Minutes of the Monetary Policy Meeting of the Reserve Bank Board
Sydney – 6 September 2016
Glenn Stevens AC (Governor and Chair), Philip Lowe (Deputy Governor), John Akehurst, Kathryn Fagg, Ian Harper, Allan Moss AO, Heather Ridout AO, Catherine Tanna
Nigel Ray (Deputy Secretary, Macroeconomic Group, Treasury) attended in place of John Fraser (Secretary to the Treasury) in terms of section 22 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)
Governor – Final Meeting
Members noted that this was the final meeting for Glenn Stevens AC.
On the occasion of his final meeting after 10 years as Governor and Chair of the Board, members warmly congratulated Glenn Stevens for his outstanding service to the Bank and to the nation. Prior to being appointed Governor in 2006, Mr Stevens had served as Deputy Governor for almost five years and had presented to the Board regularly as Assistant Governor (Economic) between 1997 and 2001. The Governor-designate, Philip Lowe, paid tribute to Mr Stevens' exceptional contribution to the deliberations of the Board over this long period. On behalf of all members, he expressed appreciation and admiration for Mr Stevens' professionalism and integrity, his thoughtful and consultative approach to policymaking and for the exceptional judgements he made during a challenging period for the global and Australian economy. Members recorded their appreciation of Mr Stevens' dedication to public policy in a career spanning more than three decades and wished him well for the future.
Domestic Economic Conditions
Members commenced their discussion of domestic economic conditions by noting that the prices of Australia's commodity exports had increased since the previous meeting and were around 30 per cent above the lows of early this year. Further reductions in production of bulk commodities by high-cost producers in China had contributed to these price increases. Reflecting the rise in commodity prices since earlier in the year, the terms of trade had increased in the June quarter.
The ABS capital expenditure survey and measures of work done on non-residential construction indicated that mining investment had continued to fall in the June quarter, in line with the forecast presented in the August Statement on Monetary Policy. The estimate of nominal investment intentions from the capital expenditure survey implied a further large decline in mining investment in 2016/17, in line with earlier expectations. However, the peak subtraction from GDP growth was still expected to have occurred in 2015/16 and members noted that there had been some signs of an improvement in sentiment in parts of the mining industry.
Members observed that developments in commodity prices and mining investment had continued to have significant effects on economic activity in resource-rich regions of the country and that the effect of the spillovers from the decline in mining investment and commodity prices would persist for some time. The regional differences had been apparent in labour market outcomes. Members noted that a decline in full-time employment since the beginning of the year had been recorded in New South Wales, Western Australia and Queensland, but that part-time employment growth had been broadly based across the country. The relative strength of part-time employment had partly reflected growth in industries that have a higher proportion of part-time jobs, such as household services, although liaison contacts had also reported that employers more generally had been taking a cautious approach to hiring. Forward-looking indicators suggested that employment growth would remain relatively subdued in Western Australia and Queensland but would be stronger elsewhere. Overall, the forward-looking indicators were consistent with little change in the unemployment rate in the coming months; the unemployment rate had fallen slightly in July to 5.7 per cent.
Growth in the aggregate wage price index (WPI) had stabilised at low levels; the private sector WPI had increased by 0.5 per cent in each of the past six quarters. Growth in the WPI had continued to be lowest in the mining-exposed industries and states, although it also looked to have stabilised in these areas.
Members noted that the June quarter national accounts, which would be released the day after the meeting, were expected to record moderate GDP growth. Net exports were expected to have made a smaller contribution to GDP growth following strong growth in resource exports in the March quarter, whereas data released during the meeting indicated that public demand had made a noticeable contribution in the June quarter. Over the first half of the year, GDP growth had been expected to have been close to estimates of potential, which was consistent with the slight change in the unemployment rate that had been observed over that period.
Growth in household consumption was expected to have remained around average in the June quarter. Household perceptions of their personal finances had continued to be above average, although growth in retail sales had declined slightly in recent months. Members discussed the effect of lower interest rates on consumption growth via the cash flow channel of monetary policy. They noted that the positive effect of lower interest rates on the disposable income of borrowing households is larger than the negative effect on the income of lender households, as the average borrower household has two-to-three times more net interest-bearing debt than the average lender household has in net interest-earning assets. In addition, on average, borrower households are likely to be significantly more responsive to changes in income that are related to changes in interest rates because they are more likely to be liquidity constrained. Members noted that, since the global financial crisis, borrower households have been likely to use more of an increase in their cash flow from any source to prepay their debt, which might imply a delay in the response of consumption spending to lower interest rates.
Private residential building approvals had increased in July, to be around the high levels observed in 2015, and there continued to be a significant amount of work in the pipeline. Members noted that this could be expected to support high levels of dwelling investment for some time.
