Minutes of the Monetary Policy Meeting of the Reserve Bank Board

Hybrid – 1 March 2022

Members participating

Philip Lowe (Governor and Chair), Guy Debelle (Deputy Governor), Mark Barnaba AM, Wendy Craik AM, Ian Harper AO, Carolyn Hewson AO, Steven Kennedy PSM, Carol Schwartz AO, Alison Watkins AM

Others participating

Luci Ellis (Assistant Governor, Economic), Christopher Kent (Assistant Governor, Financial Markets), Tom Rosewall (Deputy Head, Economic Analysis Department)

Anthony Dickman (Secretary), Penelope Smith (Deputy Secretary)

Alexandra Heath (Head, International Department), Bradley Jones (Head, Economic Analysis Department), Marion Kohler (Head, Domestic Markets Department)

International economic developments

Members commenced their discussion of international developments by focusing on Russia's invasion of Ukraine, observing that it was devastating for the people of Ukraine. The invasion had also created additional uncertainty about the global outlook and was an adverse supply shock that would result in lower growth and higher inflation. Members acknowledged that the economic implications of the war depended on the scale and duration of the conflict and the nature of any second-round effects.

Members recognised that the war in Ukraine would pose a significant setback for the recovery in Europe, particularly through the effects of disruptions to energy supply and higher energy prices. It was noted that European gas imports are mostly sourced from Russia, and natural gas prices in Europe had surged. While some gas exports could be redirected from the United States and the Middle East to Europe, this would take time; moreover, capacity constraints and the long-term nature of many gas contracts meant there were limits to the extent to which energy sources could be diverted to Europe.

More broadly, members noted that the surge in prices for energy and other commodities, including food commodities, was a substantial relative price shock, with effects that would fall unevenly across economies. It would redistribute income from energy-importing countries to energy-exporting countries. The energy intensity of many economies had fallen substantially over recent decades, and this would cushion the effects of the energy price shock compared with the 1970s. Even so, the net effect would be lower global output than otherwise. At the same time, further disruptions to global supply chains would lead to higher global inflation in the period ahead.

Members noted that, prior to the invasion of Ukraine, developments in international supply chains had been mixed; supply chains for some goods remained strained or had deteriorated further amid ongoing strong demand, while conditions had eased in other areas. Alongside broad-based price increases in energy-related commodities in recent months, prices for base metals had increased further. Inventories of base metals had been run down because smelters had cut capacity in response to high energy costs. Domestic distribution and production networks had also been significantly disrupted by record-high numbers of workers having needed to isolate because of illness. However, there were other indicators suggesting that supply-chain disruptions had begun to ease: supplier delivery times had edged lower, semiconductor prices were noticeably below previous peaks and motor vehicle production was showing signs of recovering. Members acknowledged that it would take time for supply issues in the global economy to be resolved. The war in Ukraine was adding to these challenges.

Members noted that, before the invasion of Ukraine, the global economy had continued to recover from the COVID-19 pandemic. Accommodative policy settings and strong private sector balance sheets in advanced economies were supporting the global recovery. Growth in Australia's major trading partners had increased to an above-trend pace in the final quarter of 2021, resulting in output being a little above its pre-pandemic level. The effects of the Omicron variant on the global economy were expected to be short-lived; the rate of new infections had already declined across much of the world and mobility had started to rebound. Consumption of services was picking up in advanced economies with more opportunities for discretionary spending.

Members noted that growth in China had picked up in the December quarter, following an earlier regulation-induced slowing in growth. Manufacturing output had strengthened, infrastructure construction had stabilised and consumption growth had remained resilient despite targeted lockdowns to control local COVID-19 outbreaks. Demand for iron ore had been boosted by recent policy easing measures by Chinese authorities, which were expected to support steel-intensive growth, including from infrastructure construction; partly in response, iron ore prices had increased substantially since November. Another indicator of the more supportive policy environment since late 2021 had been the sharp increase in issuance of local government special bonds.

