Minutes of the Monetary Policy Meeting of the Reserve Bank Board

Sydney – 4 December 2018

Members Present

Philip Lowe (Governor and Chair), Guy Debelle (Deputy Governor), Mark Barnaba AM, Wendy Craik AM, Philip Gaetjens, Ian Harper, Allan Moss AO, Carol Schwartz AM, Catherine Tanna

Others Present

Luci Ellis (Assistant Governor, Economic), Christopher Kent (Assistant Governor, Financial Markets), Alexandra Heath (Head, Economic Analysis Department), Gianni La Cava (Senior Research Manager, Economic Research Department)
Anthony Dickman (Secretary), Andrea Brischetto (Deputy Secretary)

International Economic Conditions

Members commenced their discussion of the global economy by noting that conditions had remained positive, particularly in the major advanced economies, where growth had remained around or above potential and labour markets had continued to tighten. However, growth in a number of economies had slowed this year; softer external demand, at least partly related to trade tensions and the associated uncertainty, had been a common driver of the slowdown. Bilateral US–China trade had contracted following the increase in import tariffs between the two countries, while indicators of external demand, such as new export orders, had softened in the euro area, Japan and other parts of Asia.

In the major advanced economies, GDP growth outcomes had diverged further in the September quarter, although there had been some loss of momentum in external demand in all regions. In the United States, growth had remained strong in the September quarter, driven in part by fiscal stimulus. In Japan, the pronounced slowing in year-ended GDP growth had been at least partly the result of disruptions in the wake of natural disasters. One-off factors had weighed on growth in some parts of the euro area, and business conditions and investment intentions there had also declined.

Employment growth had remained higher than growth in working-age populations across the major advanced economies and unemployment rates had edged lower from already low levels. Wages growth had continued to increase, but, with the exception of the United States, this had not yet translated into higher inflation in underlying terms. Core inflation had remained below target in the euro area and Japan. Members noted that headline inflation was likely to ease in coming months following the recent decline in oil prices.

Members noted that it had continued to be difficult to gauge the underlying momentum in the Chinese economy. Conditions had remained subdued in a number of sectors, including machinery & equipment production and food & clothing. By contrast, the central authorities' direction to local governments to bring forward public spending had contributed to a rebound in infrastructure investment, and the production of construction-related products had strengthened further. Infrastructure investment was expected to continue to support growth in coming months. Growth in investment in the real estate sector had continued to be driven by land purchases.

Elsewhere in east Asia, surveyed business conditions had remained around average and growth in domestic demand had generally maintained its momentum. However, new export orders had declined and growth in industrial production and export volumes had also eased somewhat in recent months. Growth in the Indian economy had eased in the September quarter, but had remained strong in year-ended terms.

The slowing in global trade and concerns about Chinese demand had been reflected in lower commodity prices over preceding weeks. Iron ore prices had followed the recent decline in Chinese steel prices, returning to levels previously seen in mid 2018. Coking coal prices had increased over the previous month despite the fall in steel prices. Thermal coal prices had declined slightly, while prices of rural commodities and base metals had been little changed.

Members noted that oil prices had declined by more than 30 per cent since their peak in early October, mainly reflecting recent and prospective increases in global supply. Oil supply from the United States had increased rapidly since the trough in oil prices in early 2016 and was expected to increase further, while production from Saudi Arabia and Russia was expected to be sustained at high levels. Members observed that the nature of US oil production allowed supply flexibility in response to changes in oil prices.

Domestic Economic Conditions

Members noted that the national accounts for the September quarter would be released the day after the meeting. Based on the partial data that were available, GDP was expected to have increased by more than 3 per cent over the year to the September quarter, above most estimates of potential growth and in line with the most recent set of Bank forecasts.

In relation to household consumption, members noted that liaison with retailers suggested that underlying trading conditions had been stable and surveys suggested that households' views about their financial situation had remained around average.

Conditions in established housing markets had continued to ease. In Sydney, housing prices had fallen by around 9 per cent since their peak in July 2017, to be around September 2016 levels. In Melbourne, housing prices had returned to levels prevailing around March 2017, having fallen by a little under 6 per cent since their peak in November 2017. Members observed that housing prices had fallen across all price segments in Sydney, but housing prices had been fairly flat at the lower end of the market in Melbourne. Auction clearance rates and indicators of private-treaty activity had also declined a little further in both cities. Housing prices in Perth and Darwin had returned to levels seen a decade earlier. At the same time, price rises were being recorded in some other cities.