Conditions in established housing markets had generally eased over 2016. Growth in housing prices had declined at the national level and across most capital cities over the past year, although there remained considerable variation by location. Housing prices had been declining in year-ended terms in Perth for some time. In the rental market, inflation had remained around historical lows and had also eased across most capital cities, most notably in Perth, where rents had continued to decline. The aggregate rental vacancy rate had drifted higher and was close to its long-run average.
Other indicators for the housing market had also generally pointed to weaker conditions than a year earlier. In the established housing market, the number of auctions had declined and remained lower than a year earlier, even though auction clearance rates had increased of late (particularly in Sydney). In the private treaty market – where, nationally, over 80 per cent of transactions occur – turnover had also declined since the previous year and the average number of days that a property was on the market had been on an upward trend. Members noted that sales of new properties were included in the turnover data, but that there might be measurement problems related to the long lag between purchasing and settling new properties bought off the plan, which could lead to revisions. Finally, in recent months the value of housing loan approvals had been broadly steady and housing credit growth had been lower than a year earlier, consistent with the earlier tightening in lending standards and low turnover.
Business investment had fallen further in the June quarter, driven by a decline in mining investment in line with earlier expectations. The ABS capital expenditure survey also indicated that non-mining business investment had been little changed over the past couple of years. Members noted that uncertainty about future demand growth still appeared to be weighing on non-mining business investment. The pipeline of non-residential construction work had remained low, although non-residential approvals had increased a little in recent months and survey measures of business conditions and capacity utilisation had remained above their long-run averages. Growth in business credit had eased a little, although non-mining profits looked to have increased.
International Economic Conditions
Growth in Australia's major trading partners had been a little below its decade average over the first half of 2016, which was in line with expectations at the time of the August Statement on Monetary Policy. Conditions in the global industrial sector remained subdued but looked to have stabilised recently. GDP growth in the major advanced economies had been close to, or above, trend over the past year and labour market outcomes had continued to improve. Globally, inflation remained low and below most central banks' targets. Members noted, however, that the weighted average of core inflation for the economies from which Australia sources its imports had been around its longer-term average and that movements in Australian dollar import prices had been dominated by changes in the exchange rate rather than global price developments.
Growth in China had continued to decline. Ongoing overcapacity in mining and parts of the manufacturing sector had resulted in much weaker output and investment growth in those industries compared with other parts of the economy, which had been more resilient. However, producer prices had ceased declining in a number of these sectors, possibly indicating some reduction in overcapacity. Residential property market conditions and residential investment growth had picked up in the first half of the year, but appeared to have eased recently. More broadly, there had been some easing of growth in financing to the real economy in recent months.
Year-ended growth in Japanese GDP had remained above estimates of potential growth, which had declined to a very low rate partly as a result of rapid population ageing. Growth in exports and business investment had remained weak. The government had announced fiscal stimulus measures, which were expected to provide some support to activity over the coming year. Across the rest of east Asia, growth in GDP had picked up a little in the June quarter, but remained below average in year-ended terms. In the high-income east Asian economies, where growth had been relatively subdued, monetary and fiscal policy measures had been implemented to support domestic demand. In the United States, output had risen modestly in the June quarter and growth had eased in year-ended terms, but had remained close to estimates of potential growth. GDP in the euro area had continued to grow at an above-trend rate.
Labour market conditions had improved in many advanced economies. The Japanese labour market remained very tight and unit labour costs growth had increased relative to long-term averages, yet both headline and core inflation in year-ended terms had fallen over the past six months or so. In the United States, the unemployment rate was around estimates of full employment and this appeared to be putting some upward pressure on wages. Members noted that growth in unit labour costs had picked up, reflecting a decline in productivity growth, which had also been evident in a number of other advanced economies. Despite this, core and headline inflation in the United States had been little changed in recent months and remained below the Federal Reserve's inflation goal. In the euro area, the unemployment rate had declined gradually since 2013 and employment growth had been increasingly driven by full-time employment, but wage growth had remained low and inflation had continued to be below the European Central Bank's target.
Members commenced their discussion of developments in financial markets by noting that it had been a relatively quiet month in financial markets, with low turnover in a number of markets.
Commentary by US Federal Reserve officials had slightly raised market expectations of an increase in the federal funds rate, with market pricing indicating that the probability of an increase by the end of the year was high. Members were briefed on the easing measures announced by the Bank of England (BoE) at its August meeting, which included a reduction in the policy rate, the introduction of a term funding scheme for banks and two bond purchase programs. These measures were projected to result in an expansion of the BoE's balance sheet over 2017, although the BoE's asset holdings as a share of GDP were projected to remain lower than those of the European Central Bank, and well below those of the Bank of Japan (BoJ). Nevertheless, the share of government securities outstanding held by the BoE was relatively high. Members noted that the BoJ had announced that it would publish a comprehensive review of policy effectiveness at its September meeting.
