Minutes of the Monetary Policy Meeting of the Reserve Bank Board

Sydney – 6 August 2019

Members Present

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

Members granted leave of absence to Carol Schwartz AO in terms of section 18A of the Reserve Bank Act 1959.

Others Present

Luci Ellis (Assistant Governor, Economic), Christopher Kent (Assistant Governor, Financial Markets), Alexandra Heath (Head, Economic Analysis Department), Marion Kohler (Head, Domestic Markets Department)

Anthony Dickman (Secretary), Ellis Connolly (Deputy Secretary)

International Economic Conditions

Members commenced their discussion of the global economy by noting that global growth had remained reasonable, having eased since mid 2018. Near-term indicators relating to trade, manufacturing and investment had remained subdued, although consumption growth had been relatively resilient, supported by strong labour market conditions especially in the advanced economies. Despite wages growth having generally trended higher over the preceding few years, inflation had remained below target in a range of economies.

Growth in major trading partners was expected to slow a little in 2019 and 2020. This outlook had been revised down a little since the May Statement on Monetary Policy in light of the escalation of the US–China trade and technology disputes and the related weakness in indicators of investment. Members noted the recent announcement by the US administration of a 10 per cent tariff to be imposed on a further US$300 billion of Chinese exports to the United States. Further escalation presented a downside risk to the outlook, particularly if heightened uncertainty weighed further on business investment. Members noted that investment intentions had already eased significantly in a number of economies, including the United States and the euro area, and investment had fallen in a number of economies with a high exposure to international trade, including South Korea.

In China, a range of activity indicators suggested that domestic economic conditions had slowed further in the June quarter. Further monetary and fiscal stimulus measures had also been announced. Fiscal support had encouraged investment in infrastructure, while residential construction had continued to grow relatively strongly, which in turn had supported steel production. The outlook for the Chinese economy had been revised lower, largely because of the ongoing US–China trade and technology disputes. Uncertainty about how these disputes would play out and how effective domestic policy measures would be in supporting Chinese demand continued to be an important consideration for the global growth outlook and, from an Australian perspective, the future demand for steel and bulk commodities.

The US–China disputes and the slowing in Chinese domestic demand had affected export and investment growth in the east Asian region. However, exports to the United States had increased for some economies in the region, including Vietnam, as a result of trade diversion. By contrast, growth in consumption in the east Asian region had generally remained more resilient. Growth in output in India had slowed and the outlook was weaker than previously forecast, largely because there had been less fiscal support and trade tensions with the United States were emerging.

In the major advanced economies, risks to the outlook remained tilted to the downside, reflecting the trade disputes. The US economy had continued to grow relatively strongly into the June quarter. This was despite the effects of the trade dispute on the manufacturing sector and on business investment more generally, partly because tight labour markets had supported strong consumption growth. Members noted that the most recent round of tariff announcements would affect US imports of consumption goods from China and could boost US consumer prices to some extent. Further slowing in investment seemed likely as the effect of earlier fiscal stimulus waned and the uncertainty related to the trade and technology disputes persisted.

Weaker global trade and greater uncertainty had also affected growth in output in the euro area. Growth in Japan was expected to be boosted temporarily by spending brought forward ahead of an increase in the consumption tax in October, although weaker external demand had weighed on export growth.

Commodity prices had generally fallen since the previous meeting, partly in response to the escalation of trade tensions in early August. After more than doubling in the first half of 2019, iron ore prices had declined to be below US$100 per tonne. Coal and oil prices had also declined over the previous month. Rural commodity prices had been little changed. Members noted that the terms of trade for Australia in the June quarter had been higher than expected.

Domestic Economic Conditions

Turning to the domestic economy, members noted that GDP growth was expected to have been firmer in the June quarter after three weak quarters. This was partly because resource exports had recovered from earlier supply disruptions and mining investment was likely to be less of a drag on growth. Partial indicators suggested that consumption growth had remained subdued in the June quarter; the volume of retail sales had been subdued and sales of new cars had declined. While dwelling investment was expected to have declined further in the June quarter, public demand and non-mining business investment were expected to have continued to support growth.

Members observed that the lower near-term GDP growth forecast mostly reflected the fact that consumption growth had been weaker than expected over recent quarters. Members noted that consumption growth per capita had been particularly weak recently. The forecast for GDP growth over 2019 had been lowered to 2½ per cent. Growth was expected to pick up to 2¾ per cent over 2020 and to around 3 per cent over 2021. This was supported by a range of factors, including lower interest rates, tax measures, signs of an earlier-than-expected stabilisation in some established housing markets, the lower exchange rate, the infrastructure pipeline and a pick-up in activity in the mining sector.

