Concerns over the fiscal position of some European countries have persisted since May. Ratings downgrades on Greece and Spain and fears that Hungary may follow are weighing on the markets.

European authorities announced results of a stress test of the largest European banks. The vast majority of banks passed the test. In order to settle markets, it was critical that the stress tests were credible and that plans are in place to deal with any capital shortfall identified by the stress tests.

For the major economies sovereign-level yields have fallen, with US 10-year yields falling below 3 percent and German yields declining back to historic lows. Australian Government yields have also fallen to 5 percent. There has been some increase in money market spreads, although these remained far lower than mid 2007 to mid 2009.

In Australia, the money market has continued to function well. There has been some upward drift in the Australian bank bills to Overnight Index Swap rate spreads. The Reserve Bank has temporarily supplied extra liquidity at the end of the financial year.

The tensions in European financial markets have seen a further pushing back in the expectations of when central banks in the three largest advanced economies would begin a rate tightening policy. Six other countries have announced monetary tightening: these included Canada, New Zealand and Sweden that took their initial steps in this cycle.

Globally, corporate bond issuance remains low but rising. Issuance by Australian entities has also picked up and some of the large domestic banks issued bonds at spreads moderately higher than earlier in the year.

After recovering in the first part of July, global equity markets turned down sharply again later in the month. The Chinese equity market has continued to record significant declines.

The People's Bank of China announced a change to the exchange rate regime. It reverted to the arrangement in place over 2005 to mid 2008, whereby the value of the Renminbi would be adjusted in small increments on a daily basis relative to a basket of currencies.

International Economic Conditions
The global economy continued to grow in the July quarter, although uncertainty about the future strength of the recovery have risen and downside risks are apparent, largely reflecting ongoing concerns about the fiscal situation in Europe and the health of the European banking system. In contrast, economies in Asia remain robust, although there are signs that growth in the region is moderating to a more sustainable pace after the strong V-shaped recovery of the previous year.

Several of the smaller European economies have announced fiscal tightening. Some of the larger European economies also announced some tightening of fiscal policy, although the cuts were smaller and would be implemented more gradually.

Confidence and business conditions are surprisingly strong. The economic data for a number of countries, most notably Germany, was more positive than had been the case a few months earlier, and it was likely that euro area GDP would record a solid rise in the July quarter after little growth over the previous half year.

In China, retail sales, fixed asset investment, exports and credit have all grown strongly. Growth in industrial production has moderated over the past few months, but this was inevitable after the 20% plus growth in previous months. Conditions in the property market are also cooling, particularly in the major cities.

Wage growth in China has picked up noticeably. This is good in the long term, but in the short term it will lead to inflation.

Elsewhere in Asia, there were also early signs that growth was returning to a more sustainable pace after the very strong bounce-back from the contraction in late 2008 and early 2009. The Japanese economy is continuing to recover, although there remained considerable excess capacity.

In the United States, economic recovery is continuing at a moderate pace. This is most apparent in the business sector, especially in manufacturing. Indicators of business equipment investment are improving, business surveys were positive and industrial production has grown solidly. Labour market conditions remain soft and the payrolls data are disappointing. Unlike in Europe, no new steps have yet been taken to tighten fiscal policy, although there would be some unwinding of temporary measures through this year.

The large output gaps in the United States and the Euro area has resulted in ongoing decline in inflation, with core inflation running at annualised rates of 0.5 0.75% over the past half-year.

Australian Economic Conditions
The domestic economy continues to expand at a solid pace, with public-sector spending providing support to activity. Growth in private demand will pick up as investment strengthens, supported by high commodity prices.

Consumer sentiment remains a little above its long-term average, although it has fallen recently. Sales of motor vehicles to households has been strong in recent months, but retail spending which has recorded growth over recent months is now slowing as discounting has slowed.

Business surveys have also indicated some easing in confidence over recent months, although trading conditions remain a little above average. Some measures of company investment intentions have increased quite strongly, and capital goods imports increased in May. The amount of work yet to be done in mining is very high, particularly for the LNG sector. Private non-residential approvals remained weak; if this persists a tightening in some commercial property markets could emerge in the medium term. The slowing in growth in Chinese steel production has been reflected in falls in iron ore and steel prices. Spot prices for iron ore are now below the estimated contract price for the September quarter. Spot prices for coking coal have also eased. These prices remain very high from a longer-term perspective, and the terms of trade are approaching the peak level seen in 2008.

There are some signs that conditions in the established housing market have eased. Auction clearance rates in Sydney and Melbourne have declined from their earlier elevated levels. Housing credit growth remains at around the average pace of the preceding year.

In the labour market, hiring has remained strong with employment now 2.5% higher over the year. The increase was entirely driven by full-time jobs. Business surveys and data on job advertisements have been firm, suggesting further solid gains in employment in coming months. The unemployment rate has fallen to 5.2% and is significantly better than had been expected a year earlier.

Consumer price inflation data for the July quarter will be published on 28 July, and is expected to show the underlying rate of inflation continuing to moderate in year-ended terms, to be below 3 percent for the first time in three years. CPI inflation is, however, expected to rise to a little above 3 percent, partly due to the effects of some higher taxes.