Preliminary data suggested that dwelling investment had continued around its recent high level in the September quarter. Given the substantial amount of work outstanding and recent data on dwelling approvals, dwelling investment was expected to remain around this level for at least the following year or so before moderating. Liaison with developers indicated that demand for new detached housing in eastern Australia had eased over the previous year or so and some developers had reported that this decline in demand had become more pronounced. Demand for off-the-plan apartments had declined significantly since mid 2017.

Partial indicators, including the Australian Bureau of Statistics (ABS) capital expenditure (Capex) survey, suggested that both mining and non-mining business investment had declined in the September quarter. Investment intentions for 2018/19 in the non-mining sector, as reported in the Capex survey, had been revised higher. Members noted that these revised expectations were consistent with surveyed business conditions, which had remained above average, and with the relatively high levels of non-residential building approvals and work yet to be done on non-residential construction projects.

Members observed that labour market conditions had continued to improve. Employment had increased solidly in October to be 2.5 per cent higher over the year. This was well above growth in the working-age population and had been driven largely by growth in full-time employment. Leading indicators of labour demand had continued to point to employment growth being above average over the following couple of quarters. The unemployment rate had remained at 5 per cent in October, following the sharp decline in the previous month. Unemployment rates had fallen in almost all states and territories over 2018. In trend terms, the unemployment rates in Victoria and New South Wales were both at their lowest levels in a decade, at around 4½ per cent. Members noted that youth employment (those aged between 15 and 24 years) had increased significantly over the previous year and the youth unemployment rate had declined.

Wages growth had picked up a little in the September quarter. The wage price index (WPI) had increased by 0.6 per cent in the September quarter to be 2.3 per cent higher over the year. This pick-up had built on the small, gradual increases in WPI growth recorded over the previous two years. The 3.5 per cent increase in minimum and award wages had contributed to growth in the September quarter. Joint Reserve Bank–ABS analysis suggested that wages growth for jobs covered by the other two wage-setting methods, namely enterprise agreements and individual agreements, had also been stronger than a year earlier. This job-level analysis had also shown that, although there had been little change over the preceding year in the size of a typical wage increase, the share of the workforce receiving an increase in any given quarter had increased. Year-ended growth in the WPI had picked up compared with the previous year across most industries and in all states and territories.

Even so, average earnings had increased at roughly the same rate as consumer prices over the previous five years or so, leaving real average earnings relatively unchanged despite moderate productivity growth. This had followed an extended period during the resources boom when real average earnings had consistently risen faster than productivity. As a result, the gap between real average earnings and productivity that had opened up during the resources boom had been largely closed.

Members also discussed a paper on some longer-term trends in the division of aggregate income between labour and capital. In Australia, the share of total income paid to workers in wages and salaries (the ‘labour share’) had risen over the 1960s and 1970s but had gradually declined since then. Over the same period, the share of income accruing to profits (the ‘capital share’) had risen. Abstracting from fluctuations associated with the terms of trade cycle, the labour and capital shares had been fairly stable for at least the previous decade. Although the Australian experience appeared to have been similar to that observed in other advanced economies, the factors driving the trends had been somewhat different. Members noted that the long-run increase in the capital share in Australia had stemmed almost entirely from higher profits accruing to financial institutions (since financial deregulation in the 1980s) and from higher rents paid to landlords and imputed to home owners (particularly before the 1990s). Members observed that the increasing use of technology to replace manual effort in the finance sector and long-run increases in the quality and size of homes, as well as a greater number of dwellings per capita, were likely to have contributed to these trends. Members also noted the measurement challenges associated with both financial services and housing services in the national accounts.

Financial Markets

Members commenced their discussion of financial market developments by noting the pick-up in business credit growth in Australia in the second half of 2018. While foreign banks had been the main driver of growth in business lending for some time, the major Australian banks had also made a noticeable contribution to business credit growth in recent months. The pick-up in business lending by the major banks had occurred as growth in their housing lending had continued to slow. Members observed that lending to large businesses had accounted for the bulk of the growth in business credit over preceding years and all of the pick-up in business credit growth in the most recent few months.

