan2015

Groupthink Stems From The Council of Financial Regulators

Behind the scenes, it is the mysterious Council of Financial Regulators which is coordinating activity across the Reserve Bank, APRA, AISC and Treasury. This body, is the conductor of the regulatory orchestra, and although formed initially in 1998, it has only had an independent website since 2013.  It is the coordinating body for Australia’s main financial regulatory agencies. It is a non-statutory body whose role is to contribute to the efficiency and effectiveness of financial regulation and to promote stability of the Australian financial system. The Reserve Bank of Australia (RBA) chairs the Council and members include the Australian Prudential Regulation Authority (APRA), the Australian Securities and Investments Commission (ASIC), and The Treasury. The Council of Financial Regulators (CFR) comprises two representatives – the chief executive and a senior representative – from each of these four member agencies.

The CFR meets in person quarterly or more often if circumstances require it. The meetings are chaired by the RBA Governor, with secretariat support provided by the RBA. In the CFR, members share information, discuss regulatory issues and, if the need arises, coordinate responses to potential threats to financial stability. The CFR also advises Government on the adequacy of Australia’s financial regulatory arrangements. A formal charter was only adopted on 13 January 2014.

The Council of Financial Regulators (CFR) aims to facilitate cooperation and collaboration between the Reserve Bank of Australia, the Australian Prudential Regulation Authority (APRA), the Australian Securities and Investments Commission and The Treasury. Its ultimate objectives are to contribute to the efficiency and effectiveness of regulation and to promote stability of the Australian financial system.

The CFR provides a forum for:

  • identifying important issues and trends in the financial system, including those that may impinge upon overall financial stability;
  • ensuring the existence of appropriate coordination arrangements for responding to actual or potential instances of financial instability, and helping to resolve any issues where members’ responsibilities overlap; and
  • harmonising regulatory and reporting requirements, paying close attention to the need to keep regulatory costs to a minimum.

So, given the intended independence of the RBA, from Government, there is an important question to consider. How can this be seen to be true? More likely, we think there is significant potential for groupthink. In addition, no minutes of discussions are made public. We think its time for greater transparency and openness.

“Sunlight is said to be the best of disinfectants; electric light the most efficient policeman” said U.S. Supreme Court Justice Louis Brandeis. We agree.

RBA Outsources Macroprudential to APRA

In the Monetary Policy Meeting of the Reserve Bank Board minutes, released today, there is significant emphasis on the role of APRA to regulate the housing market. The economic data suggested continued easing in momentum, and the rate reduction was line ball, between cutting straight away or leaving it a month. Nothing about future intentions.

Financial Markets

Members commenced their discussion of financial markets with the observation that central bank policy actions, along with developments in Greece, had been the main focus of markets over the past two months.

Members were briefed about the announcement by the European Central Bank (ECB) of a large sovereign bond purchase program in January, following its assessment that its existing measures would not be sufficient to prevent inflation from remaining well below 2 per cent for a prolonged period. Starting in March, the ECB plans to purchase €60 billion of securities each month, well above the current rate of purchases of private securities; sovereign bonds would be bought in proportion to member countries’ contributions to the ECB’s capital. Debt purchases would continue until there was a sustained increase in inflation, but they would end no earlier than September 2016. This would increase the size of the ECB’s balance sheet past its 2012 peak of €3.1 trillion. While less than the US Federal Reserve’s maximum purchases of US$85 billion a month, on an annualised basis the ECB’s purchases would be equivalent to around 7½ per cent of the euro area’s annual GDP, compared with 6 per cent of US GDP for purchases by the Federal Reserve (and 16 per cent of Japanese GDP for purchases by the Bank of Japan).

Members noted that the Federal Reserve continued to indicate that it expected to start increasing its policy rate around the middle of this year, but financial markets had pushed back expectations for the first rate rise in the United States to around the end of the year. A number of central banks had eased policy in recent months in response to the effect of lower oil prices, including the Reserve Bank of India and the Bank of Canada. Markets had also pushed back expectations for policy tightening by a number of other central banks. In contrast, the central banks of Russia and Brazil had increased their policy rates.