Members noted that although the outlook for consumption remained uncertain, the risks around the outlook were more balanced than they had been for some time. The low- and middle-income tax offset was expected to boost income growth, with a surge in the lodgement of tax returns since the end of June. In addition, signs of a recovery in some established housing markets suggested that the dampening effect of declining housing prices on consumption could dissipate earlier than had previously been assumed.

The evidence that conditions in housing markets were showing signs of a turnaround had strengthened in July. In Sydney and Melbourne, housing prices had increased, housing turnover appeared to have reached a trough and auction clearance rates had risen further. Outside the two largest cities, housing market conditions had shown tentative signs of improvement; prices had risen in Brisbane, while the pace of decline had slowed in Perth. Rental vacancies had been low in most cities except in Sydney, where they had risen further as new apartments were added to the rental stock.

Members observed that it could take some time for the stabilisation of conditions in the established housing market to translate into a pick-up in construction activity. Indeed, leading indicators suggested that dwelling investment was likely to decline further in the near term. Residential building approvals had declined further over May and June and were around their lowest levels in six years. Timely information from liaison contacts suggested that increased buyer interest had yet to translate into more housing sales. However, members noted that signs of a turnaround in housing markets suggested there were some upside risks to dwelling investment later in the forecast period, particularly given the expected strength in population growth.

Forward-looking indicators for business investment had been mixed. Survey measures of business conditions had been less positive than a year earlier, especially in the retail and transport sectors, but generally had remained around average. By contrast, non-residential building approvals had trended up in recent months and the pipeline of work under way was already quite high. There was also a large pipeline of private sector projects to build transport and renewable energy infrastructure, which was expected to support non-mining business investment.

Although mining investment had declined in the March quarter as large liquefied natural gas (LNG) projects approached completion, the medium-term outlook for mining investment had remained positive. A number of projects had been committed and others were under consideration, which would add to investment in coming years if they went ahead. Members noted that the outlook for mining investment had not been affected by the recent elevated levels of iron ore prices. However, they observed that higher iron ore prices would add to government taxation revenues and boost household income and wealth through dividends and the effect on share prices. At the margin, this could provide greater impetus to spending than currently assumed.

Resource exports had picked up during the June quarter as some supply disruptions to iron ore had been resolved and LNG production had increased further. Resource exports were expected to contribute to growth over the forecast period and the recent depreciation of the Australian dollar was expected to support further growth in service and manufacturing exports.

Members noted that recent labour market data had been mixed. The unemployment rate had remained at 5.2 per cent for the third consecutive month, which was higher than had been expected in May. However, growth in employment had continued to exceed growth in the working-age population in the June quarter and had been stronger than forecast in May. As a result, the employment-to-population ratio and the participation rate had remained around record highs. Over the previous year, there had been a particularly notable increase in the participation rates of women aged between 25 and 54 years and workers aged 65 years and over. Members noted that the increase in participation by older workers had more than offset any tendency for the ageing of the population to reduce aggregate participation in the labour force. Members discussed some of the factors that could be contributing to these trends, including slow income growth, improvements in health and greater flexibility in the labour market.

Leading indicators implied a moderation in employment growth over the following six months: job vacancies had declined slightly over the three months to May (but remained high as a share of the labour force) and firms' near-term hiring intentions had moderated, to be just above their long-run average. The unemployment rate forecast had been revised higher, with the unemployment rate expected to remain around 5¼ per cent for some time before declining to about 5 per cent as growth in output picked up.

Members noted that the outlook for the labour market was one of the key uncertainties for the forecasts, with implications for growth in wages, household income and consumption. The outlook for wages growth had been revised a little lower because the outlook for the labour market suggested that there would be more spare capacity than previously thought. Private sector wages growth was expected to pick up only modestly, while public sector wages growth would be contained by government caps on wage increases. Members observed that the outlook for household consumption spending could be weaker if households expected low income growth to persist for longer.

Members noted that the June quarter CPI had been largely as expected. Trimmed mean inflation had increased a little to 0.4 per cent in the June quarter, but had remained at 1.6 per cent over the preceding year, consistent with the forecast in May. Headline inflation had been 0.7 per cent (seasonally adjusted), partly because fuel prices had increased by around 10 per cent in the June quarter; over the year, headline inflation had also been 1.6 per cent. Overall, members noted that there had been few signs in the June quarter CPI numbers of inflationary pressures emerging.

