Minutes of the Monetary Policy Meeting of the Reserve Bank Board

Videoconference – 4 August 2020

Members Participating

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

Others Participating

Luci Ellis (Assistant Governor, Economic), Christopher Kent (Assistant Governor, Financial Markets)

Anthony Dickman (Secretary), Ellis Connolly (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 the global economy by noting that new COVID-19 cases had increased significantly over the preceding month. Case numbers were high in the United States and in several large emerging market economies. Some countries that had brought case numbers down to low levels, such as Japan and Australia, had experienced fresh outbreaks in July. In South Korea and much of Europe there had been more success in suppressing the virus after restrictions on activity had been lifted. Activity had picked up over the preceding few months, but signs of a reversal in mobility indicators were emerging in some countries, particularly those with rising infection rates. Members noted that the global economy was likely to take longer to recover than initially thought and that the damage to labour markets could linger.

The global downturn in the first half of 2020 was more severe and widespread than had been seen for many decades. The extent of the contraction in each economy depended largely on the timing and scale of lockdowns and other health-related restrictions on activity. The contraction in activity in the March quarter in advanced economies was not quite as large as had been feared, other than for some euro area economies. In the United States and Germany, GDP growth had contracted by around 10 per cent in the June quarter, while countries that had successfully implemented targeted measures, such as South Korea, had experienced smaller contractions in activity over the same period.

Members observed that business conditions in several large economies had improved in June and that this seemed to have extended into July. Surveyed conditions in the services sector, which had been very badly affected during the lockdowns, had rebounded particularly strongly. Another feature of the recovery in advanced economies had been the sharp increases in retail sales. Households had resumed spending, in some cases quite rapidly, after the end of restrictions. Household income support had contributed to this. By contrast, industrial production had been much slower to recover. The more subdued recovery in industrial production may have reflected a combination of lower expectations about future demand as well as supply chain disruptions.

Labour markets everywhere had been severely affected by the pandemic. Unemployment had risen and hours worked had declined. Some countries, such as the United States and Canada, had initially seen very large declines in the employment-to-population ratio, which partly reflected workers who had been temporarily stood down being counted as unemployed.

Members noted that the Chinese economy had recovered strongly, and by more than generally expected, in the June quarter. Steel-intensive sectors were generating levels of output around or above pre-outbreak levels, which was supporting Australia's exports of bulk commodities. Fiscal and monetary policy easing in China had also been supporting the recovery. In contrast with advanced economies, consumer spending in China had been slower to recover than industrial production. This may have partly reflected the different emphasis of fiscal policy support measures in China, which had been aimed more directly at businesses and less at households compared with advanced economies. However, it was noted that weak global demand could hamper the recovery in export-oriented manufacturing, both in China and elsewhere in east Asia.

In India, a partial recovery in employment had been evident in migrant workers returning to their home villages and obtaining work in the government's rural work guarantee programs. However, the recovery in mobility indicators had slowed recently.

More generally, members noted that a key lesson from the recent international experience is that many people voluntarily restrict their movement if they are concerned about the coronavirus, even in the absence of physical distancing restrictions.

In summarising the international outlook, members noted that the GDP of Australia's major trading partners was expected to contract by around 3 per cent in 2020, before rising by around 6 per cent in 2021, leaving GDP below where it would have been had the outbreak not occurred. Nevertheless, members agreed that the outlook was highly uncertain, and that the shape of the recovery depended on containment of the virus.

Domestic Economic Developments

Members commenced their discussion by noting that the economic downturn in Australia over the first half of 2020 was the most severe in many decades: staff estimates suggested a decline in GDP of around 7 per cent and a contraction in hours worked of around 10 per cent. Though very large, the downturn in the first half of the year had been smaller than predicted a few months earlier because restrictions had been less onerous and had been lifted earlier than expected. This had allowed an economic recovery to commence in May. Unprecedented fiscal and monetary support had also played a key role.

Members agreed that the lengthening and tightening of restrictions in Melbourne, and the extension of restrictions to regional Victoria, was a setback to the recovery and would weigh on overall domestic activity in the September quarter. In addition to the direct effects of the lockdown, there were likely to be negative effects on the confidence of households and businesses. General uncertainty was noted as affecting demand more broadly, beyond the industries or states most affected by the earlier restrictions on activity. Mobility indicators suggested that the previous recovery in activity had slowed across the country, including beyond Melbourne.