The Swiss National Bank (SNB) abandoned its exchange rate ceiling against the euro, which had been in place since September 2011, and lowered the rate on bank deposits at the SNB by 50 basis points to −0.75 per cent. The SNB’s announcement noted that divergences between the monetary policies of the major currency areas had increased significantly. The move surprised markets, resulting in considerable market volatility and the bankruptcy of several foreign exchange brokers.

Members noted that sovereign bond yields in the major markets had fallen significantly since the December meeting. The falls had occurred across the yield curve but were particularly pronounced at longer maturities, with yields on 10-year bonds in the United States falling back to around 1.6 per cent and those in Germany and Japan reaching historic lows of 30 and 20 basis points, respectively. At these levels there was very little, if any, compensation for term risk. For maturities up to five years, yields on bonds issued by Japan, Germany and most of the core euro area economies, as well as Sweden and Switzerland, had fallen below zero. Yields on Australian government bonds had mostly tracked global developments and had also fallen considerably, with the 10-year yield declining to a historical low below 2½ per cent.

The declines in global bond yields reflected a number of factors but the extent of the decline in yields was difficult to explain. The large bond purchases by major central banks had clearly contributed but so too had a reduction in bond supply, reflecting a narrowing of fiscal deficits in a number of countries. Concerns about the global growth outlook and the risk of sustained low inflation following falls in the oil price had also played a role.

Members noted that the Greek authorities had indicated that they planned to restructure the country’s debt, most of which was owed to official sector institutions. Greece had nonetheless also indicated a desire to remain part of the euro area. The current European assistance program expired at the end of February and markets had been closed to Greece since the recent election. Members also noted that the critical issue in the near term was not so much the obligations of the Greek Government but rather the funding of Greek banks. To date, there had been minimal spillover from developments in Greece to other markets.

There had been sizeable movements in exchange rates since the December meeting, reflecting the increasingly divergent paths of monetary policy among the major advanced economies. Most notably, the Swiss franc had appreciated by around 15 per cent against the euro since mid January. While the US dollar had depreciated against the Swiss franc, it had also appreciated further against most other currencies since the December meeting (including by around 10 per cent against the euro). The renminbi had been little changed against the US dollar over much of 2014, but had depreciated somewhat since the December meeting.

The Australian dollar had depreciated by around 9 per cent against the US dollar since the December meeting. On a trade-weighted basis, the Australian dollar was around 4 per cent below its early 2014 levels, notwithstanding significant falls in commodity prices over the intervening period. The depreciation of the Australian dollar against the US dollar and renminbi had been partly offset by its appreciation against the yen and euro.

Equity prices in advanced economies had been broadly unchanged since early December, notwithstanding a strong rally in European share prices following the announcement of the expansion of the ECB asset purchase program. Global equity prices had risen moderately over 2014, led by an 11 per cent increase in US equity prices, while Chinese equities had significantly outperformed other emerging markets since mid 2014.

In Australia, equity prices recorded a smaller rise over 2014 than that recorded in most global markets, primarily reflecting the decline in equity prices of resource companies. Equity prices had increased by 4 per cent since the start of 2015 even though prices of resource companies had fallen further.

Members noted that Australian lending rates on the outstanding stock of housing and business loans had continued to edge down since the December meeting. At the time of the December meeting, financial market pricing had suggested some chance of an easing in policy during 2015. This expectation strengthened somewhat during January, and by the time of the February meeting pricing reflected a two-thirds probability of a 25 basis point reduction in the cash rate at that meeting, with the cash rate expected to be 2 per cent by the end of the year.

International Economic Conditions

Members noted that growth of Australia’s major trading partners had been around its long-run average in 2014 and that early indications suggested this pace had continued into 2015. Prices of a range of commodities, notably oil and iron ore, had fallen further in recent months, reflecting a combination of both lower growth in global demand for commodities and, more importantly, significant increases in supply. Members also noted that the lower oil prices, if sustained, would be positive for the growth of Australia’s trading partners, which are net importers of energy, and would continue to put downward pressure on global prices of goods and services. Very accommodative global financial conditions were also expected to support global growth in 2015. These positive effects on trading partner growth, however, were expected to be largely offset in 2015 by a gradual decline in the pace of growth in China.

In China, economic growth had eased a little but was close to the authorities’ target for 2014. Growth of household consumption had held up over 2014, while growth of investment and industrial production – which contribute significantly to the demand for commodities – had trended lower over the past year or so. Conditions in the residential property market had remained weak, and measures introduced to support the market appear to have had only a modest effect so far.