By contrast, lending by banks to small businesses had increased only modestly over the preceding few years and had been flat in 2018. Moreover, small businesses' perceptions of their access to finance had deteriorated sharply over the year, according to the Sensis survey. Members noted that the Australian Government had recently announced a number of initiatives to support lending to small businesses.

Turning to housing credit, members noted that growth in lending to investors had remained very weak and growth in lending to owner-occupiers had continued to ease, to be 5–6 per cent in annualised terms. The slowing in housing credit growth had been almost entirely accounted for by the major banks, where the rate of growth in lending had been the slowest in many years. Housing lending by other financial institutions had continued to grow more strongly.

Members observed that the slowing in housing credit growth appeared to reflect both tighter lending conditions and some weakening in demand. On the demand side, declining housing prices in some markets had reduced investor demand. In this context, lenders had continued to compete for borrowers of high credit quality by offering new loans at lower interest rates than those offered on outstanding loans. On the supply side, credit conditions were tighter than they had been for some time. Members noted that the focus on responsible lending obligations in response to the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry was likely to have reduced some lenders' appetite for lending to both households and small businesses.

Mortgage interest rates remained low by historical standards, but had risen a little for many borrowers in previous months, as most lenders had passed on the increase in their funding costs resulting from the rise in bank bill swap rates earlier in 2018.

Members noted that financial market pricing implied that the cash rate was expected to remain unchanged for a considerable period.

Turning to global financial conditions, members noted that financial conditions in the advanced economies remained accommodative, although they had become less so over the course of the year. A few central banks had continued gradually to remove monetary policy stimulus and more recently global equity prices had declined and credit spreads had widened a little (although spreads remained relatively low).

Expectations regarding policy paths of the major central banks implied by financial market pricing had been generally little changed over the previous month. However, in the United States the path for the federal funds rate over 2019 implied by market pricing had moved further below that implied by the median of Federal Open Market Committee (FOMC) members' projections published following the September FOMC meeting. Recent public comments by senior Federal Reserve officials had emphasised that further withdrawal of monetary stimulus would increasingly depend on how the economy evolves.

Members noted that 10-year government bond yields in major markets had declined in November. In part, this was likely to have reflected the lowering of market expectations for the federal funds rate in 2019, as well as the recent sharp decline in oil prices and some easing in expectations for global economic growth. In the United Kingdom, uncertainty surrounding the approval of a Brexit deal was also likely to have weighed on long-term bond yields.

Over the year as a whole, diverging central bank policy paths and economic outlooks had seen bond yields in the United States rise relative to those in Europe and Japan. Consistent with this, the US dollar had appreciated by 5 per cent over 2018 on a trade-weighted basis.

Global equity prices had declined in October reflecting a range of factors, including US–China trade tensions, building cost pressures in some countries and a moderation in earnings growth expectations for 2019. Also, equity valuations in the United States had earlier been somewhat elevated. Members noted, however, that the US equity market continued to be supported by strong growth in underlying corporate earnings, with analysts' expectations for earnings growth in 2019 having been revised down only a little recently. In Europe, ongoing concerns about Italian fiscal policy settings, as well as the moderation in growth in the euro area in 2018, had weighed on equity prices, particularly for companies in the financial sector. Chinese equity prices had been declining throughout 2018, although they had not fallen further in November. The decline over the year was likely to have reflected concerns over US–China trade tensions and an easing in growth in economic activity.

Members observed that US corporate credit spreads had widened a little recently, although they remained low by historical standards. Members noted that this modest tightening in credit market conditions had occurred against a background of increased corporate leverage, with US non-financial corporations having increasingly sourced funding from securities markets over the preceding decade or so. Issuance of investment-grade bonds and, to a lesser extent, leveraged loans had been strong. Members also observed that securities markets had been increasingly facilitating lending to lower-rated corporations. While Europe and Australia had also seen increases in investment-grade bond financing by corporations, banks remained the predominant source of corporate funding in these markets.

