Via the suddenly sane RBA:
Minutes of the Monetary Policy Meeting of the Reserve Bank Board
Philip Lowe (Governor and Chair), Guy Debelle (Deputy Governor), Mark Barnaba AM, Wendy Craik AM, Ian Harper, Steven Kennedy PSM, Allan Moss AO, Carol Schwartz AO, Catherine Tanna
Luci Ellis (Assistant Governor, Economic), Christopher Kent (Assistant Governor, Financial Markets), Carl Schwartz (Deputy Head, Economic Analysis Department)
Anthony Dickman (Secretary), Ellis Connolly (Deputy Secretary), Alexandra Heath (Head, Economic Analysis Department
International Economic Conditions
Members commenced their discussion of the global economy by noting that growth in Australia’s major trading partners had slowed over the past year from above-trend growth in 2017 and the first half of 2018. The slowing had been led by a decline in trade and investment growth, but recent indicators suggested that this weakness had begun to spill over to the services sector in some countries. Despite this, in major advanced economies employment growth had remained above growth in working-age population, but had eased, particularly in the manufacturing sector. Overall, labour market conditions remained tight but inflation remained below central banks’ targets.
Growth in Australia’s major trading partners was forecast to be around 3½ per cent in 2019 and 2020. These forecasts had been revised down a little since the August meeting, partly because the US–China trade and technology disputes had escalated over the previous three months. Members noted that the implications of slower global growth for the Australian economy would depend on its composition; over the previous year or so, strength in steel-intensive activity in China had supported demand for Australian exports despite Chinese growth slowing overall.
The risks to the global growth forecasts were still tilted to the downside. Although the prospects for a partial trade agreement between the United States and China had improved since the previous meeting, the likelihood of a more comprehensive agreement remained uncertain. The outlook for global growth was being supported by accommodative financial conditions.
In the advanced economies, GDP growth had slowed over the preceding year or so and was forecast to slow a little further to be around, or somewhat below, trend in 2020. In the United States, GDP growth was at or above trend; consumption growth had been resilient and residential construction activity had picked up, although business investment had declined. In the euro area, subdued growth had reflected weak external demand and weak production in the automotive industry. Members noted that the introduction of new emissions testing and weak global demand for passenger vehicles had contributed to the decline in exports and car production in the euro area since mid 2018. In Japan, growth was expected to slow from an above-trend pace following an increase in the consumption tax in October. The Japanese economy was also facing slowing external demand, particularly from other parts of Asia.
In east Asia, GDP growth had been subdued in the September quarter, most notably in the more export-oriented economies, given their close integration into global supply chains. Members noted that weak global demand for memory circuits had dampened growth in South Korea and Singapore, while political unrest had contributed to a fall in output in Hong Kong. Growth in output had been relatively resilient in the less export-oriented economies. Some governments in the region had offered incentives for production to relocate from China in response to the trade disputes. There had been further signs of weakness in the Indian economy, mostly unrelated to the slowing in global trade, which authorities had tried to offset through both monetary and fiscal stimulus.
In China, GDP had increased at an annual rate of 6 per cent in the September quarter, largely as expected, with slower growth in domestic demand. Members noted that growth in nominal GDP had also slowed and that this had implications for debt-servicing capacity. Bilateral trade with the United States had contracted further, but, overall, external demand had been steadier and net exports had been positive for Chinese growth more recently. Policy measures had continued to support growth and had been tilted towards steel-intensive activities. This had supported Chinese steel production and, in turn, demand for Australian bulk commodities. There remained ongoing uncertainty about how these policy measures and trade tensions with the United States would affect growth in China. As had been the case for some time, the mix of policy measures was also an important consideration for how Australia’s exports and terms of trade might be affected.
Movements in commodity prices had been mixed since the previous meeting. Iron ore prices had declined in response to expectations of lower near-term demand. Oil, coal and base metals prices had increased a little in October. Overall, the terms of trade for the September quarter had been revised a little higher. They were still expected to decline gradually over the following few years because global demand for bulk commodities was expected to ease and more supply was expected to become available.
Domestic Economic Conditions
Quarterly GDP growth had picked up a little since its low point in the second half of 2018 and was expected to have been moderate in the September quarter. Members noted that the forecasts for growth and the labour market had been largely unchanged from those presented in August. Growth in output was expected to increase to 2¾ per cent over 2020 and around 3 per cent over 2021, supported by accommodative monetary policy, the low- and middle-income tax offset, improved conditions in the established housing market, ongoing spending on infrastructure and a pick-up in mining investment. Exports and public spending were also expected to contribute to growth over the forecast period. One near-term downside risk to the Australian economy could be a larger-than-expected contraction in housing construction activity. Further out, the risks to the growth outlook were more balanced.