In Japan, economic activity had been weaker than expected since the increase in the consumption tax in April 2014, but growth appeared to have resumed in the December quarter and the labour market remained tight. However, inflation had declined in recent months and remained well below the Bank of Japan’s target. The pace of growth had slowed a little in the rest of east Asia over 2014; as the region as a whole is a net importer of oil, activity was likely to have been supported by the decline in oil prices.

Members observed that the US economy had continued to strengthen, resulting in output growing at an above-trend pace over the second half of 2014. Employment growth had picked up further and the unemployment rate had continued to decline. Ongoing strength in the labour market and lower gasoline prices had contributed to a sharp rise in consumer sentiment. On the other hand, growth in the euro area remained modest. Inflation had remained well below the ECB’s target and inflation expectations had declined further, prompting the ECB to implement additional stimulus measures.

Domestic Economic Conditions

Members noted that the data released since the December meeting suggested that the domestic economy had continued to grow at a below-trend pace over the second half of 2014. Resource exports appeared to have continued growing in the December quarter and growth was expected to remain strong, particularly as liquefied natural gas (LNG) production came on line over the next year or so. The lower exchange rate was expected to support growth of exports, particularly service exports such as education and tourism.

Activity and prices in the housing market had continued to be bolstered by the low level of lending rates and strong population growth. A range of indicators, including residential building approvals, suggested further growth of dwelling investment in the near term. Housing price inflation had moderated from the rapid rates seen in late 2013, but remained high and in Sydney and Melbourne had been well above the growth rate of household income. Growth of owner-occupier housing credit had remained around 6 per cent in year-ended terms, while investor credit had continued to grow at a noticeably faster rate.

Members were briefed on the main regulatory actions taken recently to address housing risks in the domestic economy. In particular, the Australian Prudential Regulation Authority (APRA) had announced several policy measures in early December to reinforce sound residential mortgage lending practices. These policies included clarification of prudential expectations on what constituted acceptable growth in housing lending to investors and the possible steps that would be considered if APRA’s expectations were not met, such as increased capital requirements.

Turning to the business sector, members noted that mining investment had continued to decline in the second half of 2014, and larger declines were expected over 2015 as existing projects were completed and very few new projects were likely to proceed. Non-mining business investment had remained subdued and recent data pointed to this continuing into the first half of 2015. Growth in public demand was expected to be subdued over the next year or so.

Members observed that household consumption growth had picked up since its lows in early 2013, supported by low interest rates and rising housing wealth. However, consumption growth had remained below average. The recent decline in fuel prices was expected to provide some offset for overall household incomes from weak growth in labour incomes.

Members noted that the most recent data on the labour market had been a little more positive than early in 2014. However, while employment growth had strengthened somewhat over the past year, the unemployment rate had increased further over 2014 and average hours worked had remained below the levels of a few years ago. Leading indicators of labour demand had changed little in recent months and pointed to only modest employment growth in the months ahead.

Consumer price inflation had declined in year-ended terms, partly as a result of a large fall in fuel prices in the December quarter and the effect of the repeal of the carbon price on utility prices in the September quarter. Various measures of underlying inflation, which largely abstract from these and other temporary factors, had declined in year-ended terms to around 2¼ per cent. Non-tradables inflation (excluding utility prices) had declined further in year-ended terms to relatively low levels, consistent with subdued domestic cost pressures. Prices of tradable items (excluding volatile items and tobacco) were little changed in the December quarter, but were expected to face upward pressure over time from the pass-through of the depreciation of the Australian dollar since early 2013.

Turning their discussion to the economic outlook, members noted that staff forecasts for output, which were conditioned on an assumption of no change in the cash rate, had been revised lower in the near term. Recent data indicated that the expected pick-up in consumption and non-mining business investment was likely to occur later than had been previously anticipated, while the pick-up in LNG exports over coming quarters was now likely to be less rapid. At the same time, it was anticipated that the net effect of commodity price changes and the exchange rate depreciation over the past three months would provide a positive impetus to domestic growth over the next year or so. Overall, the underlying forces driving growth remained much as they had been for some time and GDP growth was still expected to pick up gradually to an above-trend pace in the latter part of the forecast period.