Labour market conditions had tightened further in advanced economies. Labour demand was strong and unemployment rates were near or below pre-pandemic levels. Despite this, wages growth remained contained in most economies, with the United Kingdom and the United States two key exceptions. Stronger wages growth in these economies reflected reduced labour supply in the context of strong labour demand, increased job mobility and flexible wage-setting mechanisms.

Members noted that many economies had been experiencing high inflation before the surge in energy prices arising from the invasion of Ukraine. This complicated the task for policymakers in several jurisdictions. In the United States, inflation had reached a 40-year high, and a number of other advanced economies had recently recorded their highest rates of headline and core inflation in some years. In most advanced economies, this mainly reflected unusually strong goods price inflation (most notably in the United States), although services price inflation had also picked up and was now running above rates prevailing before the pandemic. Price rises for housing services had continued to increase. Inflation had also picked up further in some higher-income Asian economies in recent months; however, inflation remained low in Japan and some emerging Asian economies, where output was generally still some way below pre-pandemic paths.

Domestic economic developments

Turning to domestic economic conditions, members observed that the Australian economy had been resilient in the face of the Omicron outbreak. This had followed a period of particularly strong momentum in activity and the labour market at the end of 2021. COVID-19 case numbers and hospitalisations had both fallen steadily after reaching a peak in mid-January, health-related restrictions had eased and indicators of mobility had recovered sharply. In line with the international experience, the main adverse effect of the Omicron outbreak on the domestic economy had been on labour supply. But these disruptions had been short-lived, with timely data on spending and information from the Bank's business liaison program having suggested that activity and hours worked had begun to recover from late January.

Members noted that firms' investment intentions, as reflected in the Capital Expenditure Survey, implied moderate growth in business investment over the following year or so. Similarly, firms in the Bank's business liaison program had indicated that their investment intentions remained at or above average levels. Business surveys had indicated that around half of firms were experiencing supply-chain disruptions, although the majority of the disruptions were having only a small effect on business operations, and business confidence had picked up in January.

Members noted that conditions in the housing market had been solid overall, if a little more uneven. Approvals for new detached housing and alterations and additions had remained strong over recent months. A large pipeline of work would continue to support housing construction over the following quarters, although supply-chain issues and labour availability were constraining how quickly this pipeline was reduced.

National housing price growth had moderated over recent months, with conditions varying across the country. In the established housing market, new listings in Sydney and Melbourne had picked up and prices had levelled off in recent months. However, in some smaller cities and regional areas, total listings had still been low and price growth had remained strong. Advertised rents continued to increase steadily across many areas of the country, supported by low vacancy rates.

Members noted that labour market conditions were the tightest since 2008 and the outlook remained positive. While the Labour Force Survey had indicated that total hours worked fell by 9 per cent in January, this reflected a higher-than-usual number of employees who were on leave or otherwise unable to work because of illness or the need to isolate. A strong bounce-back in hours worked was expected in the following months alongside further increases in employment, which had been resilient in January. The unemployment rate was unchanged in January at around the lowest level in 14 years. Forward-looking indicators of labour demand, such as job advertisements and employment intentions, including from the Bank's business liaison program, had suggested that a further tightening in labour market conditions was likely in the period ahead. Many firms were continuing to report that the availability of labour had been constraining their ability to expand output. Job mobility had increased, but not to the extent seen in some other economies.

Wages growth had picked up, but only to around its pre-pandemic rate. The Wage Price Index increased by 0.7 per cent in the December quarter to be 2.3 per cent higher in year-ended terms. Private sector wages had increased by 2.4 per cent in year-ended terms, with most industries experiencing wages growth around this rate; including bonuses and commissions, private sector wages growth had increased further to be 3 per cent higher in year-ended terms. Members agreed this was consistent with a tightening in labour market conditions and firms using alternative measures to raising base wages in an effort to attract and retain staff. Public sector wages growth had picked up to 2.1 per cent in year-ended terms, led by scheduled increases in enterprise agreements for several large state employers in New South Wales and Queensland, following a period when wage freezes had applied.

