Business surveys showed some divergence. According to the NAB survey, the business conditions index, reflecting activity and sales, remained above average levels in February, although confidence about the general business outlook had fallen well below average.

Members observed that commodity prices had been volatile in the first quarter of 2008. Prices for several commodities, including base metals and crude oil, had risen early in the year, then fluctuated below their early March peaks. The spot coal price had come off its peak somewhat, but the increase in the contract price for this year was still likely to be substantial.

All up, the terms of trade were expected to increase by around 15 per cent in the middle of 2008, based on the likely increases in contract prices for the bulk commodities of coal and iron ore. The ensuing large rise in Australian incomes would impart a significant stimulus to the economy.

Turning to the labour market and wages, members observed that there had been no sign of slowing in employment growth, which had been steady at just below 3 per cent in year-ended terms for the past year or so. Job vacancies, as measured by the ABS survey of employers, fell slightly in the three months to February but remained very high, confirming the current tightness of the labour market.

Despite the sustained strength of the labour market, wages growth remained reasonably contained, with the spike in the average earnings figures for the year to the September quarter falling away in the subsequent quarter. Looking through the volatility, growth in average earnings appeared to have picked up only modestly over the past few years. In other wages data, there had been no pick-up in the pace of wages growth associated with recent new enterprise agreements, leaving the rate of growth of wages in current enterprise agreements steady at 4 per cent during 2007.

Members were informed that the CPI data for the March quarter, to be released towards the end of April, were likely to show inflation of around 4 per cent on a year-ended basis in the March quarter. A large quarterly increase was expected partly because of recent rises in retail petrol prices. Underlying inflation was also expected to rise in year-ended terms in the March quarter, before declining over time. The staff’s inflation forecast through to 2010 would be revised after the release of the March quarter CPI, but the preliminary assessment, based on current policy settings, was that inflation on both a CPI and underlying basis would fall by a little more than earlier thought over the next two to three years. This was premised on demand growth slowing sufficiently to reduce capacity pressures. Members recognised that a considerable degree of uncertainty continued to surround the outlook for both demand and inflation.

Financial Markets

The Board noted that there had been substantial volatility in financial markets over the past month. Much of the latest bout of volatility was the consequence of the process of de-leveraging, notably by hedge funds, which had faced margin calls and subsequently needed to sell assets. It also reflected the near-collapse of Bear Stearns, an investment bank that had been at the centre of the financial crisis since mid 2007, and its rescue through a take-over by JPMorgan Chase, facilitated by the Federal Reserve assuming some of the risk in the Bear Stearns portfolio.

Information on the US mortgage market showed that delinquencies, defined as loans that were 30 days or more overdue, and foreclosures had continued to rise. This was reflected in both sub-prime and prime loans, though foreclosures were far higher on sub-prime than prime loans.

Turning to financial market conditions more generally, there had been a tightening of conditions in the market for term paper, peaking around the time of the rescue of Bear Stearns, but this had since eased somewhat. However, conditions remained tight in short-term money markets. Partly, this reflected end-quarter balance-sheet adjustments. The G10 central banks had announced co-ordinated action to increase US dollar swap lines between the Federal Reserve and European Central Bank and Swiss National Bank, which was similar to action taken in December 2007. The Fed had also announced significant changes to its framework for domestic market operations, which extended the list of counterparties with which it dealt and the collateral that it would accept. These changes did not involve any significant net injection of liquidity to the system, but gave additional flexibility for providing liquidity when it was needed.

Members discussed the process of de-leveraging, which was evident in many financial markets. Among those affected was the European government bond market, where spreads between yields on German government bonds and those on bonds of several other countries had widened sharply in March as liquidity dried up.

Volatility in share prices had also continued to be very high. Net movements in share prices around the world in March had been modest, however, with small falls in most markets apart from Japan, where share prices had fallen by a larger amount owing to the effect of the appreciating yen on listed Japanese exporters. Share prices in China, India and other emerging economies had fallen sharply over the past month. Financial stocks globally had fallen more than other stocks, and were now back to 2005 levels. Reflecting the high weighting of financial stocks in the Australian share market, it had fallen by more than most other share markets since its peak in November 2007. Traditional measures of price-earnings ratios in Australia were now below longer-run averages.

Members noted that, in addition to its other actions, the Fed had cut the federal funds rate by 75 basis points at its March meeting, to 2.25 per cent. This took the total reduction to 300 basis points over the past six months. The market expected further small reductions in the next few months. Elsewhere, the European Central Bank had continued to hold its policy setting steady, highlighting ongoing inflation risks. Policy rates were also steady in Japan and the UK, but had been cut by 50 basis points in Canada. There had been further policy tightening in China, though policy settings in other emerging economies were generally steady.

Members noted the large movements in currencies over the past month. In terms of movements against the US dollar, the yen was at its highest level since 1995 and the euro had reached a new high. The euro was at a high in real effective terms also. The US dollar had depreciated sharply in real effective terms, and on this measure was close to the lows recorded over the past two decades. The renminbi had continued to appreciate gradually against the US dollar, but depreciate against the euro. Owing to relatively high inflation in China compared with its main trading partners, the renminbi had risen in real effective terms over the past two years.

The Australian dollar had experienced large swings over the past month. Intraday volatility was among the highest in recent years, against both the US dollar and the yen. Over the past month, in trade-weighted terms the Australian dollar exchange rate fell by 4 per cent, with depreciation against most currencies in the basket, particularly the yen and the Swiss franc. Over the year, however, the Australian dollar TWI was about 4 per cent higher; over a longer period, the TWI was currently about 15 per cent above its post-float average.

In the domestic money market, members noted the 90-day bank bill rate had peaked above 8 per cent during the month, a very large spread to the expected cash rate, but had fallen since mid March to be around 7¾ per cent. The Bank had increased exchange settlement balances during the month and conducted more operations at longer terms, between 90–180 days, where liquidity was needed. There had been no deviation of the cash rate from the target.

Members then discussed recent trends in bond issuance by Australian banks, which had continued apace in the first quarter of 2008. The large amount of bond issuance by the banks in part reflected strong growth in balance sheets, owing to the increased corporate demand for bank credit after the drying up of activity in the corporate bond market in Australia. Members observed that the banks had acted as a shock-absorber in terms of corporate funding. The large bond issuance by the banks also reflected a precautionary element. Bond issuance offshore had accounted for the bulk of total issuance. Yields paid by Australian banks on their debt had continued to rise in line with international trends.

The further rises in banks’ funding costs over the past month had been passed on to borrowers in the form of higher lending rates. Business funding had risen rapidly, partly owing to reintermediation, though there were some signs of slowing in the pace of business credit expansion in February.

Members observed that financial results published during the latest corporate reporting season showed that the rise in debt levels among companies had been only modest.

Current pricing in the money market indicated that no change in the cash rate was expected at this meeting.