Members considered three scenarios for the economic outlook, given the high degree of uncertainty. The baseline scenario assumed that the Stage 4 restrictions in Victoria were not materially extended and that Australia's international borders remained closed until mid 2021. In this scenario, the recovery over the second half of 2020 was forecast to be more gradual than envisaged three months earlier. This was partly because of the reinstated lockdown in Melbourne, and partly because uncertainty had been affecting demand beyond the industries most affected by the Stage 3 restrictions on activity. In this scenario, output was expected to recover somewhat over the second half of the year, bringing the contraction over 2020 to 6 per cent. Output was then expected to expand by 5 per cent over 2021 and 4 per cent over 2022. These projections indicated that, by the end of the forecast period, GDP was expected to remain short of the level forecast before the pandemic.

The two other scenarios – an upside and a downside scenario – differed primarily in terms of assumptions over the evolution of the coronavirus. The upside scenario embodied a stronger and faster recovery on the basis of rapid progress in containing the virus in Australia, with no further extension to the Melbourne lockdown and progressive easing of restrictions nationwide after that. In this scenario, the faster pace of recovery was driven by restored confidence, which would encourage stronger consumption and the recent run-up in savings being unwound at a faster pace than assumed in the baseline scenario. Much of the near-term decline in GDP would reverse over 2020-21 as consumption growth rebounded strongly in this scenario.

The downside scenario assumed a globally widespread resurgence in infections in the near term and that Australia was faced with periodic outbreaks and ‘rolling’ lockdowns. In this scenario, consumption would fall further over the second half of 2020, despite ongoing policy support. With border restrictions remaining in place until the end of 2021, the recovery in services exports would be delayed. As a result, GDP would not recover over the second half of 2020 and the subsequent recovery would be slower, partly because of the damage to confidence (in addition to the direct effects of more lockdowns). This would affect consumption and investment even after restrictions were lifted. Members noted that the downside scenario entailed a much larger deviation in output from the baseline compared with the upside scenario, reflecting that the risks around the outlook were to the downside.

In their discussion of the forecasts, members noted that in previous downturns it had been quite unusual for consumption to decline significantly, as had been the case in this episode. Despite that, in the present episode consumption by households was likely to have rebounded sooner and by more than expected a few months earlier. This was partly because restrictions on activity had been lifted faster than previously anticipated, which translated into a decline in hours worked that was less severe than expected. But it also reflected the substantial policy support for household income, which, unusually for a downturn, had seen incomes for some households rise noticeably. Household cash flow had also been bolstered by the significant volume of superannuation withdrawals. As a result, with income holding up and consumption having declined sharply early in the June quarter, the household saving ratio was estimated to have increased substantially.

The extension of government policy support would continue to support household incomes and assist the recovery over the following few quarters. While household income was expected to decline for a period when this support was tapered, consumption would continue to be supported by higher savings, which would assist in smoothing consumption through temporary dips in income in the period ahead.

In considering the substantial amount of fiscal policy support, members noted that around 30 per cent of Australia's working-age population was receiving JobKeeper, JobSeeker or an equivalent payment. The JobKeeper program had been extended to March 2021, with tighter eligibility requirements and lower, tiered payments for full-time and part-time workers. The Coronavirus Supplement, paid to JobSeeker recipients, had also been extended at a lower rate from September. Combined with other measures and the usual automatic stabilisers, the net positive fiscal impact from the expected change in Australian Government finances was equivalent to around 4 per cent of GDP in 2019/20 and a further 5 per cent in 2020/21. State governments had also provided some support, mostly in the form of increased funding for public services and relief from taxes and fees.

In turning to housing activity, members noted that prices in the established housing market had declined moderately in Sydney, Perth and Brisbane, and a little more in Melbourne. New property listings had recovered to around similar levels in the previous year; however, the reimposition of restrictions in Melbourne was limiting sales there and would continue to do so. New housing sales were more buoyant, supported in part by the national HomeBuilder program and, in the case of Western Australia, substantial state grants for new dwelling construction. By contrast, rental markets remained particularly weak across the country. This was partly a result of lower demand and the boost to supply from properties that were previously rented to international visitors.

Information from liaison with businesses and recent surveys indicated that the weakness in non-mining business investment over recent quarters would become more pronounced in the period ahead. Investment in machinery and equipment was expected to have been particularly weak in recent months given its discretionary nature. Business liaison had reported that firms were prioritising their liquidity positions in response to uncertainty about future demand. Many non-residential building projects that had not yet commenced were on hold in part because of the uncertainty about future demand for such space. Work on projects that had already commenced was also expected to fall in the near term because of limits on worker numbers at construction sites in Melbourne. Mining investment was expected to increase in the near term, but then ease as some projects were deferred.