The revisions to GDP growth implied that the unemployment rate would peak at a higher rate and later than had been previously forecast, before declining gradually. The inflation forecast had also been revised lower, reflecting the softer outlook for labour and product markets as well as the recent fall in oil prices. Headline inflation was expected to remain low for a time, before picking up at the end of the forecast period. Underlying inflation was expected to remain well contained and consistent with the target throughout the forecast period.

Members discussed a number of uncertainties around the forecasts. They noted that developments in commodity markets, particularly the price of oil, would affect future global growth and inflation outcomes. One area of uncertainty continued to be the outlook for the Chinese property market and its implications for Chinese demand for commodities. Members also noted that developments in commodity markets were likely to be affected by supply factors; for instance, the response of ‘unconventional’ oil producers in North America to lower oil prices.

As usual, the path of the exchange rate remained a key area of uncertainty. Members noted that the exchange rate had remained above most estimates of its fundamental value, given the decline in commodity prices over the past year, and that future exchange rate movements would be affected by market expectations for monetary policy, both domestically and abroad. They noted that, all else being equal, a sustained further depreciation would, if it occurred, stimulate growth in the domestic economy and put some temporary upward pressure on inflation.

Members noted that there was considerable uncertainty around the timing and extent of the expected increase in household consumption growth and non-mining business investment. Although fundamental factors such as low interest rates and strong population growth remained in place, they had not been sufficient to see a significant pick-up in the growth of these variables or a decline in the degree of spare capacity in the labour market. In addition, recent data suggested that the expected improvement in economic conditions would occur later than had been previously expected. Members commented that a strengthening in non-mining investment was a necessary element for growth to pick up to an above-trend pace, and noted the importance of confidence in underpinning such an outcome. Indeed, an improvement in the appetite for businesses to take on risk had the potential, should it occur, to lead to much stronger growth in non-mining business investment than currently forecast.

Considerations for Monetary Policy

In assessing the appropriate stance for monetary policy in Australia, members noted that the outlook for global economic growth was little changed, with Australia’s major trading partners still forecast to grow by around the pace of recent years in 2015. Commodity prices, particularly those for iron ore and oil, had declined over the past year largely in response to expansions in global supply, though members judged that demand-side factors, such as the weakness in Chinese property markets, had also played some role. Conditions in global financial markets had remained very accommodative.

Domestically, over recent months there had been fewer indications of a near-term strengthening in growth than previous forecasts would have implied. This included survey measures of household and business confidence, which remained around or even a bit below average. As a result, the revised staff forecasts – which were based on an unchanged cash rate – suggested that GDP growth would remain below trend over the course of this year, before gradually picking up to an above-trend pace in 2016, somewhat later than had been previously expected. The unemployment rate was therefore expected to peak a little higher (and later) than in the previous forecast. The net effect of declining commodity prices and the depreciation of the exchange rate was expected to boost growth over the forecast period. Nonetheless, the higher degree of spare capacity now in prospect and lower oil prices had led to a lowering of the forecast for inflation, offset somewhat by the effects of the recent exchange rate depreciation. The restrained pace of wage increases over the past year or so and accompanying growth in productivity, which had dampened growth in unit labour costs, suggested that low rates of inflation were likely to be sustained. In other respects, the forces underpinning the outlook for domestic activity and inflation were much as they had been for some time.

Members noted the current accommodative setting of monetary policy, which had been providing support to domestic demand. They noted that the Australian dollar had depreciated noticeably against a rising US dollar over recent months, although less so against a basket of currencies, and that it remained above most estimates of its fundamental value, particularly given the significant declines in key commodity prices. Members agreed that a lower exchange rate was likely to be needed to achieve balanced growth in the economy.

Given the large increases in housing prices in some cities and ongoing strength in lending to investors in housing assets, members also agreed that developments in the housing market would bear careful monitoring. They noted that it would be important to assess the effects of the measures designed to reinforce sound residential mortgage lending practices announced by APRA in December.

On the basis of their assessment of current conditions and taking into account the revised forecasts, the Board judged that a further reduction in the cash rate would be appropriate to provide additional support to demand, while inflation outcomes were expected to remain consistent with the 2 to 3 per cent target. In deciding the timing of such a change, members assessed arguments for acting at this meeting or at the following meeting. On balance, they judged that moving at this meeting, which offered the opportunity of early additional communication in the forthcoming Statement on Monetary Policy, was the preferred course.

