Minutes of the Monetary Policy Meeting of the Reserve Bank Board
Sydney – 5 July 2016
Glenn Stevens AC (Governor and Chair), Philip Lowe (Deputy Governor), John Akehurst, John Edwards, Kathryn Fagg, John Fraser (Secretary to the Treasury), Allan Moss AO, Catherine Tanna
Members granted leave of absence to Heather Ridout AO 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), Marion Kohler (Deputy Head, International Markets and Relations, International Department)
Anthony Dickman (Secretary), Andrea Brischetto (Deputy Secretary)
Members commenced their discussion of developments in financial markets by noting that financial markets had been volatile around the time of the UK referendum on EU membership. Despite large intraday movements in prices and much greater than normal volumes, market functioning had been resilient. Members noted that this event had provided a significant stress test of market structure in the wake of the regulatory reforms introduced after the financial crisis.
The most noteworthy developments that had persisted beyond the volatility immediately surrounding the UK referendum were the depreciation of the pound, the appreciation of the yen and the decline in bond yields to historic lows in a number of major markets as well as in Australia. Sovereign yields in the United Kingdom had declined considerably, notwithstanding the UK's credit rating being downgraded. Members noted that a sizeable share of the global sovereign bond market was trading at negative rates. Swiss government bond yields were negative up to a tenor of nearly 50 years. In Australia, the 10-year bond yield reached a record low of 1.95 per cent, with the decline in the yield on Friday, 24 June having been the largest daily fall since September 2001. Some bond spreads for financial institutions in the United Kingdom and Europe had widened a little, but most other financial market movements in response to the referendum had subsequently been unwound.
Expectations for the path of monetary policy in the United States had already eased prior to the UK referendum, with the Federal Open Market Committee (FOMC) keeping monetary policy unchanged at its 15 June meeting owing to concerns about a slowing in the US labour market as well as uncertainties surrounding the UK referendum. Following the referendum, market expectations had declined further so that the FOMC was not expected to raise its policy rate again before 2018. Both the Bank of England and the European Central Bank (ECB) were expected to ease monetary policy further in the near future. The ECB had commenced its corporate bond purchase program in June, as had been announced in March.
Following the UK referendum, the pound fell sharply to its lowest level against the US dollar in over three decades. On 24 June, the pound depreciated against the US dollar by as much as 12 per cent and recorded the largest single-day movement since the pound was floated in 1971. Throughout the day, there were large volumes traded in both directions. Members noted that, as at the time of the meeting, the pound had depreciated by 9 per cent in trade-weighted terms since the referendum but remained above the levels it had reached in 2008.
Over the past month as a whole, the US dollar and euro were little changed in trade-weighted terms, while the Chinese renminbi had depreciated in both trade-weighted terms and against the US dollar. A decline in the value of the People's Bank of China's foreign currency reserves in May appeared to have reflected valuation effects, but overall the value of reserves had been broadly stable over the past few months.
The Australian dollar had appreciated against the US dollar and in trade-weighted terms over the past month, having been affected by changing expectations about the future path of monetary policy in Australia and the United States, as well as the UK referendum result.
Global share prices fell sharply following the UK referendum, but, with the exception of Japan and Europe, had subsequently largely recovered. Banking share prices were generally lower, particularly those of European and domestically focused UK banks. Members noted that ongoing problems in the Italian banking system had again come to the fore. In Australia, share prices had declined by around 4 per cent over the course of the 2015/16 financial year, with divergent outcomes across sectors reflecting the continued rebalancing of the economy following the mining investment boom.
Spreads on Australian bank debt had moved marginally higher following the UK referendum, but yields had remained at low levels. Members observed that Australian banks had issued a large amount of debt earlier in the year, limiting the need for further issuance in the near term if conditions in debt markets were unsettled. Average outstanding housing lending rates were expected to continue to edge lower as loans were refinanced following the cash rate reduction in May, although members noted that banks' serviceability requirements for borrowers had not changed.
Members noted that market pricing had assigned only a small chance of a reduction in the cash rate at the present meeting.
