Minutes of the Monetary Policy Meeting of the Reserve Bank Board
Sydney – 6 October 2015
Glenn Stevens (Governor and Chair), Philip Lowe (Deputy Governor), John Akehurst, Roger Corbett AO, John Edwards, Kathryn Fagg, John Fraser (Secretary to the Treasury), Heather Ridout AO and Catherine Tanna
Guy Debelle (Assistant Governor, Financial Markets), Malcolm Edey (Assistant Governor, Financial System), Christopher Kent (Assistant Governor, Economic), Luci Ellis (Head, Financial Stability Department), Alexandra Heath (Head, Economic Analysis Department)
Anthony Dickman (Secretary), Peter Stebbing (Deputy Secretary)
International Economic Conditions
Members commenced their discussion of the global economy by noting that growth in output had continued at around the average pace of recent years. Members noted that growth in global trade was subdued, although it had picked up a little recently. They discussed the implications of the general slowdown in trade and industrial production growth, notably in Asia, including for commodity prices. In particular, iron ore prices had declined slightly over September but remained higher than earlier in the year, while oil prices had edged higher from their recent lows. Globally, core inflation had generally remained low and at rates below the targets of most central banks.
In China, indicators of activity for July and August had suggested further moderation in growth. Members noted that growth in fixed asset investment and industrial production had eased over 2015. This had been particularly noticeable in the north-eastern provinces of China where activity was more concentrated in heavy industry and mining. The output of key industrial products, including steel, was lower than in late 2014, partly as a result of weak residential construction activity, even though both residential property prices and sales had been higher than earlier in the year. Members observed that the services sector in China had performed more strongly than the industrial sector in recent quarters.
Recent data on economic activity in Japan had been mixed. Real GDP had declined in the June quarter, while conditions in the labour market had remained tight and nominal wages had continued to increase modestly. Inflation remained low, although the Bank of Japan continued to forecast that it would reach the 2 per cent target by mid 2016. Elsewhere in east Asia, below-average growth appeared to have continued into the second half of 2015 and remained a source of concern for the strength of the global economy. A slowdown in industrial production growth in the region had become increasingly apparent over recent months and exports had declined in Korea, Singapore and Taiwan in August. In India, growth in the June quarter had been driven by robust domestic demand and inflation had remained relatively low in August.
In contrast to the situation in much of Asia, growth in the US economy had picked up to an above-average pace in mid 2015. Recent indicators pointed to further consumption-led strength in the September quarter. Labour market conditions had improved and the unemployment rate had edged lower in August to be close to most estimates of full employment.
In the euro area, timely indicators suggested that the gradual recovery in the economy had continued in the second half of 2015, supported by both external and domestic demand. Unemployment had drifted lower, although the unemployment rate remained high. Inflation remained subdued.
Domestic Economic Conditions
Members began their discussion of the domestic economy by reviewing the national accounts for the June quarter, which had been released the day after the previous meeting. They noted that, as expected, GDP had increased only slightly following the strong growth recorded in the March quarter. The weakness in the June quarter had reflected temporary, weather-related disruptions to resource exports as well as the ongoing decline in mining investment. Members noted that overall growth was expected to have strengthened in the September quarter, with indications of growth in resource exports and dwelling investment. Members also observed that employment growth had strengthened despite GDP growth over the year having been at the lower end of the forecast range of a year earlier.
Consumption growth had been relatively steady at a below-average pace for the past year, although this was stronger than in 2013. Household income was estimated to have increased by a little less than consumption over the past year, with a modest decline in the household saving ratio. Members noted that the strength of wealth effects on consumption behaviour would affect whether the saving ratio would continue to trend down over the next year or so. While the year-ended growth in retail sales had been little changed in recent months, surveys of households' perceptions of their personal financial situation compared with a year earlier remained above average.
Dwelling investment had increased strongly over the year to June, despite recording a decline in the June quarter. Building approvals had declined a little from their recent peak, but remained at levels that implied further growth in dwelling investment, albeit at a gradually declining rate. Loan approvals for construction of new dwellings had also fallen over the past year. Growth in housing prices in Sydney appeared to have eased slightly in recent months and auction clearance rates in Sydney and Melbourne had declined a little from their recent peaks. However, it was too early to be confident that these signs of slowing in housing price inflation would be sustained.
In relation to lending for housing, members noted that the data on the split of lending to owner-occupiers and investors were of questionable quality at present. The available data suggested that there had been a modest decline in the growth of credit extended to investors in housing of late, which was consistent with the tightening in banks' lending standards in response to actions of the Australian Prudential Regulation Authority (APRA). With housing credit growth overall remaining steady over the past year, there had reportedly been a slight pick-up in the growth of housing credit to owner-occupiers.