Retail sales volumes had declined in the September quarter, which suggested that consumption growth was likely to have remained subdued in recent months despite the tax offset payments and the reductions in interest rates. Although some liaison contacts had reported a modest pick-up in sales growth, they had found it difficult to attribute this to a specific cause given other factors at play, such as the pass-through of the exchange rate depreciation. Consumer sentiment had fallen to below-average levels over recent months.
Growth in consumption was expected to increase over the forecast period, supported by some recovery in growth in household income and the turnaround in prices in the established housing market. Growth in household disposable income was forecast to increase, because labour market conditions were expected to continue to support labour income and the recent monetary policy easing and tax offsets would lower household interest and tax payments. In the near term, however, forecast growth in household income had been revised slightly lower, partly to reflect the effects of the drought on farm incomes and the downturn in housing construction on related businesses, as well as continuing evidence of strong tax collections. Overall, although there remained considerable uncertainty around the outlook for consumption growth, the medium-term risks were considered to be balanced.
Members noted that housing market conditions had continued to strengthen in Sydney and Melbourne, and conditions appeared to have firmed in other cities, including Brisbane. However, housing market conditions had remained weak in Perth and Darwin. In Sydney and Melbourne, housing prices had been on an upward trajectory since June, the number of auctions had increased and auction clearance rates had been at relatively high levels. Housing turnover had remained low across the capital cities, although there had been signs that turnover was starting to rise.
Despite the stronger-than-expected pick-up in established housing markets, there had been little evidence of a lift in the early stages of residential development activity. In the near term, the risks to growth from dwelling investment were tilted to the downside. Building approvals had declined in the September quarter, to be more than 20 per cent lower over the year. Liaison with industry participants suggested that the recent improvement in housing market conditions had not yet translated into stronger sales for new housing. A larger-than-expected contraction in dwelling investment could delay the gradual improvement in GDP growth. Members noted that the recent strengthening in housing market conditions would support building activity in time. The lagged response to higher housing prices and a period of low building activity had raised the likelihood that dwelling investment would be stronger in the medium term than currently expected.
Recent indicators pointed to ongoing support for non-residential construction activity over the following year or so. Non-residential building approvals had increased in recent months and the pipeline of work for both non-residential building and private infrastructure had remained at a high level. Business conditions had been around average since the beginning of the year. Mining-related activity was expected to increase over the forecast period and it was possible that mining investment could be stronger than expected towards the end of the forecast period. In contrast, members noted that rural conditions had remained difficult in many parts of the country and that the outlook for rural exports over the following year had been downgraded.
Employment had continued to grow strongly, at 2.5 per cent in year-ended terms. The unemployment rate had been 5.2 per cent in September, which was little changed since April. The employment-to-population ratio had continued to rise and was at its highest level since 2008. Leading indicators suggested that labour demand would be around average over the following six months. The outlook for the labour market had been little changed since August. Employment growth was expected to ease over the forecast period, but to remain above growth in the working-age population. The unemployment rate was forecast to decline to be just under 5 per cent in late 2021, which was still above estimates of full employment.
Wages growth was expected to remain around its recent rate over the forecast period. A large share of firms in the Bank’s liaison program had continued to report that they expect wages growth to remain around this rate over the year ahead and very few firms expect higher wages growth. New enterprise bargaining agreements were still generally delivering lower wage outcomes than the agreements they were replacing. Public sector wages growth was also expected to be constrained over the forecast period, owing to ongoing government caps on wage increases.
Inflation in the September quarter had been in line with forecasts presented in August and confirmed that inflationary pressures remained subdued. CPI inflation had been 0.3 per cent in the September quarter and 1.7 per cent over the year. Trimmed mean inflation had been low and steady at 1.6 per cent in year-ended terms, which was consistent with slow output growth, continued spare capacity in the labour market and weak housing market conditions weighing on housing-related prices.
In the September quarter, housing-related consumer prices had remained very subdued. New dwelling prices had declined for the third consecutive quarter. Rent inflation had remained low because of the strong supply of rental housing, particularly in Sydney. Electricity prices had fallen as a result of regulatory changes in the quarter. Overall, inflation in non-tradable items had been steady. In contrast, tradable inflation (excluding volatile items) had picked up in the quarter, reflecting continued pass-through of the earlier exchange rate depreciation to retail prices; the prices of consumer durables had risen over the previous four quarters, following a decade of declining prices. Grocery price inflation had also picked up, driven by the ongoing effect of the drought on food prices. Members noted that meat prices had also been supported by strong demand from China to replace lost domestic pork production as a result of African swine flu and were likely to remain high for some time after the drought breaks, given that it would take time to rebuild herds.