International Economic Conditions
Members noted that, while the UK referendum decision was likely to have an adverse effect on the UK economy, it was too early to gauge the size of that effect. Also, any adverse effects on growth arising from a reduction in access to EU markets and heightened political uncertainty were likely to be offset to some extent in the near term by the depreciation of the pound. In 2015, around one-half of the United Kingdom's exports (12 per cent of GDP) went to EU countries. Around one-half of these exports were services, of which around one-third were financial services. Estimates from the International Monetary Fund had suggested that in a relatively pessimistic scenario, in which output in the United Kingdom was around 5 per cent lower than otherwise over three years, global growth could average a little more than 0.1 percentage points lower over the next few years. Members noted that the direct effect on the Australian economy was likely to be quite small, given that only around 3 per cent of Australia's exports went to the United Kingdom and around 4½ per cent went to the rest of the European Union.
Meanwhile, growth in Australia's major trading partners looked to have remained a little below average over recent months. Growth in global industrial production had remained weak in year-ended terms, while growth in merchandise trade had picked up slightly. Inflation had generally remained below most central banks' targets, although core inflation in the major advanced economies had picked up since the previous year as labour market conditions had tightened further. Overall, commodity prices had risen over the month to be well above the low levels reached around the turn of the year.
GDP growth in the United States appeared to have picked up in the June quarter, after moderating in the March quarter, and the gradual recovery in the euro area looked to have continued. In both economies, activity in the March quarter had been driven by relatively strong growth in household consumption. Members noted that business investment had contributed to growth in the euro area and in the United States (excluding the energy sector). Growth in business investment in the United Kingdom had been moderating, which may have been partly related to the effect of uncertainty leading up to the UK referendum.
Although US employment growth had moderated in May, the unemployment rate had declined to be below estimates of its long-run equilibrium. Inflation remained below the Federal Reserve's inflation goal, although it was higher than it had been a year earlier. The unemployment rate had also declined further in the euro area, although considerable spare capacity remained. Inflation had continued to be well below the ECB's target of 2 per cent or a little below. In the United Kingdom, the unemployment rate had fallen to around long-run equilibrium levels and core inflation had been picking up.
Recent data suggested that economic growth in China had continued to ease. Subdued conditions in the mining and manufacturing sectors had contributed to weakness in private investment. The output of some key industrial products, including steel, had been little changed over the past year, although iron ore imports from Australia had increased further. Members noted that the general weakness in industrial activity had been partly offset by an increase in public sector spending, which had been particularly apparent in the strong growth of public infrastructure investment over the past year or so. Dwelling investment had also picked up since late 2015, following measures by the Chinese authorities to support demand for real estate. Buoyant property market conditions, particularly in some larger cities, had more recently prompted authorities in some regions to introduce measures to constrain housing demand. Total social financing flows had moderated in recent months and overall inflationary pressures remained subdued.
In Japan, conditions in the labour market remained tight and base wages were rising at an above-average pace. However, inflation was still below the Bank of Japan's target of 2 per cent. In the rest of east Asia, recent data pointed to a continuation of below-average growth. Economic conditions had been relatively subdued in the higher-income economies in the region, in part reflecting their greater exposure to trade.
Domestic Economic Conditions
Members observed that there had been relatively little new data on the Australian economy since the previous meeting, most of which had related to labour and housing markets. Overall, the available data for the June quarter were consistent with a moderation in GDP growth following the stronger-than-expected outcome in the March quarter, mainly because there appeared to have been a smaller contribution to growth from net exports in the June quarter. Trade data suggested that iron ore export volumes had declined from very high levels in April and May, while coal export volumes had increased marginally.
Consumption had grown at around its decade-average rate in the March quarter. More recent indicators had been mixed. The value of retail sales had increased only slightly in April and May but liaison indicated that growth in retail sales had picked up in June, partly because cold weather had boosted clothing and apparel sales. However, liaison had also pointed to ongoing pressure to discount prices in response to increased competition in some retail markets. Meanwhile, survey measures of households' perceptions of their own finances had increased in May and June, to be clearly above average.
Survey measures of business conditions and capacity utilisation had remained noticeably above their long-run averages in May. Members noted that these indicators were consistent with data and evidence from liaison suggesting that non-mining business investment had been growing in some parts of the economy that were less exposed to the effects of the decline in commodity prices and the fall in mining investment. Business credit growth was higher than a year earlier, despite easing a little recently. Liaison had suggested that the outlook for investment was relatively favourable in some commercial property sectors including retail, hotels, student accommodation and aged care. However, non-residential building approvals had remained at relatively low levels over the past year.
