Minutes of the Monetary Policy Meeting of the Reserve Bank Board
Sydney – 6 December 2016
Philip Lowe (Governor and Chair), Guy Debelle (Deputy Governor), John Akehurst, Kathryn Fagg, John Fraser (Secretary to the Treasury), Ian Harper, Allan Moss AO, Heather Ridout AO, Catherine Tanna
Christopher Kent (Assistant Governor, Economic), Chris Ryan (Acting Assistant Governor, Financial Markets), Luci Ellis (Head, Financial Stability Department), Alexandra Heath (Head, Economic Analysis Department)
Anthony Dickman (Secretary), Andrea Brischetto (Deputy Secretary)
Domestic Economic Conditions
Members commenced their discussion of the domestic economy by noting that the unemployment rate was unchanged at 5.6 per cent in October, somewhat more than ½ percentage point below its peak in mid 2015. Despite a rise in full-time employment in October, all of the growth in employment over 2016 had been in part-time employment, with an increased share of people in the labour force reporting that they would like to work more hours. Members discussed various measures of labour underutilisation, including those that account for the number of hours sought by the unemployed and the additional hours desired by those who are underemployed (and who are also recorded as actively searching for additional hours). Such hours-based measures of underutilisation had declined to a similar extent as the unemployment rate since late 2015 and, unlike the heads-based measure, had not increased recently.
Wage growth had remained low and continued to be lower than implied by the historical relationship with the unemployment rate. The wage price index (WPI) had increased by a little less than expected in the September quarter and year-ended growth in the WPI had eased a little further. Although there had been some evidence from enterprise agreements that growth in construction wages had picked up recently, these agreements covered a relatively small share of the total workforce.
Members noted that the September quarter national accounts would be released the day after the meeting. Based on recent data, GDP growth was likely to be weaker than expected at the time of the November Statement on Monetary Policy and lower in year-ended terms than estimates of potential growth.
Consumption growth was expected to have remained below average in the September quarter. The volume of retail sales, which represent around one-third of total consumption, had been little changed in the quarter, pointing to continued weakness in growth of goods consumption. In contrast, in recent months, the value of retail sales had grown at an above-average pace and liaison with retailers suggested that trading conditions had remained steady. Households' perceptions of their personal finances had remained at above-average levels.
Members noted that the work done on residential construction had fallen in the September quarter, suggesting that the national accounts measure of dwelling investment was likely to have declined in the same period. Although residential building approvals had declined sharply in October, the significant amount of work in the pipeline suggested that the level of dwelling investment activity would remain high. Nevertheless, the contribution of dwelling investment to growth was expected to decline over the forecast period.
Overall, conditions in the established housing market had strengthened over recent months. Members noted, however, that supply and demand conditions had continued to vary across the country. In Sydney and Melbourne, housing price inflation had picked up and auction clearance rates were at high levels. Outside of Sydney, increases in prices of apartments had generally been smaller than increases in prices of detached houses. Investor housing loan approvals had picked up noticeably and credit growth had also increased a little over recent months, particularly in New South Wales. In contrast, housing market conditions had remained weak in Perth. Rental markets had been subdued overall and continued to be particularly weak in Perth.
Business investment looked to have been a little weaker than expected in the September quarter. The ABS capital expenditure survey and separate data on non-residential building work done had suggested that mining investment fell in the quarter. Further falls were anticipated, but the subtraction from GDP growth in 2016/17 was expected to be smaller than in 2015/16. Capital expenditure for the non-mining activity covered by the survey, which is less than half of the activity covered in the national accounts measure of non-mining business investment, was little changed over the year to September. Capital expenditure survey data on investment intentions continued to point to a decline in non-mining investment in 2016/17. Members also noted that, over the past few years, the national accounts had tended to report slightly stronger outcomes for non-mining business investment than implied by the data on capital expenditure intentions. Non-residential building approvals had increased in recent months, but the pipeline of non-residential construction work was low. Private sector survey measures of business conditions and non-mining capacity utilisation had been above their long-run averages, but had eased since earlier in the year.
