From our Bill at Westpac:
The minutes of the March monetary policy meeting of the Board of the RBA provided no real surprises. When we assessed the Governor’s statement following the March meeting we pointed out that the key sentence “Members noted that continued low inflation would provide scope to ease monetary policy further, should that be appropriate to lend support to demand” had been changed from the February statement to include the word “would” instead of “may”. We interpreted that as a clear strengthening of the easing bias.
That decision may have been prompted by a concern that the December quarter GDP report that was set to be released the following day was going to show a significant slowdown in growth. As it turned out the report showed growth in 2015 to be 3%, comfortably above trend growth of 2.75%. In the minutes it is noted that it was reported to the Board that based on data available “growth appeared to have been slightly below average in the December quarter and over 2015 as a whole”. Clearly this assessment proved to be more cautious than turned out to be the final result. It is reasonable to argue that knowledge of the stronger GDP may have allowed the Board to retain its earlier more modest easing bias.
Of course we were also interested in the assessment of the surprise rise in the unemployment rate from 5.8% to 6.0% in January. The minutes while recognising that development point out that “leading indicators of employment had increased further and were consistent with employment growth in the months ahead”.
The minutes also clarified the relevance of the Capex survey. While the particularly weak Capex survey pointed out further but not surprising large falls in mining investment the picture around non-mining investment from the survey seemed to be overly pessimistic. The minutes point out that roughly half of non-mining investment is not covered by the Capex survey and that it had on occasions proved to be unreliable. Further boosting the view around business is the observation that surveys continue to point to conditions and capacity utilisation remaining above average levels.
The minutes have qualified the assessment that low wage growth points to some spare capacity in the labour market. They speculate that weak wages growth may be due to increasing globalisation.
There is a long discussion on China, particularly around longer run economic performance and risks to growth. The discussion covers potential financial problems in China but concludes that China’s low household debt and low level of foreign currency debt gave it much more protection from a crisis than in other emerging economies.
At the time of the last meeting the AUD was around USD0.715, little changed from the February meeting. With the currency subsequently rising to USD0.75 there may have been some temptation to use this document to signal any discomfort. This has not happened and the term “responded to the evolving economic outlook” has been maintained.
The minutes provide some insight into expectations around GDP; reaction to the surprise rise in the unemployment rate in January; and the weak Capex report. The ‘spin’ on all of these developments indicates a Bank that is comfortably on hold. However clearly considerable attention is being paid by the Bank to developments in China and sudden adverse developments in that region would undoubtedly prompt consideration for policy change.
We will have to await new communication from the Bank to assess its degree of unrest around the recent sharp jump in the AUD.
Westpac continues to expect that the Bank will remain on hold for the remainder of the course of 2016.
Here are the full minutes:
Domestic Economic Conditions
Members began their discussion of the domestic economy by noting that the December quarter national accounts would be released the day after the meeting. Based on the data available and in line with earlier expectations, growth appeared to have been slightly below average in the December quarter and over 2015 as a whole. There had been further indications of a rebalancing of activity towards the non-mining sectors of the economy. More recent data had suggested that the economy had continued to grow at a moderate pace in early 2016.
As expected, mining investment had fallen further in the December quarter as more large projects reached completion. The latest ABS capital expenditure (capex) survey of firms’ investment intentions had pointed to further large falls in mining investment in 2015/16 and again in 2016/17, in line with the forecasts presented in the February Statement on Monetary Policy. Members noted that non-mining investment appeared to have been little changed over 2015. Although the capex survey had pointed to declines in 2015/16 and 2016/17, roughly half of non-mining investment was not covered by the capex survey and in the past there had been differences between signals provided by the capex survey and what was measured in the national accounts data. At the same time, members noted that survey measures of business conditions and capacity utilisation had remained at above-average levels and business credit growth had increased a little further over recent months.
Members observed that there had been only modest growth in resource export volumes in the December quarter. They noted that more production capacity – particularly for liquefied natural gas, but also iron ore – was expected to come on line over 2016. Chinese iron ore imports had increased over the past year, although by less than earlier years, and Australia’s share of that had remained at a high level. The volume of coal exports had fallen, partly because Chinese demand for coal had eased. Meanwhile, iron ore prices had increased over the past month, while coal prices had fallen slightly. Notwithstanding the recent increases in iron ore prices, bulk commodity prices were still about 20 per cent below levels of a year earlier. Oil prices had been volatile over recent months, rising somewhat since the previous meeting but still lower than late last year, which largely reflected the ongoing strength of supply.
Members noted that household demand had continued to be supported by low interest rates and above-average employment growth. Consumption growth was expected to have been close to its average over 2015 and in early 2016. Survey measures of households’ perceptions of their own finances had remained at above-average levels into early 2016. Information from the Bank’s retail liaison suggested that there had been an improvement in trading conditions around the Christmas–New Year period.
While growth in dwelling investment had been strong over 2015, there were indications that it would gradually moderate over the course of this year. The level of building approvals had declined over 2015, but remained high. Conditions in the established housing market had eased since late 2015. Housing price growth in Sydney and Melbourne was lower than in September last year. Meanwhile, housing credit growth overall had remained around 7½ per cent, after having risen through to the middle of 2015. Members noted that growth in lending to investors in housing had slowed significantly over that period and, more recently, housing loan approvals overall had declined a little.
