Minutes of the Monetary Policy Meeting of the Reserve Bank Board
Sydney – 7 June 2016
Glenn Stevens (Governor and Chair), John Akehurst, John Edwards, Kathryn Fagg, John Fraser (Secretary to the Treasury), Allan Moss AO, Heather Ridout AO, Catherine Tanna
Members granted leave of absence to Philip Lowe (Deputy Governor) in terms of section 18A of the Reserve Bank Act 1959.
Guy Debelle (Assistant Governor, Financial Markets), Christopher Kent (Assistant Governor, Economic), Alexandra Heath (Head, Economic Analysis Department)
Anthony Dickman (Secretary), Andrea Brischetto (Deputy Secretary)
Domestic Economic Conditions
Members began their discussion of the Australian economy by noting that growth in real GDP in the March quarter was stronger than anticipated in the May Statement on Monetary Policy. Growth was expected to be more moderate in the June quarter, but year-ended growth was likely to remain slightly above estimates of potential. Growth in nominal GDP had been lower than growth in real GDP, as had been expected, reflecting declines in the terms of trade and some decline in domestic prices.
Growth in the March quarter was underpinned by a large contribution from net exports. Export volumes had been boosted by further increases in resource production from newly completed projects and the absence of adverse weather, which often affects the ability to export resource commodities around the beginning of the year. Service exports had also grown strongly, supported by the depreciation of the Australian dollar in recent years. Members noted that the contribution of resource exports to year-ended GDP growth had been offset by further falls in mining investment, such that growth in mining activity overall had been quite modest over the year to the March quarter.
In contrast, year-ended growth in non-mining activity had been running at above 3 per cent. Over the year to the March quarter, consumption growth had been around its decade average and there had been continued growth in dwelling investment, supported by the low level of interest rates. Government spending had also grown at an around-average pace, while non-mining investment had declined.
Consumption increased by 3 per cent over the year to the March quarter. This was slightly stronger than the growth in household disposable income, which members observed had been stronger than measures of income growth for the economy as a whole. The household saving rate rose in the quarter, but had declined gradually over the year. Liaison suggested that retailers had been more cautious about the outlook of late, although trading conditions had remained generally positive, and surveys suggested that consumers' perceptions of their own finances were still a little above average.
Dwelling investment had continued to grow strongly over the year, consistent with the substantial amount of work in the pipeline noted in previous meetings. Members observed that private residential building approvals had increased strongly in April, to be close to peaks seen earlier in 2015. Although these data are quite volatile from month to month, the trend for building approvals had been stronger than expected of late and the pipeline of residential work yet to be done had remained at high levels. This implied that growth in new dwelling investment would continue to add to the supply of housing over the next year or so, particularly in the eastern capitals.
In established housing markets, prices increased significantly in Sydney and Melbourne over April and May and, to a lesser extent, in a number of other capital cities. Auction clearance rates and the number of auctions increased in May, but remained lower than a year earlier. At the same time, the monthly data available for April showed that there had been a further easing in housing credit growth and the total value of housing loan approvals, excluding refinancing, had fallen in the month. Members noted that the divergence in the trends in housing price and credit growth was not expected to persist over a long period of time.
As had been expected, business investment continued to decline in the March quarter. As a share of GDP, mining investment had fallen to around 4 per cent, down from a peak of 8 per cent in 2012. Non-mining investment also appeared to have declined in the quarter, reflecting a fall in non-residential construction consistent with the low level of non-residential building approvals. Investment intentions from the latest ABS capital expenditure survey continued to imply a further sharp fall in mining investment and a decline in non-mining investment in 2016/17. Members noted that this survey captures less than half of the activity included in the more comprehensive national accounts measure of non-mining business investment. In particular, the ABS capital expenditure survey excludes some industries, such as health and education, and investment in intangible assets such as software, which had become an increasingly important component of investment.
Business surveys implied that non-mining business conditions and capacity utilisation had remained above average more recently, despite non-mining business profits declining a little as a share of GDP in the March quarter. Growth in business credit remained on a gradual upward trend.
Public expenditure increased at an around-average rate over the year to the March quarter. The 2016/17 Australian Government Budget, along with the state budgets that had been released by the time of the meeting, implied a number of years of slightly larger deficits than in the midyear fiscal updates. Most of the revisions had reflected lower-than-expected tax receipts owing to the weaker outlook for wage growth. The consolidated deficit was still expected to narrow progressively from 2017/18.
As expected, there had been some moderation in employment growth in 2016, following the strength seen at the end of 2015, while the unemployment rate had been steady at around 5¾ per cent. Forward-looking indicators for employment in the near term had been mixed, but overall they were consistent with moderate employment growth in the months ahead.
