Minutes just now:
International Economic Developments
In their discussion of international economic developments since the previous meeting, members noted that the global economy was in the early stages of recovery following the largest contraction in decades. GDP outcomes in major economies in the September quarter had generally been somewhat better than expected after very large declines in activity in the first half of the year. In China, where the recovery was most advanced, and in some other Asian economies where health outcomes had been relatively favourable, the contraction in GDP earlier in the year had been largely or fully reversed. However, GDP in the September quarter in Europe and the United States remained well below pre-pandemic levels, even after the rebound in the quarter, and this was expected to be the case for some time.
Members emphasised that the global outlook continued to be subject to a high degree of uncertainty. The main source of uncertainty related to the evolution of the pandemic, and the policy and behavioural responses to it. Indicators suggested that the pace of the global recovery had faltered and was quite uneven. The resurgence in new cases of the virus in recent weeks threatened the recovery in some economies, notably in Europe.
In their discussion of global labour markets, members noted that while recent trends in unemployment rates had varied across economies, significant spare capacity was evident. To date, fiscal and monetary policy support had been effective in limiting the rise in recorded unemployment in some countries. However, underemployment was still high and the recent upswing in new cases of the virus in the northern hemisphere could damage these economies’ labour markets in the period ahead. Members noted that, in these circumstances, substantial ongoing policy support would be needed.
Trends in global commodity markets had been mixed and reflected a range of developments. Over the prior 6 months, the recovery in industrial production and fixed asset investment, particularly in China, had supported the prices of base metals and iron ore. Supply disruptions in Brazil had also supported higher iron ore prices through the year, although in recent months prices had retraced a little to be around 25 per cent higher since January. Liquefied natural gas (LNG) spot prices had fallen significantly in the first half of the year alongside a very sharp decline in oil prices, before rebounding strongly in recent months. A pick-up in demand, extended maintenance at some Australian LNG facilities and disruptions to US supply had all contributed to this rebound. Meanwhile, global demand for thermal and coking coal had generally been subdued and prices were still around 20 per cent below levels at the start of the year, following large declines in April.
Domestic Economic Developments
In reviewing the updated set of forecasts for the domestic economy, members noted that the outlook for GDP in the near term had been revised up a little. They noted that, since the onset of the pandemic, consumption, business investment and labour market outcomes had generally been better than initially feared, with significant policy support a key factor during and after the intensive period of lockdowns. However, the recovery in activity was expected to be modest in the context of the largest peacetime contraction in GDP since the Great Depression, and members acknowledged that GDP was not expected to return to its pre-pandemic level until the end of 2021.
A feature of the forecast profile was a significant further downward revision to expected population growth, in line with the updated projections in the Australian Government Budget, which had been announced in October. These projections for population growth, of around 0.2 per cent in 2020/21 and 0.4 per cent in 2021/22, represented the lowest rates of growth since the First World War.
Members considered 3 scenarios in their discussion of the outlook. In the baseline scenario, GDP growth was expected to contract by around 4 per cent over 2020, before growing by 5 per cent over 2021 and by 4 per cent over 2022. This assumed no additional significant COVID-19 outbreaks and that domestic activity restrictions would continue to be lifted, although restrictions on international travel would remain in place until the end of 2021.
Given the high degree of uncertainty about the outlook, 2 alternative scenarios were considered, based largely on different assumptions about health outcomes and restrictions on activity. A plausible downside scenario involved further significant outbreaks of the virus in Australia and abroad. This would result in renewed lockdowns, further delays in the opening of international borders and a material deterioration in household and business confidence. The recovery would be substantially delayed in this scenario, with the level of GDP still falling a little short of pre-pandemic levels by the end of the forecast period in 2022. A stronger economic recovery than envisaged in the baseline scenario was also considered, where additional progress in the control of the virus is achieved, leading to a more rapid easing of restrictions and a faster rebound in confidence, private demand and services exports. In this scenario, the level of GDP would exceed pre-pandemic levels in mid 2021 and would be a couple of per cent higher than in the baseline scenario by the end of 2022.