Members noted that, although overall corporate leverage in the United States had increased over preceding years, it was not high compared with levels in other economies. Nevertheless, high and rising debt-servicing burdens and the relative increase in debt owed by borrowers of lower credit quality were likely to have increased the vulnerability of the corporate sector to adverse future shocks. On the lending side, the non-bank institutional investors that had recently provided most of the debt financing for corporations tended to have more stable funding and less leverage than banks. Members discussed implications of this for financial stability, given that, by itself, the reduced lending role of banks means that the US financial system would be better placed to withstand a deterioration in credit conditions than in the past. Overall, members agreed that developments in these markets warranted continued monitoring.

In China, growth in total social financing had slowed through much of 2018, mostly due to a contraction in non-bank lending, which had previously been a key source of funding for private firms. This followed earlier measures by the authorities to restrict the availability of credit provided by non-bank entities in order to reduce risks in the financial system. By contrast, growth in bank lending, which historically had been disproportionately directed towards state-owned enterprises, had been stable at a solid rate for a number of years. In recent months, the authorities had been taking steps to encourage banks to increase their lending to the private sector (especially smaller enterprises), although members noted that, relative to smaller banks and non-bank lenders, larger banks were less accustomed to lending to this sector.

Considerations for Monetary Policy

Globally, the economic expansion had continued, although there had been some signs of a slowing in global trade in the September quarter. In China, the authorities had continued to ease policy in a targeted way to support growth, while paying close attention to the risks in the financial sector. Members noted that balancing these considerations remained a key challenge for the Chinese authorities. Globally, inflation remained low, although wages growth had picked up in economies where labour markets had tightened significantly. Core inflation had picked up in the United States, which had experienced a sizeable fiscal stimulus against the background of very tight labour market conditions, but core inflation had remained low elsewhere. Members noted that the significant fall in oil prices was likely to reduce global headline inflation over the following year or so, should it be sustained.

Financial conditions in the advanced economies remained expansionary but had tightened somewhat because of lower equity prices, higher credit spreads and a broad-based appreciation of the US dollar over 2018, as the gradual withdrawal of US monetary policy accommodation had continued. In Australia, there had been a generalised tightening of credit availability. There had been little net growth in credit to small businesses in prior months. Standard variable mortgage rates were a little higher than a few months earlier, while the rates charged to new borrowers for housing were generally lower than for outstanding loans. The Australian dollar remained within its range of recent years on a trade-weighted basis. Australia's terms of trade had increased over recent years, which had helped to boost national income.

Members noted that the Australian economy had continued to perform well. GDP growth was expected to remain above potential over this year and next, before slowing in 2020 as resource exports were expected to reach peak production levels around the end of 2019. Business conditions were positive and non-mining business investment was expected to increase. Higher levels of public infrastructure investment were also supporting the economy. The drought had led to difficult conditions in parts of the farm sector.

The outlook for household consumption continued to be a source of uncertainty because growth in household income remained low, debt levels were high and housing prices had declined. Members noted that this combination of factors posed downside risks. Notwithstanding this, the central scenario remained for steady growth in consumption, supported by continued strength in labour market conditions and a gradual pick-up in wages growth. The unemployment rate was 5 per cent, its lowest level in six years, and further falls in the unemployment rate were likely given the expectation that the economy would continue to grow above trend. The vacancy rate was high and there were reports of skills shortages in some areas.

Conditions in the Sydney and Melbourne housing markets had continued to ease and nationwide rent inflation was low. Growth in housing credit was very weak for investors and had also eased for owner-occupiers, reflecting both tighter lending conditions and some softening in demand. Mortgage rates remained low, and competition was strongest for borrowers of high credit quality.

Taking account of the available information on current economic and financial conditions, members assessed that the current stance of monetary policy would continue to support economic growth and allow for further gradual progress to be made in reducing the unemployment rate and returning inflation towards the midpoint of the target. In these circumstances, members continued to agree that the next move in the cash rate was more likely to be an increase than a decrease, but that there was no strong case for a near-term adjustment in monetary policy. Rather, members assessed that it would be appropriate to hold the cash rate steady and for the Bank to be a source of stability and confidence while this progress unfolds. Members judged that holding the stance of monetary policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time.

The Decision

The Board decided to leave the cash rate unchanged at 1.5 per cent.