Members noted that new data on growth in labour costs for the March quarter had also been somewhat mixed, although they continued to suggest that wage pressures remained low. Growth in the wage price index (WPI) edged down in the March quarter. However, the WPI measure including bonuses implied that private-sector wage growth had been little changed for the past two years. Also, the measure of earnings derived from the national accounts picked up over the year to the March quarter, and was growing a little faster outside Western Australia and Queensland, which had been most directly affected by the decline in mining investment and commodity prices over the past few years.
The rise in labour productivity apparent in the data over the year to the March quarter meant that unit labour costs as measured had increased only modestly over this period, and had even declined a little in the March quarter. Members observed a broad correspondence between movements in unit labour cost growth and the terms of trade over the past decade or so: unit labour costs had grown at an above-average pace throughout the period when the terms of trade were increasing, but were little changed over the past four and a half years while the terms of trade had been declining. This suggested that, while changes in the nominal exchange rate had played the key role in helping the economy adjust to the rise and fall in the terms of trade, this process had been assisted by adjustments in the growth rate of wages.
Short-term measures of inflation expectations – from consumers, market economists, union officials and inflation swaps – had remained below average. Long-term inflation expectations had also remained below average.
International Economic Conditions
Largely as expected, growth in Australia's major trading partners moderated in the March quarter to a year-ended rate that was about ½ percentage point below its decade average. Growth in China and east Asia eased further and Japanese GDP was unchanged over the year to the March quarter. Output growth in the United States and the euro area had remained around – or even a little above – trend in year-ended terms and the unemployment rates in these economies continued to decline. Growth in global industrial production and merchandise trade remained subdued and inflation in most advanced economies remained below central banks' targets.
Recent indicators suggested that the weakness in the Chinese industrial sector had continued, although policy measures to support activity appeared to have been providing some offset. Growth in industrial production remained relatively subdued and growth in private-sector fixed asset investment had declined further, while public-sector investment (particularly in infrastructure) had grown strongly and government spending remained at an elevated level. Conditions in the real estate sector had strengthened over recent months, following earlier measures by the Chinese authorities to support demand for housing. Growth in real estate investment had increased, following a prolonged period of weakness, and the level of floor space sold had risen further. Despite this, steel production had been little changed over the preceding year. Actions by the Chinese authorities designed to curb speculative activity in commodity futures markets appeared to have contributed to recent falls in spot iron ore prices, although they remained around 30 per cent above their trough in December 2015.
Output in east Asia continued to grow at a below-average pace in the March quarter, reflecting moderate domestic final demand growth and a decline in exports. Members noted that the high-income economies in the region were particularly exposed to trade and had experienced weaker investment outcomes than middle-income economies in the region. Employment growth had also been slowing over the past year in the high-income economies and there were tentative signs that unemployment had begun to edge higher in South Korea and Taiwan. Core inflation had been drifting lower recently, particularly among the high-income east Asian economies. Despite external weakness, growth in India increased to around 8 per cent in year-ended terms and inflation remained around 5 per cent (the Reserve Bank of India's target for 2016).
Members noted that growth in many advanced economies had been at, or a little above, potential, which was consistent with ongoing improvements in labour market conditions in these economies. In the United States, although the most recent monthly increase in payrolls employment was small, the unemployment rate continued to fall. The improvement in US labour market conditions and rising wealth had supported relatively strong growth of household consumption and residential investment over the past year. In the euro area, the unemployment rate continued to decline and the level of GDP had surpassed its pre-crisis peak in the March quarter.
Members observed that the ongoing tightening of labour market conditions in the United States and Japan had led to some increase in wage pressures and that unit labour cost growth had been noticeably higher than its 20-year average in both countries. In the United States, this had contributed to a pick-up in core inflation over the past six months or so. In Japan, core inflation had remained around its highs of recent years, although it had declined a little since the beginning of 2016. Japanese inflation expectations had declined markedly over the past year and the Bank of Japan had revised down its GDP and inflation forecasts at its most recent policy meeting. Improvements in labour market conditions in the euro area had not yet been sufficient to increase wage and unit labour cost growth. Core inflation had declined further in year-ended terms in recent months and remained below the European Central Bank's target.
Members commenced their discussion of developments in financial markets by noting that market expectations about the timing of monetary policy tightening by the US Federal Reserve had changed markedly during the past month. Expectations of a tightening in the near term had increased following the release of the minutes of the April meeting of the Federal Open Market Committee, but had subsequently declined after the release of the lower-than-expected US employment data for May. At the time of the meeting, market pricing implied that a policy tightening was likely only by around the end of the year.