The Decision

The Board decided to lower the cash rate by 25 basis points to 2.25 per cent, effective 4 February 2015.

RBA Trading Economic Growth Against Sydney Property

In Glenn Stevens Opening Statement to House of Representatives Standing Committee on Economics today, we get a glimpse of the drivers to lower interest rates. In addition, they are prepared to cut rates even if it leads to more growth in the Sydney property market to drive growth, even if that lever is now less powerful than previously.

Since the hearing in August last year, the economy has continued to grow at a moderate, but below-trend pace. Inflation as measured by the CPI has been affected by movements in energy prices and government policy changes, but even aside from these effects, inflation is low and appears likely to remain so.

The international context is one in which the global economy likewise is growing, but according to most observers at a pace a little below its longer-run average. There are some notable differences in performance by region. The US economy has picked up momentum, growing above trend with a falling unemployment rate. China’s economy met its growth target in 2014. A slightly lower target seems likely to be set for 2015, perhaps something like 7 per cent. But that would still be robust growth for an economy of China’s size. On the other hand, the euro area and Japan have recorded lower growth rates than expected a year ago.

Commodity prices have fallen, in some cases quite sharply. These trends appear to reflect primarily major increases in supply, with some moderation in demand playing a role. That would appear to be the case for iron ore and oil prices (and, prospectively, liquefied natural gas prices, which are typically tied to oil prices). Base metals prices, where few significant supply changes have occurred, have fallen by much less.

So there has been what economists refer to as a ‘positive supply shock’: more of the product is available with lower prices. The effect of this on individual countries will vary, depending on whether they are a producer or a consumer of such raw materials. On the whole for the global economy, however, this is a positive development.

Inflation is quite low in a range of countries, and very low in some. The decline in energy prices is temporarily pushing headline CPI inflation rates even lower.

The very low interest rates in evidence around the world when we last met have fallen further. This has been most pronounced in Europe, where yields on long-term German sovereign debt have fallen to be about the same as those in Japan. German sovereign debt has recently traded at negative yields for terms as long as 5 years. Official deposit rates are negative in the euro area, and the European Central Bank has announced a large-scale asset purchase program – colloquially referred to as ‘quantitative easing’. The euro has depreciated. Some surrounding countries to which funds tend to flow in anticipation of further depreciation – such as Switzerland – have reduced interest rates to significantly below zero and indeed 10-year Swiss government debt has traded at a negative yield. The Swiss National Bank took the decision to remove the cap on the Swiss franc, as it assessed that the size of the intervention likely to be required to hold it was becoming just too large. This move occasioned considerable turbulence in foreign exchange markets.

Meanwhile, the US Federal Reserve, faced with a strengthening US economy and having ended its asset purchase program last year, is expected to begin a gradual process of lifting its policy rate in a few months from now. So the monetary policies of the major jurisdictions look like they will be heading in differing directions. This means there is ample potential for further turbulence in financial markets this year.

The falls in prices for key export commodities are lowering Australia’s terms of trade and hence the purchasing power of our national income. This is a well-understood mechanism and has been the subject of much discussion. It will continue to constrain income growth for households and mining companies, and revenues for both state and federal governments, over the period ahead.

Resource export shipments are increasing strongly, as the capacity put in place by the period of high investment is put to use. At the same time, the high levels of capital spending by the resources sector, which had been a strong driver of domestic demand for several years, peaked during mid 2012 and turned down. All indications are that this downswing will accelerate this year. That has always been our forecast. The recent declines in commodity prices don’t change it, though they do reinforce that this trend is well and truly under way.

The various areas of domestic demand outside mining investment are mixed. Dwelling construction is rising strongly and commencements of new dwellings will reach a new high over the coming 12 months. Consumer spending is responding both to income trends and financial incentives, which are pulling in different directions. Growth in wages, by historical standards, is quite subdued. This and the fall in the terms of trade is working to restrain growth in disposable incomes. Working the other way, the fall in petrol prices, assuming it persists, is adding noticeably to the real incomes of consumers. Increased asset values, which push up gross measures of wealth, and low interest rates are also working to push consumption up relative to income. The net effect of these opposing forces is producing moderate, though not strong, consumption growth.

