European debt problems key focus of RBA, minutes show

The Reserve Bank of Australia is monitoring the ongoing debt problems in Europe, with any escalation in activity there likely to affect interest rate movements in 2011, the latest minutes of the December board meeting reveal.

The board also said that the current problems in Europe have “increased the downside risks” to the local economy, and the implications of this in Australia are difficult to predict. The board also said these problems in part prompted the latest rate rise to 4.75%, which now sets the cash rate at a “mildly restrictive” setting.

The RBA also said that domestically, the medium-term outlook hasn’t changed, with employment growth remaining strong and the pick-up in private investment set to continue.

“Following the Board’s decision in November to lift the cash rate and the subsequent increases in lending rates, and taking into account the level of the exchange rate, monetary policy was judged to be mildly restrictive.”

“Given the very high level of the terms of trade and the positive outlook for business investment, this policy setting was regarded as appropriate.”

It also noted that despite pressure on wages, price pressures remained “relatively modest… reflecting discounting activity and exchange rate effects”.

The board also said that household consumption and borrowing remained restrained despite high levels of confidence and the savings rate has increased, with this restraint likely to provide scope for investment without causing inflationary pressures – more reason to suspect rates will remain on hold.

These European debt problems were the main focus of the meeting, according to the minutes. Members were briefed by the European Union and the IMF over debt bailout plans, which are set to assist countries including Ireland, Portugal, Spain and Italy.

Members said the European debt problems could either exacerbate or fade, but at this point, “an escalation of the current problems was not out of the question”. It also said that any escalation would “have more impact on Australia than any trade effect”.

Elsewhere overseas, the board noted that data in the United States had improved, although overall jobs growth “had fallen short of expectations”.

“Members observed that recent indicators of business investment, business conditions and household spending suggested that the economy was continuing to expand, albeit at a modest pace.”

“The recent indicators for the housing sector, however, showed few signs of improvement. The household saving rate was well above the levels of the middle of the decade.”

Domestically, the RBA said that GDP was estimated to increase by 0.2% in the September quarter and by 2.7% over the year, and that over the past decade, “a significant part of the growth in real incomes had come from the terms of trade”.

“Overall, the expected rebalancing of growth from public to private demand looked to be occurring, though public demand remained strong.”

“The accounts confirmed that conditions varied considerably across sectors, with manufacturing output having been flat over the first three quarters of 2010, in contrast to solid rises in output in the mining sector and of some professional services.”

The RBA also noted other factors indicating a pick-up in investment, including an increase in the September quarter capital expenditure figures, along with investment intentions for 2010-11.

However, the board also noted some pessimistic figures including flat outlooks for construction, along with business credit falling in October. And among households, the RBA said “spending and borrowing… remained subdued”.

“Members observed that the restraint being shown by households, and the pick-up in the saving rate, would help reduce the medium-term risk from household balance sheets after a long period when debt ratios had risen, and would help to make room for the expected increase in investment.”