The unemployment rate had remained steady at around 5¾ per cent for some months, having fallen by around ½ percentage point over 2015, and the participation rate had been little changed of late. Following strong outcomes in late 2015, employment growth had moderated to be around its long-run average in year-ended terms. Over the course of 2016, employment growth had been driven by part-time jobs, while full-time employment had retraced some of its earlier strong gains. Members noted that, over the past year or so, the underemployment rate (which captures those who are employed but wanting and available to work more hours) had not fallen to the same extent as the unemployment rate. Employment growth had been relatively strong in the household services sector since the beginning of 2016 and construction employment had been rising. The forward-looking indicators of employment had been slightly weaker over recent months following gains over the preceding year, but were still consistent with employment growth in the months ahead.
Housing prices in June had risen moderately in Sydney but had declined in some other capital cities. This followed unusually large increases recorded in April and May, particularly in Sydney and Melbourne. Other indicators of housing market activity had been mixed over recent months. Auction clearance rates and sales volumes had been lower than a year earlier, although both remained a little above average. Housing credit growth had eased further, consistent with a relatively low level of turnover in the housing market and the earlier tightening in lending standards.
Recent indicators suggested that dwelling investment had continued to grow strongly, particularly for higher-density dwellings. Looking through the volatility of the data, building approvals were a little lower than a year earlier but remained elevated and implied a considerable amount of work yet to be done. At the same time, a number of measures were being implemented that could dampen foreign investors' demand for new dwellings. Several state governments had increased or were preparing to increase taxes on foreign investors in housing, while the major banks had increased restrictions on housing loan approvals for applicants relying on foreign income. Nationally, growth in rents had declined over the past year to low levels and the vacancy rate had increased to around its long-term average.
Measures of inflation expectations – from consumers, market economists, union officials and financial markets – had remained below average.
Considerations for Monetary Policy
GDP growth in Australia's major trading partners looked to have remained slightly below average over recent months, in line with earlier forecasts. GDP growth in China appeared to have eased further, which was continuing to affect economic conditions throughout the Asian region. Monetary policy remained very accommodative across the major economies and was expected to remain so given that inflation was below most central banks' targets, despite improvements in labour markets leading to full employment in several large advanced economies.
The United Kingdom's vote to leave the European Union had led to considerable financial market volatility, which had since settled. Financial markets had functioned effectively throughout the episode and borrowing costs for high-quality borrowers remained low. Any effects of the referendum outcome on UK and global economic activity remained to be seen. In any event, the referendum result implied a period of uncertainty about the outlook for the United Kingdom and the European Union. In the absence of significant financial dislocation, the staff's central case was that this uncertainty was expected to have only a modest adverse effect on global economic activity.
Commodity prices had generally increased since the previous meeting. At the time of the present meeting, the Australian dollar (in trade-weighted terms) was around the levels assumed in the forecasts at the time of the May Statement on Monetary Policy.
In the domestic economy, the transition of economic activity to the non-resources sector was now well advanced and recent data suggested that growth had continued at a moderate pace in the June quarter. Low interest rates were continuing to support household spending and the lower exchange rate since 2013 had continued to assist the traded sector of the economy. Members noted that an appreciating exchange rate could complicate the necessary economic adjustments.
Recent data showed that conditions in the labour market had been more mixed of late. The unemployment rate had remained around 5¾ per cent for most of 2016, having fallen noticeably over 2015. Inflation was still expected to remain quite low for some time given very subdued growth in labour costs and very low cost pressures elsewhere in the world.
Indicators of conditions in housing markets had been somewhat mixed over recent months. Housing prices were recorded as having risen in Sydney and Melbourne in April and May, but were little changed in June. Building approvals remained elevated at levels that would add to the considerable amount of dwelling construction work already in the pipeline. Considerable supply of apartments was scheduled to come on stream over the next few years, particularly in the eastern capital cities. At the same time, however, housing credit growth had eased, in line with a lower turnover of housing and the earlier tightening in banks' lending standards following the announcement of supervisory measures. Various state government measures and changes to bank lending requirements were likely to temper foreign investor demand for housing.
Taking account of the available information, the Board judged that holding monetary policy steady would be the most prudent course of action at this meeting. The Board noted that further information on inflationary pressures, the labour market and housing market activity would be available over the following month and that the staff would provide an update of their forecasts ahead of the August Statement on Monetary Policy. This information would allow the Board to refine its assessment of the outlook for growth and inflation and to make any adjustment to the stance of policy that may be appropriate.
The Board decided to leave the cash rate unchanged at 1.75 per cent.