Meanwhile, at this point non-mining business investment spending is still very subdued. While several key fundamentals are in place for stronger performance, clear signs of a near-term strengthening remain unconvincing at this stage. This is a weaker outcome than we had expected six months ago. Public sector final spending – about one-fifth of aggregate demand – is fairly subdued, and the intent of governments, as you know, is to restrain their own spending over the period ahead. The lower exchange rate is likely to help export volumes outside the resources sector, and of late better trends have been observed in some services export categories including tourism and education.

Overall, growth in non-mining economic activity has picked up, but is still a little below average. Our expectation had been that a further pick-up would occur in 2015. When we reviewed our forecasts in late January, we didn’t feel that growth in the recent past had been materially different from what we had estimated a few months ago. But when we tried to look ahead, we concluded that there were fewer signs of a further pick-up in non-mining activity than we had hoped to see by now. As a result, the revised forecasts we took to the February Board meeting embodied a longer period of below-trend growth, and a higher peak in the rate of unemployment, than earlier forecasts. They also suggested that inflation was likely to remain pretty low over the forecast horizon. The inflation outlook was revised slightly lower, in part reflecting the effect of declining oil prices as well as the weaker outlook for economic activity.

At its meeting in February the Board considered that this revised assessment – that is, sub-trend growth for longer, a higher peak in the unemployment rate, slightly lower inflation – warranted consideration of some further adjustment to monetary policy, after a fairly long period during which the cash rate had remained steady. These were incremental changes to the outlook but all in a consistent direction.

Another factor in our consideration was dwelling prices, which have continued to increase. Price rises in Sydney are very strong, and they are pretty solid in Melbourne. On the other hand they are much more mixed elsewhere. Excluding Sydney, the rise for Australia as a whole over the past year was about 5 per cent. That is a healthy pace but not alarming, and some cities have seen price falls. Developments in the Sydney market remain concerning, but in the end we did not see these trends as overwhelming a case for a further easing in monetary policy that was made on more general grounds.

I note that, on the regulatory front, APRA has announced its supervisory approach to managing the potential risks posed by the rise in lending to investors in housing. This involves more intense scrutiny of investor loan portfolios growing at over 10 per cent per year, with the possibility, ultimately, of additional capital being required if APRA deems it necessary. APRA has also reiterated its expectations for other elements of lending standards such as interest rate buffers and floors. And ASIC has begun a review of interest-only lending in the context of consumer protection legislation. The Bank welcomes these steps and will keep working with other regulators in these areas.

The Board is also very conscious of the possibility that monetary policy’s power to summon up additional growth in demand could, at these levels of interest rates, be less than it was in the past. A decade ago, when there was, it seems, an underlying latent desire among households to borrow and spend, it was perhaps easier for a reduction in interest rates to spark additional demand in the economy. Today, such a channel may be less effective. Nonetheless we do not think that monetary policy has reached the point where it has no ability at all to give additional support to demand. Our judgement is that it still has some ability to assist the transition the economy is making, and we regarded it as appropriate to provide that support.

The forecasts published last week in the Statement on Monetary Policy assume a lower path for interest rates and a lower exchange rate than both earlier forecasts and the ones the Board responded to at the February meeting. These are assumptions rather than forecasts or commitments to a course of action.

It is worth noting that, despite concerns at various times about whether the exchange rate would adjust appropriately to our changing circumstances, it has been doing so over the period since we last met with the Committee. Against the US dollar it has fallen by around 17 per cent since our last hearing. The US dollar itself has been rising against all currencies, of course, so much of this movement is an American story rather than an Australian one. Against a basket of relevant currencies the Australian dollar has fallen by less, but the decline is still about 11 per cent since August. Further adjustment is probably going to occur.

One other development since our last meeting with the Committee was the final report of the Financial System Inquiry. This was quite a wide-ranging report and there is now a further period of consultation. I simply note that the Inquiry did not find major problems in the financial system, but did make recommendations about capital, to enhance the resilience of the banking system, and about loss-absorbency more broadly in the context of resolution. These will be mostly in the province of APRA to consider. The Inquiry also made some observations about payments matters, generally supporting the steps the Payments System Board has taken since its inception in 1998, and pointing to some areas where further steps may be appropriate. The Payments System Board will be considering these matters at its meeting next week.