Inflation in market-based services had remained steady, which was consistent with a lack of wage pressures in the economy. Inflation in the housing-related components of the CPI had been around historical lows. New dwelling prices had declined again in the June quarter, reflecting the use of bonus offers and purchase incentives by developers to counter the weak housing conditions. Rent inflation had been flat in the quarter in aggregate, but had fallen noticeably in Sydney, consistent with the rising vacancy rate; rent deflation had eased in Perth and had been steady in most other cities. Members noted that low inflation in new dwelling costs and rents, which represent around one-sixth of the CPI basket, was likely to persist in the near term.

There had been an increase in inflation for retail items because there had been some pass-through of the exchange rate depreciation and the drought had boosted certain food prices. These effects were expected to dissipate if there was no further exchange rate depreciation, as is usually assumed in the forecasts, and once normal seasonal conditions returned. Inflation in the prices of administered items and utilities had remained well below typical increases recorded a few years earlier.

Inflation was expected to pick up more gradually than previously forecast because of subdued wage outcomes and the evidence of spare capacity in the economy. The experience of other economies suggested that any pick-up in wages growth might take longer to translate into inflation than in the past. Underlying inflation and headline inflation were both expected to pick up to be a little above 2 per cent over 2021, as spare capacity in the labour market declined and as growth increased to run above potential. Members noted that there were downside risks to some individual CPI components. In the near term, electricity prices could grow at a below-average pace or even fall, and government cost-of-living initiatives could weigh on other items in the CPI basket. Inflation rates for both new dwelling prices and rents were also expected to remain low in the near term, but were more uncertain towards the end of the forecast period.

Financial Markets

Members commenced their discussion of financial markets by noting that central banks in the major economies had eased, or were expected to ease, policy settings in response to downside risks to growth and subdued inflation outcomes. Financial market volatility had increased recently from low levels, in response to the escalation of the trade and technology disputes between the United States and China.

The US Federal Reserve lowered its policy rate target by 25 basis points in July. Market pricing suggested that the federal funds rate was expected to decline by a further 100 basis points or so over the following year. The Federal Reserve noted that the US labour market had remained strong. However, it was perceived by members of the Federal Open Market Committee that there was room for some easing of monetary policy given the implications of global developments for the US economic outlook and subdued inflation pressures. Elsewhere, the European Central Bank (ECB) had foreshadowed additional monetary stimulus unless the outlook for inflation in the euro area improved. The ECB indicated that it could expand its bond-buying program, among other measures, and market pricing suggested that the ECB was likely to reduce its policy rate over the following months. Market participants were also expecting the Bank of Japan to ease monetary policy further in the period ahead.

In response to the shift in the outlook for monetary policy, long-term interest rates had declined to historical lows in several markets, including in Australia. Yields on government bonds were negative for a number of European sovereigns and Japan. In addition, corporate bond spreads were low globally, with a growing portion of corporate debt in the euro area trading at yields below zero. Members discussed the implications of the low level of bond yields for corporate balance sheets and investment.

Global equity markets had declined sharply prior to the meeting, in response to the recent escalation of the trade and technology disputes. Nevertheless, equity market indices were still well above their levels earlier in the year, supported by lower bond yields and expectations that earnings growth would be reasonable. During July, equity market indices in the United States and Australia had reached record high levels.

In foreign exchange markets, prior to the meeting there had been an increase in volatility, from very low levels, in response to the escalation of the trade and technology disputes. In particular, the yen had appreciated against the US dollar while the Chinese yuan had depreciated. Members took note of the market commentary that the US and Japanese authorities could intervene in an effort to lower the value of their currencies. The Australian dollar had depreciated in recent times to be at its lowest level in many years.

In Australia, the reduction in variable mortgage rates had been broadly consistent with the reduction in the cash rate in June and July. The degree of pass-through of the cash rate reductions was also comparable to that observed over the preceding decade. Housing credit growth had declined in June, for both owner-occupiers and investors. At the same time, however, loan approvals had picked up in June, which for investors was the first sizeable increase for some time. This was consistent with other indicators suggesting that the housing market had stabilised over recent months. However, loan approvals to property developers had remained subdued. Members also noted that access to finance for small businesses continued to be tight.