With international borders expected to remain closed for six months longer than assumed in May, the outlook for services exports had been revised down. The profile for education exports was relatively flat, and other travel-related services exports were not expected to recover until later in 2021; even then, they would do so only gradually. The outlook for other exports had been revised a little lower compared with the forecast in May, reflecting weak global demand, heightened restrictions in Melbourne and the recent exchange rate appreciation. The main exception was rural exports, which had been revised a little higher because of favourable weather. Imports had also been revised lower, reflecting in part the effect on outbound tourism of longer border closures.

Turning to the labour market, employment had been recovering since May, but weekly payroll data showed that there was a loss of momentum in late June and the first half of July. This was most evident in Victoria, but could also be seen across the other states. Members noted that female workers had been affected disproportionately in the early phase of the contraction. This pattern reflected industry employment trends, where female workers were disproportionately represented in industries most affected in the early phase of the restrictions. However, male workers had been more heavily represented in industries that had shed jobs in the recent period.

Members noted that the contraction in hours worked had been less severe than initially thought. However, relative to earlier expectations, more of the fall in hours worked had reflected job losses rather than people working reduced hours. This was despite one in ten workers continuing to be employed on reduced hours and a large number of full-time workers continuing to be stood down on zero hours. This suggested that the contraction in activity and employment was the result of expected weakness in demand and general uncertainty, in addition to restrictions on activity. It also indicated the recovery in employment would be slower than earlier assumed.

More broadly, significant spare capacity in the labour market was constraining wages growth; ahead of the pandemic, wages growth had been around 2 per cent. Information from the Bank's liaison program indicated that the share of contacts expecting to freeze wages or to implement temporary wage cuts was higher than in the past.

In the baseline scenario, the unemployment rate, which had risen from just over 5 per cent before the pandemic to 7.4 per cent in June, was expected to rise to around 10 per cent in late 2020 before declining gradually to around 7 per cent in 2022. The upward trajectory for the unemployment rate reflected moderate employment losses in the second half of 2020 and an increase in the number of people re-joining the labour force. This followed a period earlier in the year when an unusually large number of people who lost employment had left the labour force altogether. An increase in labour force participation, which would translate into a higher unemployment rate, was expected to result partly from JobSeeker recipients again having to undertake job search activities to qualify for the payment and partly from the progressive lifting of restrictions enabling more people to search for work. In considering other possible paths for the unemployment rate, members noted that the upside scenario could result in a slightly lower peak in the unemployment rate, and a faster subsequent decline, falling to around 6 per cent by the end of 2022. Alternatively, in the downside scenario, the unemployment rate would be expected to peak at around 10½ per cent, and decline very gradually to around 9 per cent by the end of the forecast period.

In turning to the discussion on recent inflation developments, members noted that the 2 per cent decline in headline CPI in the June quarter reflected unusually large declines in a number of components, including child care and pre-school fees, petrol prices and rents, and the effect of rebates on some administered items. In underlying terms, the severe contraction in economic activity in the June quarter had resulted in disinflationary pressures, although prices of certain grocery and household items had risen because of strong demand and constraints on supply. Around 9 per cent of the CPI basket was not available to have prices measured for at least some of the quarter, necessitating the use of imputed prices. Members noted that the June quarter outcomes for child care and pre-school fees, and fuel prices, would be largely reversed in the September quarter. However, the weakness observed in rents in the June quarter was expected to persist over the forecast period, given the slowdown in population growth because of lower migration.

In discussing the outlook for inflation, members noted that significant spare capacity, high unemployment and slow wages growth would contribute to a prolonged period of low inflation. The possibility that supply disruptions could lessen disinflationary pressures was considered, but weakness in demand was expected to be the dominant factor affecting inflation outcomes in the period ahead. Underlying inflation was forecast to remain below 2 per cent over the forecast period in each of the scenarios considered. In the baseline scenario, underlying inflation was expected to reach a trough of around 1 per cent late in 2021 and to be around 1½ per cent by end 2022. In the upside scenario, a more rapid tightening in the labour market was expected to contribute to inflation reaching around 1¾ per cent by the end of 2022. In the downside scenario, where the unemployment rate remained at elevated levels over the forecast period, inflation was expected to trough at around ½ per cent and increase only a little by the end of 2022. But the overall message from the scenario analysis was that underlying inflationary pressures would remain subdued for a considerable period.