Launch of the Official Australian Renminbi Clearing Bank

Glenn Stevens spoke at the launch yesterday. The launch of a local RMB clearing bank in Australia is an important event. It should make it easier to make RMB for payments, especially for larger transactions. It should establish a more direct connection  with the liquidity in RMB which is provided by China’s central bank, the People’s Bank of China (PBC). Next, it will facilitate access to China’s Real-time Gross Settlement System (CNAPS), making it will be easier to track and confirm when payments to China reach their recipients. Finally, as it develops, it has the potential to reduce risks via access to fiduciary accounts structures maintained by the PBC on behalf of its clients. In addition, more broadly, the establishment of an RMB clearing bank underscores the international importance of Sydney as an Asian financial centre and strengthens the bilateral relationships. Now, it is up to local businesses to grasp the opportunity to transact in RMB in Australia.

Today’s events mark an important step in the further development of a local renminbi – or RMB – market. But more than that, they mark one more step in a lengthy and very important journey that has seen the flowering of trade relations between China and Australia, and which promises benefits from the maturing of financial ties.

On its own, the key direct benefit of the official Australian RMB clearing bank is that it can more efficiently facilitate transactions between Australian firms and their mainland Chinese counterparts using the Chinese currency. Bank of China (Sydney)’s ‘official’ status – which was granted by the People’s Bank of China (PBC) – affords it more direct access to the Chinese financial system, with flow-on effects for local financial institutions and their customers.

But an official Australian RMB clearing bank also confers some indirect benefits on the Australian financial sector and its customers, particularly when viewed as one element of a broader range of initiatives.

In particular, the establishment of the clearing bank helps to raise awareness among Australian firms that the local financial system has the capacity to effect cross-border RMB transactions on their behalf. This is important, because over the long run, Chinese firms may increasingly wish their trade with Australian firms to be settled in RMB. To be sure, today the bulk of global trade is settled in US dollars. But with China now a very large trading nation, and continuing to grow into a ‘continental sized’ economy, it would be surprising if at some point we do not see much more use of China’s currency for trade purposes. Already its usage is growing quickly, if only from a small base. So Australian firms and the Australian financial system need to be well prepared.

To that end, the RBA has been directly involved in several initiatives, with the aim in each instance being to ensure that there are mechanisms in place that allow the private sector to increase its use of the Chinese currency as and when it chooses to do so. This of course included the signing of a Memorandum of Understanding with the PBC to enable the establishment of an official RMB clearing bank in Australia, in November last year following the G20 Leaders’ Summit in Brisbane.

In addition, there was the establishment of a bilateral local currency swap line with the PBC in 2012, which is designed to provide confidence to both Chinese and Australian financial institutions that appropriate RMB and AUD liquidity arrangements are in place in the event of dislocation in the market.

More recently, there was the negotiation of a quota to allow financial institutions based in Australia to invest in approved mainland Chinese securities under the Renminbi Qualified Foreign Institutional Investor Scheme – better known as RQFII.

Finally, I note the RBA has invested a small proportion of Australia’s foreign currency reserves in RMB.

Official initiatives like these help to lay the groundwork. But ultimately, the development of an RMB market in Australia will depend on the extent of benefit the private sector sees in using RMB for trade settlement and investment purposes. It is worth noting that private sector-led initiatives are now becoming increasingly important drivers of the RMB market’s development. For example, forums such as the Australia-Hong Kong RMB Trade and Investment Dialogue and the ‘Sydney for RMB’ Working Group are beginning to have a more prominent role in raising awareness of the financial sector’s capacity to conduct RMB business and in identifying any further market development issues that may need to be addressed.

RBA Lowers Growth Forecast

The RBA published their statement on monetary policy today.  They point to a lower than expected growth and inflation forecast, but higher rates of unemployment. GDP is now projected at 2.25 per cent to June, and a quarter percent lower by the end of the year than their last projection.  They are expecting unemployment to remain higher for longer, and above 6 per cent during 2017. Inflation is forecast at a headline level of just 1.25 per cent, thanks to lower oil prices, although the bank’s favoured core inflation measure still sits within its 2-3 per cent target.