Across industries and states, wages growth outcomes had been unusually tightly clustered in the low-to-mid 2 per cent range. While the share of jobs recording wage increases of 2–3 per cent had recently returned to around pre-pandemic levels, the share of jobs with wage increases above 3 per cent had been little changed in recent quarters. The share of jobs that experienced a wage change was higher than usual for the December quarter in both the public and private sectors, but this largely reflected catch-up following pandemic-related delays to regular pay increases. Information from the Bank's business liaison program had suggested that the distribution of firms' wages growth expectations over the coming year remained similar to the pre-pandemic pattern. Surveys of unions' expectations had also been consistent with wages growth of around 2½–3 per cent over the year ahead. Members agreed that the risks to the outlook for wages growth were skewed to the upside, reflecting the low rate of labour underutilisation; at the same time, there was a high degree of uncertainty about the behaviour of nominal and real wages at historically low levels of unemployment.

Members concluded their discussion of domestic economic conditions by noting that non-labour input cost pressures remained widespread across industries, but were most acute for goods-importing industries. Information from the Bank's business liaison program had suggested that firms were increasingly prepared to pass these higher costs onto their customers, particularly in the construction, manufacturing and retail industries, where upstream cost pressures had been most acute. High international shipping rates had remained a source of cost pressure for firms across many industries. Members agreed that a key issue for the inflation outlook was whether recent price adjustments represented a one-off shift in the level of prices or the beginning of a period of ongoing price increases.

International financial markets

Russia's invasion of Ukraine had adversely affected sentiment in financial markets. Members noted there had been an increase in market volatility. Major equity markets had declined despite generally positive earnings announcements from listed companies. By contrast, the Australian equity market had increased in February, driven by the financial, energy and materials sectors.

In Russia, the market reaction had been pronounced, largely in response to the step-up in global sanctions. Sanctions on the Central Bank of Russia (CBR) had significantly curtailed its ability to use its foreign exchange reserves to support the rouble. The CBR had increased interest rates from 9.5 per cent to 20 per cent after the rouble had depreciated by 30 per cent. Meanwhile, equity prices in Russia had declined significantly and government bond yields had increased sharply.

Over the preceding month, expectations for how quickly central banks in advanced economies would withdraw monetary stimulus had increased because inflation in many advanced economies had continued to be higher than expected. The increase in prices for oil and European natural gas following the invasion of Ukraine had added to near-term inflationary pressures. However, the pace of expected policy rate increases had been pared back modestly.

The US Federal Reserve had indicated that it expected to commence raising its policy rate in March. Market pricing had suggested that the federal funds rate may be increased by as much as 125 basis points during 2022. Similar increases in policy rates were expected to occur this year in Canada, New Zealand and the United Kingdom. In light of the change to the inflation outlook, market participants had expected the European Central Bank to cease its asset purchases this year and to begin increasing its policy rate. By contrast, the Bank of Japan had reaffirmed that it would maintain its highly accommodative policy settings – including the target for 10-year government bond yields – because it was still some way from achieving its inflation target.

Government bond yields had risen further in most markets over the preceding month, reflecting higher expected policy rates and inflation expectations, especially for shorter maturities. Globally, yields on corporate debt had increased by a little more than those on government bonds over the period. Members noted that increasing risk aversion following the invasion of Ukraine had resulted in a decline in sovereign yields over the week preceding the meeting.

The major currencies had been little changed in prior months, following an appreciation of the US dollar during the second half of 2021. The Australian dollar had appreciated a little over the preceding month, but had remained around the lower end of its range over the previous year on a trade-weighted basis.

Domestic financial markets

Members observed that the Board's decision to cease purchases under the bond purchase program in February had been widely anticipated and there had been little reaction to the announcement. Yields on 10-year Australian Government Securities had increased along with those on global sovereign bonds during the preceding two months and were at their highest level in three years. Meanwhile, measures of market functioning had improved. Demand to borrow Australian Government bonds from the Bank, which was supporting market functioning, had increased further.