Underlying and headline inflation were expected to increase to around 2 per cent by the end of 2021. Inflationary pressures were expected to pick up in response to above-trend growth in output and gradually tightening labour market conditions. However, the upward pressure on prices from the earlier exchange rate depreciation and the drought was expected to be temporary, although there was some uncertainty around the persistence of these effects. Utilities price inflation was expected to be below average over the following few years and could be lower than forecast as more renewable energy capacity comes on line. New dwelling inflation was expected to remain subdued until construction activity recovers later in the forecast period. Rent inflation was expected to increase from its recent low rate given that ongoing population growth was expected to be higher than growth in the housing stock.
Members noted that the risks to the wage and price inflation forecasts were balanced. Wages could increase more quickly than forecast if the pick-up in output growth erodes spare capacity more quickly than anticipated. However, an extended period of low wages growth and inflation could mean that wage-setting norms would be slow to move higher. Members observed that a further gradual lift in wages growth would be needed for inflation to be sustainably within the 2–3 per cent target range.
Members considered a detailed review of how the economy had evolved over the preceding year relative to the Bank’s forecasts for GDP growth, unemployment and inflation. Over the year since the November 2018 forecasts, GDP growth had been much weaker than expected. Inflation had also been lower than forecast. The extent and breadth of the spillovers from the housing downturn – particularly for consumption, household income, dwelling investment and inflation – had been an important driver of these outcomes. These spillovers had mostly been identified at the time as downside risks to the forecasts, but their extent had been considerably larger than expected. Despite the slower-than-expected growth in output, there had been sustained strength in employment growth, which had been met with greater labour force participation. As a result, the unemployment rate had been only marginally higher than forecast and there had been little upward pressure on wages.
Members noted that global financial conditions remained accommodative. Market sentiment had improved a little since the previous meeting, following signs of an easing of some concerns about the downside risks for the global economy.
While a number of central banks had eased policy in recent months, expectations for additional easing had been scaled back. As widely expected, the US Federal Reserve reduced the federal funds rate by 25 basis points in October, the third successive meeting at which policy rates had been reduced. The Federal Reserve noted the decision had been based on the implications of global developments for the economic outlook as well as muted inflation pressures. However, it also noted that the US economy continued to perform solidly and that it would take a material change in the outlook for the Federal Reserve to adjust policy settings further. After announcing a broad-based stimulus package in September, the European Central Bank left policy settings unchanged at its October meeting, but stated that it was prepared to ease policy further if necessary. The People’s Bank of China continued to employ a range of targeted measures to maintain accommodative financing conditions in support of economic activity, including further cuts to banks’ required reserve ratios.
During October, government bond yields had increased modestly in a wide range of economies, including Australia. The increase followed positive developments in the US–China disputes and Brexit negotiations, and was associated with the scaling back of expectations for further monetary policy stimulus. Nevertheless, government bond yields remained close to the very low levels reached in the middle of the year.
Financing conditions for corporations remained accommodative. Globally, equity prices had increased, and the US market was at a record high. Spreads on corporate bonds were low. In Australia, growth in business debt had slowed, reflecting softer demand for funding from large businesses, while credit conditions for small and medium-sized businesses remained tight.
The US dollar and Japanese yen had depreciated a little over October (after having appreciated over the previous few years) in response to the easing in concerns about global downside risks. After depreciating over much of 2019, the Chinese renminbi had appreciated somewhat in recent times. The Australian dollar had appreciated slightly in October, but remained at the lower end of its range over recent times.
In Australia, banks’ funding costs had declined following the reductions in the cash rate, which had been reflected in short-term money market rates and deposit rates over recent months. Members discussed the range of pricing on deposits. While close to a quarter of deposits were estimated to be earning interest at rates between 0 and 50 basis points, most deposits earned interest at rates over 1 per cent. Following the cumulative 75 basis point reduction in the cash rate this year, banks were estimated to have lowered the interest rates on at-call retail deposits by an average of 60 to 70 basis points.
Borrowing rates for households and businesses were at historic lows. A large share of the recent monetary policy easing had been passed through to mortgage rates paid by households. After passing through most of the June and July cash rate cuts to standard variable mortgage rates (SVRs), financial institutions had passed through less of the October rate cut, bringing the total reduction in SVRs since June to around 60 basis points. Strong competition for high-quality borrowers had led to rates for new and refinanced loans being lower than for existing loans. In addition, borrowers were continuing to switch from interest-only loans to lower-rate principal-and-interest loans. This meant that average outstanding mortgage rates had declined by around 65 basis points since the middle of the year. This process was expected to continue.