The main effect of the swings in market expectations about US monetary policy had been on exchange rates. There had been a broad-based appreciation of the US dollar as expectations of tightening increased, which was partly reversed following the release of the US employment data.
The Chinese renminbi had been little changed over the past month on a trade-weighted basis. The People's Bank of China had generally been setting the renminbi fixing rate against the US dollar lower to offset the broad-based US dollar appreciation. Members noted that the decline in Chinese foreign currency reserves had ceased in the previous two months.
Reflecting changes in the current and expected stance of both domestic and US monetary policy, the Australian dollar depreciated by around 4 per cent against the US dollar and by around 3 per cent on a trade-weighted basis over the past month, to be a little above its January lows.
Uncertainty about the outcome of the upcoming referendum on whether the United Kingdom should exit the European Union had resulted in an increase in forward-looking measures of volatility in the UK pound exchange rate against the US dollar.
Sovereign bond yields had been generally steady over the past month, before dropping sharply in most major markets following the softer-than-expected US employment data. Yields on long-term Australian Government Securities had also declined to reach an all-time low in early June, and the spread to US Treasuries had narrowed.
Global equity indices were broadly unchanged over the past month, while emerging market share prices had declined a little. The Australian share market had outperformed other markets, supported by the reduction in the cash rate in May, although resource companies' share prices had declined in line with iron ore prices.
Bond issuance by Australian banks had been strong over the past month, with issuance of hybrids particularly large.
Following the 25 basis point cut in the cash rate in May, most deposit and lending rates had been reduced by 25 basis points. This reversed the rate increases in 2015 to borrowers for owner-occupier housing, while borrowers for investor housing continued to pay higher rates than a year earlier. Members observed that although the rates being paid by most borrowers had moved lower as a result of the reduction in the cash rate, banks' serviceability requirements for borrowers had not changed.
Pricing in domestic financial markets indicated that there was a very low chance of a reduction in the cash rate at the present meeting.
Considerations for Monetary Policy
In considering the stance of monetary policy, members noted that, as had been previously expected, Australia's trading partners were likely to grow by a bit less than average in 2016 and 2017. In year-ended terms, growth had continued to moderate in China and much of east Asia, while growth in the United States and the euro area had continued at, or a little above, trend and had been accompanied by further declines in unemployment rates. Monetary policy was very accommodative in the major economies and was expected to remain so given that inflation was below most central bank targets. Members noted that conditions in global financial markets had generally been calmer over recent months following the period of volatility early in the year.
The Australian dollar had depreciated noticeably since the previous meeting, following the reduction in the cash rate and the publication of the Bank's revised inflation outlook in the May Statement on Monetary Policy. An increase in expectations of a tightening in US monetary policy had also played a role, as had the decline in commodity prices, which was consistent with expectations that the rally in bulk commodity prices in early 2016 would unwind at some point.
Recent data on the domestic economy had generally been positive. GDP growth had picked up in the March quarter to be about ½ percentage point stronger than expected. Growth over the year had increased to be a bit above estimates of potential growth, reflecting a stronger expansion in non-mining activity. This was being supported by low interest rates and the depreciation of the exchange rate since 2013. Further declines in mining investment had been largely offset by strength in net resource exports. Members noted that an appreciation of the exchange rate could complicate the adjustment of the economy to the lower terms of trade.
The pick-up in output growth was broadly consistent with the decline in the unemployment rate from 6¼ per cent to 5¾ per cent over the year to the March quarter. More timely labour market data indicated that the unemployment rate had remained around 5¾ per cent, but that employment growth appeared to have lost some momentum following very strong growth in late 2015, which was largely as expected. While the latest suite of data had confirmed that labour cost pressures remained subdued in the March quarter, a few of the wage measures were slightly more positive. Nevertheless, inflation was expected to remain low for some time.
In the housing market, there continued to be indications that the effects of supervisory measures had strengthened lending standards, with a number of lenders taking a more cautious attitude to lending in certain segments. Housing prices had begun to rise again recently, particularly in Sydney and Melbourne. The extent of future rises, however, was likely to be affected by the considerable supply of apartments scheduled to come on stream over the next couple of years. In recent months, the pace of housing credit growth had edged down further, having peaked towards the end of last year, while growth in credit to businesses had increased over the past year.
Given these developments, and following the reduction in the cash rate in May, the Board judged that leaving the stance of monetary policy unchanged at this meeting would be consistent with sustainable growth in the economy and inflation returning to target over time.
The Board decided to leave the cash rate unchanged at 1.75 per cent.