International Financial Markets

Members noted that global financial conditions had remained accommodative. Central banks in the advanced economies had mostly left their policy settings unchanged and had continued to signal that they would maintain highly accommodative monetary policies for some time. Central banks' asset purchase programs had contributed to the accommodative financial conditions, with market functioning having been largely restored. These purchases had assisted bond markets to absorb the significant increase in sovereign debt issuance associated with the expansion in fiscal policy, thereby helping to keep government bond yields around historic lows. Spreads between the yields of euro area periphery bonds and German Bunds had declined following the announcement of a €750 billion package of loans and grants designed to support the recovery in Europe.

Over the preceding month, the Bank of Canada had committed to maintaining its policy rate at the effective lower bound until spare capacity had been absorbed and the inflation target had been sustainably achieved. The US Federal Reserve had extended the duration of various lending facilities.

The costs of raising corporate debt had remained low. Corporate debt issuance had eased in July, from the record high levels in preceding months. Equity market prices had risen further and had recovered much of their sharp falls from earlier in the year, supported by optimism around the development of a COVID-19 vaccine and a general expectation that the decline in earnings recorded in the first half of the year would be relatively short-lived. Members noted that the relative strength of US equity prices could be explained partly by the large weight in market indexes of tech-related stocks, which had benefited from an increase in demand for digital services and online shopping. By contrast, low oil prices had contributed to the underperformance of energy stocks. In Australia, equity prices had recovered around half of their decline earlier in the year.

Financial conditions in emerging markets had improved a little over the prior month. Low and stable inflation had allowed for a further easing in monetary policies. Also, capital flows had mostly stabilised, following significant portfolio outflows earlier in the year. Indeed, currency intervention operations had been scaled back and exchange rates had generally stabilised, although at lower levels than before the outbreak of the pandemic. Members noted that many emerging market economies in Asia had performed well compared with other emerging market economies because they had faced the onset of the pandemic with stronger economic fundamentals.

In China, better-than-expected domestic economic data had contributed to a strong increase in equity prices early in July, while money market conditions had tightened, consistent with the improved economic situation and the authorities' desire to limit the build-up of risks in parts of the financial system. While this had led to a broader increase in borrowing rates, financial conditions had generally remained accommodative and broad measures of financing were growing at a slightly faster rate than in 2019, as intended.

Members noted that there had been a broad-based depreciation of the US dollar, and that the currencies of other advanced economies had returned to levels seen earlier in the year. The euro had appreciated to its highest level in several years, supported by the recent agreement on a European Union recovery fund. The Australian dollar had also appreciated against the US dollar to be a little above where it had started the year. The Australian dollar had been broadly in line with its fundamental determinants, such as commodity prices and interest rate differentials, which had returned to their levels at the start of the year. Despite further tensions between China and the United States, the Chinese renminbi had remained stable.

Domestic Financial Markets

Members commenced their discussion of domestic financial markets by noting that government bond markets had continued to function normally alongside a significant increase in issuance. The yield on 10-year Australian Government Securities (AGS) had remained low. While the yield on 3-year AGS had remained consistent with the target, it had been a little higher than 25 basis points over the preceding weeks. Members supported the Bank purchasing AGS in the secondary market to ensure that the yield on the 3-year bond remained consistent with the target. Conditions in markets for bonds issued by the state and territory borrowing authorities (semis) had normalised in recent months.

Activity in the cash market had remained low, reflecting sizeable Exchange Settlement balances, and the cash rate had remained around 13 basis points. Other money market rates had also remained low.

Funding costs for banks had eased a little further to historic lows. Take-up of the Term Funding Facility (TFF) had increased as the end-September deadline for accessing initial allowances had drawn closer. Many banks had indicated that they would have taken up their initial allowance in full by that time. Members noted that funding through the TFF was a less expensive option than issuing bonds. The stock of bonds on issue by the major banks had declined, but remained substantial.

Interest rates for business loans had also fallen to historically low levels because banks had passed through the cash rate reductions and the effects of other policy measures to business borrowers. Nevertheless, business lending had contracted, following strong growth earlier in the year, as large businesses repaid credit they had earlier drawn down for precautionary reasons in response to the pandemic. Meanwhile, lending to small and medium-sized enterprises (SMEs), many of which were operating in the most affected sectors of the economy, had been little changed. Demand for new loans – especially from SMEs – had been low, reflecting the weak economic conditions and the unusually uncertain outlook, although the supply of credit also appeared to have tightened a little. Members noted the importance of the JobKeeper program and other policy interventions for supporting SMEs through the current difficult period.