The unemployment rate rose to 6 per cent in January, from around 5¾ per cent in November and December, and employment had declined slightly. Nevertheless, conditions in the labour market had clearly improved since early 2015. Employment growth had been above average, the unemployment rate had declined by a little more than ¼ percentage point and the participation rate had been on an upward trend. Members noted that there was some uncertainty around the future trajectory of the participation rate. This was partly because the degree to which people had been encouraged to enter the labour force over the course of the past year had been unexpected, and partly because it was difficult to assess the net effect on the participation rate of population ageing (which tends to reduce participation rates). The fact that each generation has tended to have a higher participation rate than the one preceding it also contributed to uncertainty around the trajectory of the participation rate. Meanwhile, leading indicators of employment had increased recently, consistent with employment growth in the months ahead.
Data from the wage price index had confirmed that wage growth was low across all industries over 2015. Although wage growth had continued to slow in a number of mining-exposed industries, it appeared to have stabilised in some industries where employment growth had been relatively strong over the course of the past year. Members observed that ongoing low wage growth was consistent with there being some spare capacity in the labour market, though they also noted that this was not unique to Australia, which suggested that a common global factor, such as the increasingly globalised nature of the labour force, could have been playing a role.
International Economic Conditions
Growth in Australia’s major trading partners had eased in the December quarter, although it had been little changed over the past year at slightly below its decade average. Labour market conditions had improved in a number of economies, which was consistent with ongoing consumption growth, particularly in the United States and the euro area. Aggregate growth had also been supported by low oil prices. Although measures of core inflation had edged higher over the second half of 2015 in Japan and the euro area, they had shown some signs of declining in the early part of 2016. There had been a more noticeable increase in core inflation in the United States over this period. However, inflation remained below most central banks’ targets and monetary policies had remained very expansionary.
Growth in the US economy had been close to trend over 2015, despite slowing late in the year. Employment had continued to grow more rapidly than the working-age population, and the unemployment rate was around its long-run average level. While nominal wage growth had remained relatively modest, growth in unit labour costs was above its long-run average. Measures of core inflation had picked up, but remained below the inflation objective of the Federal Reserve Board. The euro area economy had continued to expand at an above-trend rate over 2015, driven by domestic demand, although industrial activity had remained weak. There had been a further gradual decline in the unemployment rate, but there was considerable spare capacity and wage growth had drifted lower. Inflation had remained low relative to the European Central Bank’s target.
GDP had contracted in Japan in the December quarter, driven by a decline in consumption. Despite recent weakness in economic activity, labour market conditions had remained tight and nominal wage growth had been positive. Core inflation had picked up to close to 1 per cent by the end of 2015, but had eased a little in early 2016. Headline inflation had been low, reflecting the effect of lower oil prices. In the rest of east Asia, GDP growth had been a bit below average, particularly for the economies with larger exposures to the slowing in China through their direct trade links. Recent exchange rate depreciations, low oil prices and monetary and fiscal stimulus measures had been providing some support for activity in the east Asian region.
Recent Chinese data had pointed to continued weakness in the industrial and real estate sectors, although members noted that the variable timing of the Chinese New Year holidays made it difficult to interpret data in the early part of the calendar year. Overall, housing prices had increased a little over the past year, but prices had still declined in the smaller cities. Total sales had declined since mid 2015 and the stock of unsold housing remained substantial. In February, the authorities took further steps to support the demand for housing, particularly in markets where housing prices had been weakest. The downward trend in both exports and imports had continued in January, while the trade surplus remained at a high level.
Members spent part of the meeting discussing some issues relevant to China’s longer-run economic performance and the risks to growth. They observed that demographic changes and strong productivity growth had been key drivers of economic growth in China for some time, but these forces were now reversing and were likely to weigh on future growth as a result. In particular, China’s growth had been supported by an increase in the size of the working-age population and the migration of many agricultural workers to urban areas, where they had been more productive. The working-age population had started to fall but the urban workforce was still growing because of continued urbanisation. China’s urbanisation rate was still relatively low by international standards, which suggested that this process had further to run, with the pace of reform to the urban registration system (hukou) likely to have some effect on how rapidly the growth of the urban workforce would moderate. Structural reform was also important for the future trajectory of productivity growth, which had slowed over the past decade.
China’s economic development had been characterised by very strong investment growth, which had been funded to a significant extent by high saving rates in the household sector. An element of the policy response to the global financial crisis had been to increase the credit available to the non-financial corporate and government sectors, which had led to sizeable increases in the debt held by these sectors. Slowing aggregate growth and excess capacity in some industries had raised the risk that some firms would find it more difficult to make repayments on their debt, which could, at some point, be associated with more widespread financial problems. Notwithstanding this, members noted that household debt-to-income ratios and the share of debt denominated in foreign currency were both low. The low level of foreign currency debt, in particular, differentiated China from other emerging economies that had previously experienced financial crises. While the overhang of residential housing inventory and excess capacity in the industrial sector would affect demand for Australia’s resource exports and their prices, the scope for Chinese household incomes to rise over time created long-run potential for Australia to increase exports of rural produce and services, including tourism, to China.