Banks' debt funding costs and borrowing rates for households and businesses were at historically low levels. Rates in short-term money markets, bank bond yields and deposit rates had all declined to historically low levels. The proportion of bank deposits that attract no interest had increased marginally to be just under 10 per cent. Despite the low level of funding costs, banks' bond issuance remained subdued. This reflected slow credit growth, along with the banks increasing their issuance of hybrid securities to fulfil new regulatory capital requirements. Members also noted that mergers and acquisitions activity had not been especially high, despite funding conditions being very accommodative for large businesses.

Market pricing implied that the cash rate was expected to remain unchanged in August. A 25 basis points reduction had been fully priced in by November 2019, with a further 25 basis points reduction expected in 2020. The low level of bond yields implied that the cash rate was expected to remain very low for several years.

Members reviewed the experience of other advanced economies with unconventional monetary policy measures over the preceding decade. These measures comprised: very low and negative policy interest rates; explicit forward guidance; lowering longer-term risk-free rates by purchasing government securities; providing longer-term funding to banks to support credit creation; purchasing private sector assets; and foreign exchange intervention. Members considered the key lessons from the international experience, noting that a full evaluation could not be undertaken as many of these measures were yet to be unwound. One key lesson was that the effectiveness of these measures depended upon the specific circumstances facing each economy and the nature of its financial system. Some measures had been successful in reducing government bond yields, which had flowed through to lower interest rates for private borrowers. Other measures had been effective in addressing dislocations in credit supply. Members noted that a package of measures tended to be more effective than measures implemented in isolation. Finally, it was important for the central bank to communicate clearly and consistently about these measures.

Considerations for Monetary Policy

Turning to the policy decision, members observed that the escalation of the trade and technology disputes had increased the downside risks to the global growth outlook, although the central forecast was still for reasonable growth. Uncertainty around trade policy had already had a negative effect on investment in many economies. Members noted that, against this backdrop, the low inflation outcomes in many economies provided central banks with scope to ease monetary policy further if required. Indeed, a number of central banks had reduced interest rates this year and further monetary easing was widely expected. In China, the authorities had taken steps to support economic growth, while continuing to address risks in the financial system.

Overall, global financial conditions remained accommodative. Long-term government bond yields had declined further and were at record lows in many economies, including Australia. Borrowing rates for both households and businesses were also at historically low levels and there was strong competition for borrowers of high credit quality. Despite this, demand for housing credit, particularly from investors, remained subdued, while access to credit for some types of borrowers, especially small businesses, remained tight. The Australian dollar had depreciated to its lowest level in recent times.

Domestically, growth had been lower than expected in the first half of 2019. Looking forward, growth was expected to strengthen gradually, to 2¾ per cent over 2020 and to around 3 per cent over 2021. This outlook was supported by a number of developments, including lower interest rates, higher growth in household income (including from the recent tax cuts), the depreciation of the Australian dollar, a positive outlook for investment in the resources sector, some stabilisation of the housing market and ongoing high levels of investment in infrastructure. Overall, the domestic risks to the forecast for output growth appeared to be tilted to the downside in the near term, but were more balanced later in the forecast period.

Employment growth had been stronger than expected and labour force participation had increased to a record high. However, the unemployment rate had increased and there appeared to have been more spare capacity in the labour market than previously appreciated, although there was uncertainty around the extent of this. The unemployment rate was expected to decline to around 5 per cent over the following couple of years, consistent with the gradual pick-up in GDP growth. Wages growth had been subdued and there were few signs of wage pressures building in the economy. Combined with the reassessment of spare capacity in the labour market, this had led to a more subdued outlook for wages growth than three months earlier.

In the June quarter, inflation had been broadly as expected at 1.6 per cent. Members noted that inflation had averaged a little below 2 per cent for a number of years. In the near term, there were few signs of inflationary pressures building, but, over time, inflation was expected to increase gradually to be a little under 2 per cent over 2020 and a little above 2 per cent over 2021.

Based on the information available and the central scenario that was presented, members judged it reasonable to expect that an extended period of low interest rates would be required in Australia to make sustained progress towards full employment and achieve more assured progress towards the inflation target. Having eased monetary policy at the previous two meetings, the Board judged it appropriate to assess developments in the global and domestic economies before considering further change to the setting of monetary policy. Members would consider a further easing of monetary policy if the accumulation of additional evidence suggested this was needed to support sustainable growth in the economy and the achievement of the inflation target over time.

The Decision

The Board decided to leave the cash rate unchanged at 1.00 per cent.