Interest rates on housing loans had also declined to historic lows; over half of the decline in the cash rate in 2020 had flowed through to variable mortgage rates. Competition for high-quality borrowers had remained strong and rates on fixed-rate loans had declined to be noticeably lower than variable rates; a larger-than-usual share of borrowers had applied for fixed-rate loans. External refinancing had risen sharply, consistent with the very low level of interest rates and offers of cash back to borrowers for refinancing an existing loan previously held with another lender. Commitments for refinancing had recently been almost as high as those for new loans. Banks had announced extensions to their loan payment deferral schemes, but were encouraging borrowers to make repayments if they could afford to do so. The balance in offset and redraw accounts had risen noticeably in April and May, but borrowers had withdrawn some of these funds in June; even so, balances held in these accounts remained large and above levels in March.

Owner-occupier housing credit growth had slowed and investor housing credit had continued to decline, consistent with the earlier slowdown in housing market activity and the decline in loan commitments since March. While activity in the housing market and loan commitments had picked up in recent months, the flow of new commitments had remained well below its peak and was likely to remain subdued in the face of recent developments in Victoria and uncertainty about the economic recovery.

Considerations for Monetary Policy

In considering the policy decision, members observed that the global economy was experiencing a severe downturn as countries sought to contain the COVID-19 outbreak. Even though the worst of the global economic contraction had passed, the outlook remained highly uncertain and would depend upon containment of the coronavirus. Infection rates had declined in some countries, but were still very high and rising in other countries.

The Australian economy was going through a very difficult period and was experiencing the biggest shock to economic activity since the 1930s. A very large number of people had lost their jobs, with many others retaining their jobs over this period only because of government support programs. Nevertheless, members noted that the downturn had not been as severe as earlier expected and a recovery was under way in most of Australia. The recovery was, however, likely to be slower than earlier expected, with the COVID-19 outbreak in Victoria having a major impact on the economy. Uncertainty about the health situation and the future path of the economy was continuing to affect the spending plans of many households and businesses.

Members agreed that the Bank's policy package was continuing to work broadly as expected. The package had helped to lower funding costs and stabilise financial conditions, and was supporting the economy. There was a very high level of liquidity in the Australian financial system and authorised deposit-taking institutions were continuing to draw on the TFF, with further use expected over subsequent months. Members noted that the Australian banking system, with its strong capital and liquidity buffers, remained resilient and was helping the economy traverse this difficult period. Government bond markets were operating effectively and the yield on 3-year Australian Government bonds had been consistent with the target of around 25 basis points. The yield had, however, been a little higher than 25 basis points over the weeks preceding the meeting. Given this, the Bank would purchase Australian Government bonds in the secondary market from 5 August 2020 as necessary to ensure that the yield on 3-year bonds remains consistent with the target. It would also stand ready to purchase Australian Government bonds and semis in the event of a recurrence of market dysfunction.

Members reaffirmed that there was no need to adjust the package of measures in Australia in the current environment. Members agreed, however, to continue to assess the evolving situation in Australia and did not rule out adjusting the current package if circumstances warranted.

Board members recognised that the substantial, coordinated and unprecedented easing of fiscal and monetary policy in Australia was helping to sustain the economy through this difficult period. They welcomed the Australian Government's recent announcement that various income support measures would be extended, and considered it likely that fiscal and monetary support would be required for some time given the outlook for the economy and the labour market. The Board affirmed its commitment to supporting jobs, incomes and businesses and to making sure that Australia is well placed for recovery. The Board considered that its actions were keeping funding costs low and supporting the supply of credit to households and businesses, and resolved that this accommodative approach would be maintained for as long as necessary.

The Decision

The Board reaffirmed the elements of the policy package announced on 19 March 2020, namely:

• a target for the cash rate of 0.25 per cent
• a target of 0.25 per cent for the yield on 3-year Australian Government bonds
• the Term Funding Facility to support credit to businesses, particularly small and medium-sized businesses
• an interest rate of 10 basis points on Exchange Settlement balances held by financial institutions at the Bank.

The Board affirmed that the yield target for 3-year bonds would be maintained until progress is made towards the Bank's goals of full employment and the inflation target, and that it would be appropriate to remove the yield target before the cash rate itself is raised. The Board determined that it would not increase the cash rate target until progress is made towards full employment and it is confident that inflation will be sustainably within the 2-3 per cent target band.