Consistent with the improvements in some housing markets, housing loan approvals had risen strongly since May, driven largely by approvals to owner-occupiers. Members noted that there was strong competition for borrowers of high credit quality. Despite this, the pace of growth in housing credit for owner-occupiers had picked up only slightly, while the stock of housing credit for investors had continued to decline a little. This implied that the increase in new loans over recent months had been accompanied by faster repayment of existing loans, as usually occurs in the months immediately following an interest rate reduction.
Financial market pricing implied that expectations for a further reduction in the cash rate had been scaled back since the previous meeting, with some chance of a 25 basis point reduction around the middle of 2020.
Considerations for Monetary Policy
Turning to the policy decision, members observed that while the outlook for the global economy remained reasonable, the risks continued to be tilted to the downside. Although there had been some recent progress in resolving the US–China trade and technology disputes, there was still the potential for re-escalation. In the major advanced economies, inflation remained subdued despite low unemployment rates and a lift in wages growth. In China, the authorities had taken steps to support the economy while continuing to address risks in the financial system.
Global financial conditions remained accommodative, and market sentiment had improved a little despite ongoing concerns about the economic outlook. While a number of central banks had eased policy recently, expectations for additional easing had declined over the prior month. Government bond yields remained very low in many economies, including Australia. Borrowing rates for households and businesses in Australia were also at historically low levels and there was strong competition for borrowers of high credit quality. There were further signs of a turnaround in established housing markets, although demand for credit by investors had remained subdued and credit conditions for some firms, especially small and medium-sized businesses, remained tight. The Australian dollar was at the lower end of its range over recent times.
The outlook for the Australian economy was little changed since August. After a soft period in the second half of 2018, GDP growth had picked up a little in the first half of 2019 and it appeared that a gentle turning point had been reached. Looking forward, growth was expected to strengthen gradually to 2¾ per cent over 2020 and around 3 per cent over 2021. This outlook was expected to be supported by accommodative monetary policy, recent tax cuts, ongoing spending on infrastructure, the upswing in housing prices in some markets and a pick-up in mining investment. An important domestic uncertainty continued to be the outlook for consumption, with the sustained period of only modest increases in household disposable income continuing to weigh on consumer spending.
Employment had continued to grow strongly and had been matched by strong growth in labour supply. The unemployment rate had remained steady at around 5¼ per cent and was expected to decline only gradually. Spare capacity was likely to remain in the labour market for some years. Wages growth had remained subdued and was expected to remain at around its current rate for some time yet. Members agreed that a further gradual lift in wages growth would be a welcome development and was needed for inflation to be sustainably within the 2–3 per cent target range.
In the September quarter, inflation had been broadly as expected at 1.7 per cent over the year. Inflationary pressures had remained subdued, held down by very low housing-related prices and slow growth in labour costs and administered prices. Over time, inflation was expected to increase gradually in response to some tightening in labour market conditions, to be close to 2 per cent in 2020 and 2021.
Given this outlook, members considered how best to respond.
The Board agreed that a case could be made to ease monetary policy at this meeting, but that the most appropriate approach would be to maintain the current stance of monetary policy and to make another full assessment once more evidence of the effects of the earlier monetary easing had become available. Global financial markets were signalling a decline in pessimism, which, if sustained, could lead to better than expected outcomes for the global economy. The significant easing of monetary policy in Australia since the middle of the year was supporting employment and income growth and a gradual return of inflation to the medium-term target range. The established housing market was picking up, which would have positive spillovers for the broader economy, although the size of these spillovers was uncertain. Further evidence on spending by households was required before drawing a conclusion on the effects of the tax cuts and low interest rates. Having already delivered a substantial monetary stimulus in recent months, there was a case to wait and assess the effects of this stimulus, especially given the long and variable lags.
In reaching this conclusion, members reviewed the case for a further reduction at the present meeting. This case largely rested on only gradual progress having been made towards the Bank’s goals. While members judged that lower interest rates were supporting the economy through the usual transmission channels (including a lower exchange rate, higher asset prices and higher cash flows for borrowers), they recognised the negative effects of lower interest rates on savers and confidence. They also discussed the possibility that a further reduction in interest rates could have a different effect on confidence than in the past, when interest rates were at higher levels.
The Board concluded that the cash rate should be held steady at this meeting. As part of their deliberations, members also agreed that it was reasonable to expect that an extended period of low interest rates would be required in Australia to reach full employment and achieve the inflation target. The Board would continue to monitor developments, including in the labour market, and was prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time.
The Board decided to leave the cash rate unchanged at 0.75 per cent.
That’s as dovish as it gets for the glass half full RBA. The December meeting has to be considered live after the jobs market swoon given that was not a part of the Bank’s calculus. February is a lock.
Bonds were bid and AUD sank.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
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