Mining investment had continued to fall in the June quarter and now accounted for around 5 per cent of nominal GDP, down from a peak of around 8 per cent. Members noted that there had been a correspondingly significant decline in capital imports. In addition, profits of mining firms had fallen sharply over the past year, in line with lower commodity prices. Mining investment was expected to continue to fall over the next couple of years as the current pipeline of work was completed, but resource export volumes, particularly for liquefied natural gas, were expected to increase substantially over the same period.
Non-mining investment was estimated to have picked up a little in the June quarter and had risen modestly over the past year. Over the same period, profits of non-mining companies had kept pace with nominal GDP. Survey measures of business conditions had increased to be further above their long-run averages, notably in the household and business services sectors. Conditions in the goods production and distribution sectors, though weaker than in some other sectors, had also shown improvement of late. Members noted that the depreciation of the exchange rate had led to an increase in exports of services, including tourism, as well as a noticeable decline in imports of services.
Employment growth had strengthened to be 2 per cent over the year to August and the participation rate had increased. The unemployment rate had remained in its 6–6¼ per cent range over recent months. Forward-looking indicators had generally been consistent with the unemployment rate being around its current level or possibly slightly lower in the months ahead. Measures of earnings and productivity growth from the national accounts had remained soft in the June quarter, with negligible growth in either measure over the past year. Overall, unit labour costs had been little changed for around four years, which members saw as helping to explain the stronger-than-expected growth in employment.
Members noted that the improvement in labour demand had been concentrated in the household and business service sectors of the economy. This was consistent with the data on business conditions and output growth by industry. In contrast, employment in goods-related sectors had been little changed for some time. Members discussed the differences in the nature of the investment and employment required in the services sector relative to goods-related industries.
The discussion of financial markets commenced with the observation that the two major drivers of markets over the past month continued to be concerns about Chinese growth, and the implications for the global economy, as well as the timing of the first increase in the federal funds rate in the United States.
While the Federal Open Market Committee (FOMC) left monetary policy unchanged at its September meeting, citing concerns about global growth, a majority of FOMC members had indicated nonetheless that they still expect to start raising the federal funds rate before the end of this year. Market expectations immediately prior to the FOMC meeting implied a one-in-three chance of a rate rise occurring at the September meeting and a very high probability of a rate rise by the end of the year. Following the meeting, however, market expectations changed significantly, with an increase in the federal funds rate by the end of this year given only a 50 per cent chance of occurring and markets not fully pricing in a rate rise until April next year at the earliest. Members noted that some market participants did not expect an increase in the policy rate for the foreseeable future.
Bond yields in the major markets had declined in net terms over September. In the United States and Germany, 10-year government bond yields had risen in the first half of the month, mainly in response to some better-than-expected US economic data, before declining following the Fed's decision to leave the federal funds rate unchanged. Yields on Australian Government Securities had moved broadly in line with global yields over the past month.
The changed exchange rate arrangements in China in August had initially led to a depreciation of the renminbi, but the exchange rate had appreciated slightly over the course of September. Members noted that there had been a significant decline in Chinese foreign currency reserves since mid 2014, with apparent sizeable sales or non-reinvestment of maturities of US bonds. Following the depreciation of the renminbi in August, sales of reserves were likely to have continued in response to net private capital outflows. A significant share of private capital outflows over the past year appeared to have been in the form of increased foreign currency bank deposits. The Chinese authorities had announced that existing restrictions on private capital outflows would be more rigorously enforced.
Financial market conditions in a number of emerging market economies had deteriorated further in recent months, reflecting lower commodity prices and country-specific risks, especially for Brazil, Russia and Turkey, where yields on local currency denominated sovereign bonds had increased noticeably. In contrast, developments in some other emerging markets, notably India and Mexico, continued to be relatively benign. Corporate bond issuance in emerging markets in aggregate had fallen sharply in the September quarter. This had been accompanied with significant outflows from both emerging market bond and equity investment funds since the middle of the year. The currencies of some emerging market economies had depreciated further over the past month and some Asian currencies were back to the lows recorded around the time of the financial crisis in the late 1990s.
The US dollar was unchanged on a trade-weighted basis over the past month, while the exchange rates of most other advanced economies had been little changed. The Australian dollar had depreciated marginally to be around its recent lows against the US dollar and on a trade-weighted basis.