Shorter-term inflation expectations implied by market prices had increased, while implied longer-term inflation expectations had been little changed. Expectations for policy tightening had increased. Money market pricing had implied that the cash rate would begin to be increased from around the middle of the year, to reach about 1 per cent by the end of 2022 and around 2 per cent by the end of 2023.

While some elements of banks' funding costs had risen, overall they had remained close to historic lows. In particular, bank bond yields and some new term deposit rates had risen, although a high proportion of banks' funding costs were linked to three-month bank bill swap rates, which remained very low. Even though interest rates on new fixed-rate loans had increased sharply over prior months, in line with swap rates, the average rate paid on outstanding housing loans had declined a little further. Growth in credit to owner-occupiers remained strong, while growth in credit to investors had picked up further in prior months. Business credit growth had eased a little in January but remained at high levels, reflecting continued strong growth in lending to large businesses.

Members noted that the Bank planned some operational changes to its regular open market liquidity operations as conditions evolved in a financial environment of substantial system liquidity. These would be operational changes, and would not have any implications for the future path for monetary policy.

Considerations for monetary policy

In considering the policy decision, members noted that the global economy was continuing to recover from the pandemic. However, the war in Ukraine was a major new source of uncertainty. Inflation in parts of the world had increased sharply as a result of large increases in energy prices and disruptions to supply chains at a time of strong demand. In this environment of higher inflation, the prices of many commodities had increased further.

The Australian economy remained resilient and spending was expected to pick up further after the Omicron outbreak. The economic outlook was being supported by household and business balance sheets that were generally in good shape, a large pipeline of construction work to be completed and an expected recovery in business investment. Members agreed that macroeconomic policy settings remained supportive of growth.

Members acknowledged the ongoing resilience of the labour market. The rates of both unemployment and underemployment were at their lowest levels since 2008. Forward-looking indicators of labour demand remained strong, and the staff's central forecast would see the unemployment rate fall to levels not seen since the early-to-mid-1970s. Members observed that wages growth had picked up, but at the aggregate level was only around the relatively low levels prevailing prior to the onset of the pandemic. Wages growth and broader measures of labour costs were expected to increase as the labour market continued to tighten. The pick-up was expected to be only gradual, although members noted the uncertainty about the behaviour of wages as the unemployment rate declined to historically low levels.

Inflation in Australia had picked up, but was still lower than in many other countries. In year-ended terms, underlying inflation was expected to increase further over coming quarters before moderating as supply problems are resolved. However, the war in Ukraine and the associated increase in energy prices had created additional uncertainty about the inflation outlook. Members noted headline inflation would increase by more than underlying inflation in the near term because of the effect of global developments on petrol prices.

Members agreed that financial conditions in Australia remained highly accommodative. Interest rates remained at very low levels, although some fixed rates on new housing and business lending had risen recently. The Australian dollar exchange rate was around its lows of the preceding year or so. Housing prices had risen strongly, although the rate of increase had declined and, in some cities, prices had been steady or declined a little. Members observed that high rates of household saving meant many households had built substantial buffers. Members continued to emphasise the importance of maintaining lending standards and borrowers having adequate buffers.

Turning to the decision for the cash rate, members remained committed to maintaining highly supportive monetary conditions to achieve the objectives of a return to full employment in Australia and inflation consistent with the target. As agreed at previous meetings, the Board will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target band. While inflation had picked up, members agreed it was too early to conclude that it was sustainably within the target band. There were uncertainties about how persistent the pick-up in inflation would be given recent developments in global energy markets and ongoing supply-side problems. Wages growth also remained modest and it was likely to be some time before aggregate wages growth would be at a rate consistent with inflation being sustainably at target. The Board is prepared to be patient as it monitors how the various factors affecting inflation in Australia evolve.

The decision

The Board decided to maintain the cash rate target at 10 basis points and the interest rate on Exchange Settlement balances at zero per cent.