Export volumes increased in the September quarter, led by service exports. Prices for a number of Australia's key commodities, including coking coal, iron ore and base metals, had increased noticeably over the June and September quarters, which had contributed to the increase in Australia's terms of trade of about 6 per cent over that period. Commodity prices had risen further over November, suggesting that an increase in the terms of trade in the December quarter was likely. Oil prices had increased over recent months, partly in response to announcements by OPEC about reductions to supply.
International Economic Conditions
Growth in GDP of Australia's major trading partners had picked up a bit over recent months, although growth remained a little below average. Members noted that there had been a general improvement in survey measures of global business conditions. They also noted that the downside risks to global inflation appeared to have diminished somewhat, in part because commodity prices had increased significantly over 2016 to date. Prospects for fiscal expansion in some countries had also contributed to expectations that inflation would increase. However, inflation had remained below most central banks' targets and monetary policies had continued to be accommodative.
Economic activity in China had continued to be supported by accommodative financial conditions and public spending, particularly on infrastructure. However, high and rising levels of debt remained a risk to the outlook over the longer term. Members observed that measures had been introduced to dampen housing price inflation in a number of cities and that this posed an additional risk that growth in housing market activity might be lower in the period ahead. Producer prices had increased over the preceding year, following declines over several years, and measures of consumer price inflation had edged higher.
In the United States, GDP growth had been around estimates of potential over the past year. While business investment had been weak, consumption growth had continued to be supported by strong labour market outcomes. Members noted that it was too early to know much about the effect of the outcome of the US Presidential election on the outlook for US economic activity and inflation, or the potential spillovers to other economies. There was uncertainty about the policy agenda of the incoming administration. A range of estimates suggested that the plans for fiscal policy could provide a boost to economic activity over the next few years and place some upward pressure on inflation. Working in the other direction, however, if policies were enacted to restrict trade, there could be significant adverse effects on the economic outlook in the United States and beyond.
Economic activity in the euro area had continued to recover. Members noted that some economies in the euro area were facing larger structural challenges than others. In Italy, the level of GDP remained lower than it had been prior to the global financial crisis, non-performing loans had remained at a high level and gross public debt was around 135 per cent of GDP.
Labour market conditions had continued to tighten in most advanced economies. In the United States, this had led to a modest pick-up in nominal wage growth, but unit labour costs had been rising at an above-average rate. Growth in wages and unit labour costs had also been above average in Japan. In the United States, core inflation had been only a little below the Federal Reserve's goal during 2016, while core inflation in Japan had moderated over the course of the year to date and inflation expectations had remained relatively low. In the euro area, inflation had remained lower than the target of the European Central Bank, but measures of longer-run inflation expectations had stabilised.
Members commenced their discussion of financial markets by noting that there had been some large market movements following the outcome of the US Presidential election, but that movements had been generally orderly and the increase in volatility had been short-lived.
US Treasury yields had risen sharply following the outcome of the US Presidential election, reflecting the assessment in financial markets that the Trump administration's policies overall were likely to boost growth and inflation, although there was considerable uncertainty around this. Sovereign bond yields had also increased in the other major economies, though by less than in the United States. Members observed that the increase in US Treasury yields, while large, was not as large as some other movements in recent decades and yields remained very low by historical standards.
The US Federal Open Market Committee (FOMC) left the policy rate unchanged at its November meeting. Members noted that markets had fully priced in an increase in the policy rate at the FOMC's December meeting and expected a steeper, although still gradual, path for future rate increases owing, in part, to the fiscal stimulus expected to be pursued by the Trump administration.
European sovereign bond spreads to German Bunds had widened ahead of the Italian referendum and upcoming elections in some other countries. There had been little movement in corporate bond spreads in the major economies in the previous month.
Share market indices in the United States fell immediately following the outcome of the US Presidential election, but very quickly recovered to be higher over November as a whole. The sectoral pattern of movements across US stocks reflected the expected effects of the Trump administration's policies as well as higher oil prices. In Japan, the depreciation of the yen and better-than-expected growth had contributed to a rise in share prices. European share prices had declined slightly in November.