Equity prices had fluctuated around the lower levels reached in late August in many advanced economies as well as in China, with some large daily movements in both directions. News of the Volkswagen emissions scandal in late September adversely affected European equities, while equity prices in emerging markets had partly recovered from their falls in late August, although they remained lower than at the start of the year. Australian equity prices continued to decline in September, led by the resources sector.
Financial market pricing indicated an expectation that the cash rate would remain unchanged at this meeting.
Members were briefed on the Bank's half-yearly assessment of the financial system.
Global financial stability risks had been shifting from advanced country banking systems to China and other emerging market economies. Partly in reaction to this, financial market volatility had picked up following a lengthy period of low volatility and compressed risk premia. Members noted the possibility of a sharp repricing in markets where investors for years had been ‘searching for yield’.
Members noted that domestic sources of risk to financial stability in Australia continued to revolve mainly around developments in local property markets. In the context of recent developments in the housing market and household credit, members discussed the findings from the enhanced scrutiny of housing lending practices undertaken by APRA and the Australian Securities and Investments Commission since the end of 2014. This scrutiny and related work had shown that investor activity was considerably higher – and lending standards in some parts of the market weaker – than had originally been thought.
Members further observed that the risks in commercial property and the property development sector were rising. Building approvals for new apartments remained very strong over 2015, even though rental markets appeared soft in some areas. The divergence between commercial property valuations and rents had widened further, with strong domestic and foreign investor interest for new and existing office buildings in particular, even though vacancy rates were quite high. At the same time, falling commodity prices were weighing on the profitability of many resource-related companies. The rest of the business sector seemed to be in relatively good shape, in contrast, with both gearing and failure rates at relatively low levels.
Members were also briefed on the risks in the New Zealand housing market and dairy sector, given the sizeable exposures of Australian banks through their New Zealand subsidiaries.
While Australian banks continued to perform well, they were taking steps to enhance their resilience. Banks' asset performance continued to improve, profitability remained high, and the large banks had raised substantial amounts of capital in advance of forthcoming prudential requirements. Most banks had strengthened the serviceability metrics used in their mortgage lending and taken steps to slow the pace of growth in investor lending towards the prudential regulator's expectations. Banks were also reportedly becoming increasingly wary of lending to property developers in markets that were thought to be at risk of becoming oversupplied. Nonetheless, competition among lenders had intensified in the owner-occupied segment of the housing market and had continued to do so in parts of the business lending market. Members observed that a key challenge would be to ensure that lending standards at both Australian and foreign-owned banks did not weaken from this point.
Considerations for Monetary Policy
Members noted that recent data continued to raise concerns about the outlook for economic growth in China in particular and east Asia more generally, while economic activity in the United States and euro area continued to recover. Below-average growth in the Asian region had been most evident in weak growth in industrial production, which had been mirrored in lower export volumes. While global commodity prices had fallen over the past year, they had been little changed over recent months. Global financial conditions remained very accommodative and low oil prices were expected to continue to provide a measure of support to growth in Australia's major trading partners.
Domestically, the moderate expansion of the economy had continued, although GDP growth in the June quarter was low, in line with expectations, reflecting what appeared to be temporary weakness in resource exports as well as further falls in mining investment. GDP growth had been below average over the past year, but there had been further evidence of rebalancing from the resources sector towards non-mining activity. This rebalancing was being increasingly supported by the depreciation of the Australian dollar, which had led to a noticeable increase in net service exports over the past year.
Members noted that reductions in the cash rate earlier in the year continued to provide support to aggregate demand, particularly dwelling investment and household consumption. Members also noted that conditions in the labour market had strengthened further over recent months and were somewhat better than had been expected earlier in the year. Nevertheless, spare capacity remained in the economy, domestic cost pressures were very low and inflation was expected to remain consistent with the target over the next one to two years.
The key domestic sources of risk to financial stability, and stability of the Australian economy more broadly, revolved around developments in local property markets. Members noted that growth in lending for housing had been steady over recent months and that there were some signs of an easing in the strong rate of increase in dwelling prices in Sydney, in particular, although trends had been more varied in a number of other cities. At the same time, members judged that there were signs that the response of the banks to supervisory measures implemented by APRA were helping to manage risks in the housing market. Credit growth overall had been moderate.
Given these considerations, the Board judged that it was appropriate to leave the cash rate unchanged at this meeting. Information about economic and financial developments, both domestically and abroad, would continue to inform the Board's assessment of the outlook and whether the current stance of policy remained appropriate to foster sustainable growth and inflation consistent with the target.
The Board decided to leave the cash rate unchanged at 2.0 per cent.