Members noted that the yield curve in the United Kingdom had shifted down markedly since the start of 2016, with around half of this shift having occurred after the June referendum. Japanese government bond yields had been largely unchanged since rising significantly following the BoJ's decision in late July to provide little additional stimulus. Yields on 10-year Australian government bonds had reached a record low following the Board's decision to lower the target cash rate in August and the spread to US Treasuries had also narrowed to its lowest level in around 15 years.
Corporate bond spreads in the United Kingdom had narrowed after the BoE announced that, as part of its suite of easing measures, in September it would begin purchasing investment grade bonds issued by non-financial corporates. Issuance of sterling-denominated bonds by UK corporates had increased strongly in August.
Members were briefed on the continued impact of the BoJ's stimulatory policy and US money market reforms on global funding markets. The cost of borrowing US dollars in short-term money markets had risen further over the past month, ahead of the implementation of US money market reforms in October. The cost of borrowing US dollars in exchange for yen and some other currencies in short-term foreign exchange swap markets had also remained elevated. This appeared to reflect strong demand from Japanese investors and banks as they searched for yield in light of the BoJ's quantitative easing measures. The profitability of lending Australian dollar securities for cash, swapping the proceeds into yen and purchasing Japanese government bonds had pushed Australian short-term secured lending rates higher. Members noted that, prior to the meeting, these developments had had little effect on Australian banks' funding costs – the spread of the bank bill swap rate to the overnight index swap rate had declined in recent months.
While currency markets had continued to be influenced by monetary policy developments in the advanced economies, there had been little change in the Japanese yen, Chinese renminbi or Australian dollar exchange rates over the past month.
Global equity markets had been little changed over the past month, while Australian equity prices had declined a little, as profit results had been generally somewhat weaker than expected in most sectors.
Members noted that the reductions in the cash rate in May and August this year had now been largely passed through to deposit rates, with the exception of rates on term deposits, which account for around 20 per cent of banks' overall funding. Term deposit interest rates for maturities of less than one year, which account for the vast majority, had been little changed during 2016. While rates on term deposits for longer maturities had increased in August, these make up only around 2 per cent of major banks' funding.
Australian banks' bond issuance had remained strong in August and costs of this funding had declined further.
Members observed that around half of the reduction in the cash rate in August had been passed through to housing and business lending rates.
Pricing in domestic financial markets indicated that there was little chance of a reduction in the cash rate at the present meeting.
Considerations for Monetary Policy
Members observed that the data for the international and domestic economies over the past month had been broadly consistent with the forecasts published in the August Statement on Monetary Policy.
Growth in Australia's major trading partners had been slightly below average. Growth had eased a little further in China and had remained relatively subdued in the higher-income economies in the Asian region. There appeared to have been some reduction in mining production in China, which had contributed, in part, to an increase in commodity prices over the course of this year. Labour market conditions had continued to improve in several advanced economies, but inflation had remained lower than central banks' targets. Globally, monetary policy remained very accommodative. Members noted that in the United States there had been some signs of gradually rising wage pressures and employment growth had been strong of late. This had led financial markets to increase their assessment of the likelihood of a rise in the US federal funds rate before the end of the year.
Financial markets had continued to function effectively and funding costs for high-quality borrowers remained low.
Domestically, recent data suggested that growth had been around estimates of potential growth over the first half of 2016, despite further large falls in business investment. Interest-sensitive sectors of the economy were being supported by accommodative monetary policy. The lower exchange rate since 2013 was continuing to support activity in the traded sector of the economy, though an appreciating exchange rate could complicate the necessary adjustments in the economy.
The unemployment rate had been little changed at around 5¾ per cent over 2016 and employment growth had been steady at around 2 per cent in year-ended terms. Strong growth in part-time employment had been apparent in most states, while full-time employment had fallen in the mining-exposed states. Forward-looking indicators had been consistent with only a slight change in the unemployment rate in coming months. Domestic cost pressures, including wage growth, had remained low and were expected to remain so for some time.
Housing market conditions overall appeared to have eased since the previous year, although the dwelling construction cycle remained in a strong upswing. The best available information suggested that housing prices had risen modestly over the past year and turnover had been below average. Consistent with this and supervisory measures that had strengthened lending standards in the housing market, housing credit growth had slowed over 2016. Members noted that there continued to be a considerable volume of apartments scheduled to be completed over the next couple of years, particularly in the eastern states.
Taking into account the recent data, and having eased monetary policy at its May and August meetings, the Board judged that the current stance of monetary policy was consistent with sustainable growth in the Australian economy and achieving the inflation target over time.
The Board decided to leave the cash rate unchanged at 1.5 per cent.