Looking at the economic drivers, the banks said that the 9 per cent fall in exchange rates had yet to flow through into higher prices, and the fall in oil prices are estimated to have increased real household disposable income by 0.25 per cent over the last half of 2014, and will lift spending power by an additional 0.5 per cent over the first three months of this year.

“While growth in non-mining activity has picked up a little over the past two years, all components except dwelling investment look to have grown at a below average pace over the past year,” the RBA said.

The ABS capital expenditure survey suggests that there will be only very modest growth in non-mining investment in 2015.

The most significant comment for me related to the behaviour of households who have experienced significant lifts in wealth thanks to rising house prices, yet may not be turning this into higher rates of consumption.

“However, another possibility is that ongoing buoyant conditions in housing markets will have less of an effect on consumption than previously. In particular, in recent years fewer households appear to have been utilising the increase in the value of their dwelling to increase their leverage or trade up”.

This cuts to the heart of the problem. Their core strategy was to allow housing to expand, to lift wealth, to encourage spending, to drive growth, until the business sector kicks in. However, there is mounting evidence that households are not convinced, and are unwilling or unable to spend. Retail is still below trend, and as interest rates of savings fall, households become more conservative. It could be that their core thesis is flawed.  Indeed, they had previously acknowledged

“we shouldn’t expect consumption to grow consistently and significantly faster than incomes like it did in the 1990s and early 2000s, given that the debt load is already substantial”.

In our recently published household finance confidence index we noted a consistent fall. No surprise then households are not performing as expected.

RBA Cuts Rate to 2.25%

The RBA has cut the cash rate by 25 basis points to 2.25 per cent, effective 4 February 2015.

Growth in the global economy continued at a moderate pace in 2014. China’s growth was in line with policymakers’ objectives. The US economy continued to strengthen, but the euro area and Japanese economies were both weaker than expected. Forecasts for global growth in 2015 envisage continued moderate growth.

Commodity prices have continued to decline, in some cases sharply. The price of oil in particular has fallen significantly over the past few months. These trends appear to reflect a combination of lower growth in demand and, more importantly, significant increases in supply. The much lower levels of energy prices will act to strengthen global output and temporarily to lower CPI inflation rates.

Financial conditions are very accommodative globally, with long-term borrowing rates for several major sovereigns reaching new all-time lows over recent months. Some risk spreads have widened a little but overall financing costs for creditworthy borrowers remain remarkably low.

In Australia the available information suggests that growth is continuing at a below-trend pace, with domestic demand growth overall quite weak. As a result, the unemployment rate has gradually moved higher over the past year. The fall in energy prices can be expected to offer significant support to consumer spending, but at the same time the decline in the terms of trade is reducing income growth. Overall, the Bank’s assessment is that output growth will probably remain a little below trend for somewhat longer, and the rate of unemployment peak a little higher, than earlier expected. The economy is likely to be operating with a degree of spare capacity for some time yet.

The CPI recorded the lowest increase for several years in 2014. This was affected by the sharp decline in oil prices at the end of the year and the removal of the price on carbon. Measures of underlying inflation also declined a little, to around 2¼ per cent over the year. With growth in labour costs subdued, it appears likely that inflation will remain consistent with the target over the next one to two years, even with a lower exchange rate.

Credit growth picked up to moderate rates in 2014, with stronger growth in lending to investors in housing assets. Dwelling prices have continued to rise strongly in Sydney, though trends have been more varied in a number of other cities over recent months. The Bank is working with other regulators to assess and contain economic risks that may arise from the housing market.

The Australian dollar has declined noticeably against a rising US dollar over recent months, though less so against a basket of currencies. It remains above most estimates of its fundamental value, particularly given the significant declines in key commodity prices. A lower exchange rate is likely to be needed to achieve balanced growth in the economy.

For the past year and a half, the cash rate has been stable, as the Board has taken time to assess the effects of the substantial easing in policy that had already been put in place and monitored developments in Australia and abroad. At today’s meeting, taking into account the flow of recent information and updated forecasts, the Board judged that, on balance, a further reduction in the cash rate was appropriate. This action is expected to add some further support to demand, so as to foster sustainable growth and inflation outcomes consistent with the target.