Members commenced their discussion of financial markets with a review of movements in a range of markets following the Bank of Japan’s unexpected lowering of the interest rate for some deposits held at the central bank in order to provide further stimulus. This decision led to significant movements in fixed income and foreign exchange markets in particular, and had also highlighted concerns over bank profits in an environment of low or negative interest rates. Members noted that implementation of the policy decision had been designed to minimise the adverse effect on the Japanese banking system; although the negative rate is effectively the marginal rate on excess funds and therefore had pushed other short-term rates lower, most central bank deposits continued to be remunerated with a positive rate.
Expectations of further increases in the US federal funds rate had been pushed out over the past month, with markets now pricing in only a 70 per cent chance of a further rate rise in 2016 and some market participants expecting a reduction in the federal funds rate this year. In contrast, expectations for additional monetary easing by the European Central Bank this year had increased over the past month, including at the next policy meeting later in the month.
Recent policy developments had contributed to further falls in sovereign bond yields. Members noted that the Japanese government bond yield curve was very flat, with the 10-year bond yield below zero. Almost two-thirds of Japanese government bonds and one-third of short-term bonds issued by euro area governments were currently trading at yields below zero. Australian government bond yields had moved broadly in line with US sovereign bonds.
The sharp declines in global share prices in early February, led by financial sector shares, had, more recently, been partly retraced by price rises. Australian equity prices declined by 2 per cent over February, with movements in prices closely linked to changes in commodity prices. Members noted the generally solid profit reports of Australian listed companies and discussed recent developments in relation to dividend policies.
Share prices of banks in the advanced economies, including Australia, had fallen significantly since early January. The declines had been largest in Europe and Japan. Globally, there had been concerns about the effect of the prevailing low or negative interest rates on interest margins and yields on banks’ high-quality liquid asset holdings and, ultimately, on bank profits and business models. These concerns had been compounded in the euro area by specific issues in particular countries as well as uncertainty about the operation of the new European bank resolution regime.
In foreign exchange markets, volatility increased over the previous month alongside the changing current and prospective stance of monetary policy in the major economies. The US dollar had depreciated slightly on a trade-weighted basis, while the euro was little changed. Since the policy announcement by the Bank of Japan, the yen had appreciated by 5 per cent on a trade-weighted basis. The Chinese authorities had emphasised their intention to preserve stability in the trade-weighted value of the renminbi, which had moved in only a narrow range over the past year. The People’s Bank of China had continued to sell foreign currency reserves in January in response to net private capital outflow. The Australian dollar was little changed on a trade-weighted basis and against the US dollar since the previous meeting.
Bond issuance by Australian banks had been solid in the first quarter to date, despite volatility in global financial markets in the period. Wholesale funding costs for Australian banks had continued to edge higher, but for long-term funding the cost of issuing new paper was still below the average cost of the existing stock on issue. The rise in short-term wholesale bank funding costs had been passed through to some business lending rates.
Pricing in domestic financial markets indicated that there was no expectation of a change in the cash rate at the present meeting.
Considerations for Monetary Policy
In considering the stance of monetary policy, members noted that the recent data on the international and domestic economies had been largely consistent with the outlook presented at the previous meeting. Growth in Australia’s major trading partners had remained a little below average in year-ended terms and commodity prices were still significantly lower than they had been a year earlier. Meanwhile, global financial markets had been volatile in the aftermath of the Bank of Japan’s decision to implement negative interest rates and generally there appeared to be more uncertainty about the direction and potency of monetary policy in the major jurisdictions. However, given the usual lags in the data, it was still too early to assess whether the bout of financial market volatility since the turn of the year foreshadowed or would lead to a weakening in global economic conditions. Globally, monetary policy remained very accommodative.
The available data suggested that the domestic economy had continued to grow at a slightly below-trend pace. There had also been further signs of a rebalancing of activity towards non-mining sectors of the economy, aided by the low level of interest rates and the depreciation of the exchange rate over the past couple of years, which had responded to the evolving economic outlook. There was a small decline in employment in January and a modest rise in the unemployment rate, following a run of much better-than-expected outcomes in the December quarter. Leading indicators of employment had increased further and were consistent with employment growth in the months ahead. Wage growth had remained at quite low levels.
Conditions in the established housing market had eased somewhat since September 2015, in part reflecting the effect of supervisory measures implemented in that year. In addition, after rising for some time, the growth in aggregate housing credit had stabilised over the past six months or so, with a significant easing in growth in lending to investors.
Members judged that there were reasonable prospects for continued growth in the economy and that it was appropriate to leave the cash rate unchanged at an accommodative setting. Over the period ahead, new information should allow the Board to assess whether the improvement in labour market conditions was continuing and whether the recent financial turbulence presaged weaker global and domestic demand. Members noted that continued low inflation would provide scope to ease monetary policy further, should that be appropriate to lend support to demand.
The Board decided to leave the cash rate unchanged at 2.0 per cent.