Emerging market bonds and equities were generally sold off following the outcome of the US Presidential election, reflecting market expectations of a possible increase in trade protection and increased US dollar debt-servicing costs for firms in emerging market economies, given higher US yields and exchange rate depreciations against the US dollar. The depreciation of the Mexican peso against the US dollar was particularly marked. Several emerging market central banks had intervened in the foreign exchange market. The US dollar had also appreciated against most advanced economy currencies. A notable exception was the appreciation of the UK pound against the US dollar during November.
The Chinese renminbi had appreciated on a trade-weighted basis over November, but had depreciated against the US dollar. Net private sector capital outflows had increased over the September quarter and the Chinese authorities had recently introduced a number of measures to increase scrutiny of capital outflows.
Members noted that the Australian dollar had depreciated by 2 per cent against the US dollar since the previous meeting but had appreciated against the yen and some other Asian currencies, to be little changed on a trade-weighted basis.
Australian government bond yields and share prices rose in November. As in other markets, resource stocks had outperformed the broader market, reflecting higher commodity prices, while high-dividend yielding stocks had fallen owing to higher bond yields. Australian banks' bond issuance was above average in November and strong in 2016 overall. Banks had issued more longer-term bonds in recent years in response to increased demand from investors searching for yield and the forthcoming introduction of new prudential requirements.
Members noted that banks' deposit rates had been little changed during November. While the cost of new bond issuance had increased, it remained below that seen at the start of 2016. Some banks had announced increases to advertised lending rates, mostly for housing and in particular to investors.
Pricing in domestic financial markets indicated that market participants did not expect a reduction in the cash rate at the December meeting.
Considerations for Monetary Policy
In considering the stance of monetary policy, members discussed the policy decisions made throughout the easing phase since late 2011, during which the cash rate had been lowered in aggregate by 3¼ percentage points. The lower rates had helped support the economy in the transition following the mining investment boom and, more recently, had been in response to lower-than-expected inflation. Members discussed the effect of lower interest rates on asset prices and the decisions by households to borrow, particularly given the already high levels of household debt. Over recent years the Board had sought to balance the benefits of lower interest rates in supporting growth and achieving the inflation target with the potential risks to household balance sheets. Members recognised that this balance would need to be kept under review.
Turning to the policy decision for the December meeting, members noted that the international environment had been more positive in recent months, while observing that significant risks to the outlook for global activity persisted. The Chinese economy had remained resilient, supported by expansionary fiscal policy and rapid growth in financing. International financial markets had interpreted the outcome of the US election, specifically the implications for infrastructure spending, as being positive for growth and inflation in the United States. At the same time, there were increased expectations that the Federal Reserve would increase policy rates at the next meeting of the FOMC. Rising commodity prices had also contributed to an assessment that the outlook for global inflation was more balanced than it had been for some time, although inflation remained below most central banks' targets.
Domestically, data that had become available over the previous month indicated that GDP growth in the September quarter was likely to be lower than the forecast at the time of the November Statement on Monetary Policy. Year-ended growth was expected to decline before picking up to be above potential later in the forecast period, supported by low interest rates and the lower exchange rate since 2013. Members noted that these factors had assisted the economy in its transition following the mining investment boom and that an appreciating exchange rate could complicate the adjustment. Falls in mining investment were expected to subtract less from GDP growth over time and resource exports were expected to continue to make a substantial contribution to growth.
There was still considerable uncertainty about the momentum in the labour market. The unemployment rate had declined over the past year, as had measures of excess capacity that accounted for the number of additional desired hours of work. Part-time employment had grown strongly over the previous year, but employment growth overall had slowed. Members noted that there was expected to be excess capacity in the labour market for some time, which was consistent with further indications of subdued labour cost pressures. This suggested that inflation would remain low for some time before returning to more normal levels.
Housing market conditions had strengthened overall over preceding months, although there was considerable variation across the country and between houses and apartments. Housing credit growth had picked up a little, particularly for investors. The supervisory measures that had strengthened lending standards in the housing market had led some lenders to take a more cautious attitude to lending in certain segments. At the same time, the increase in global bond yields had led some lenders to increase their rates on fixed-interest rate loans.
Taking into account the information that had become available over the previous month, and having eased monetary policy earlier in the year, the Board judged that holding the stance of policy unchanged would be consistent with sustainable growth in the economy and achieving the inflation target over time.
The Board decided to leave the cash rate unchanged at 1.5 per cent.