The starting point for these economic projections was a little higher than expected 3 months earlier, despite the expected effects of the restrictions in Victoria in the September and December quarters. Household cash flow and the rebound in consumption were seen as driving the recovery. Reduced consumption possibilities as a result of restrictions on activity were important in driving the 12 per cent decline in consumption in the June quarter. The subsequent easing in these restrictions was expected to underpin the recovery through to the end of the year and into 2021. Even so, consumption in the December quarter 2020 was expected to be around 5 per cent below the level of a year earlier.
Members discussed the causes and implications of the unusually high rate of household saving in the June quarter. The increase in savings had been due to limits on spending opportunities and strong growth in household disposable income, despite a sharp fall in employment and hours worked. The increase in social assistance payments had been particularly important in supporting the growth in incomes during the pandemic. Households were expected to consume a larger share of their income in the period ahead as more opportunities for consumption became possible, and as some households felt a reduced need to accumulate or maintain high levels of savings for precautionary reasons. This was expected to support overall economic activity through the period where household disposable income declined as a result of reduced social assistance payments and the expiry of other temporary support measures.
Members discussed the substantial support for the economy announced in the Australian Government Budget. The positive net fiscal impact on the economy was projected to be the largest in many decades. Forecasts for public consumption and investment, including infrastructure spending, had been upgraded. Tax incentives for firms, such as accelerated depreciation allowances, had prompted an upward revision to the forecasts for business investment. Even so, high uncertainty and expectations of subdued demand were likely to restrain business spending over the forecast period.
Turning to the housing market, members noted that prices had declined over recent months in Melbourne and, to a lesser extent, in Sydney. These declines had been smaller than those recorded in 2018. Elsewhere, housing prices had generally increased in recent months. Housing loan commitments and price trends across the country suggested that conditions in the detached housing market remained stronger than in the apartment market; growth in rents for apartments remained weak in most cities.
Members discussed recent developments in Australian trade volumes, noting that while services accounted for a smaller share of overall trade than goods, services trade had been particularly affected during the pandemic. The closure of international borders had led to sharp falls in tourism imports and exports, and education exports had also been much lower. In cases where foreign students were studying online at Australian educational institutions but not physically in the country, this would generate fee income. However, these students would not be consuming other goods and services in Australia; typically, this contributes a little more to education exports than fees.
In their discussion of the labour market, members noted that conditions in the September quarter had improved and outcomes had been better than expected. But labour market conditions remained soft overall. In the month of September, outcomes had been mixed: employment had declined, led by developments in Victoria, while total hours worked had recovered a little further as the increase in average hours worked had more than offset the decline in employment. Members observed that hours for part-time workers had recovered to pre-pandemic levels, while many full-time workers were still on reduced hours.
Under the baseline scenario, the unemployment rate was forecast to increase to a little below 8 per cent by the end of the year. This was higher than the 6.9 per cent rate of unemployment in September, but below the 10 per cent peak forecast 3 months earlier. With employment expected to grow steadily and more people drawn back into the labour market over the forecast period, the unemployment rate was expected to remain above pre-pandemic levels through to the end of 2022. However, in the downside and upside scenarios, the unemployment rate could be significantly higher or lower than projected in the baseline forecast, depending largely on the evolution of the pandemic. Members noted a high degree of uncertainty is likely around unemployment rate outcomes in the coming months as restrictions are eased in Victoria and temporary support policies for the labour market are adjusted or expire. Members also discussed the high level of underemployment, which highlighted that significant spare capacity remained in the labour market and that this was likely to be the case for a considerable period.
Members noted that spare capacity in the labour market had been weighing on wages and underlying inflation, and would continue to do so for some time. Headline inflation outcomes in the June and September quarters had been volatile because of the introduction and subsequent removal of policy measures, especially the subsidy for child care and preschool, as well as large changes in fuel prices. The effect of temporary policy changes was expected to persist into 2021, but to a lesser extent. Behavioural changes during the pandemic had also had a large effect on some prices; for instance, prices of consumer durables had been supported by unusually strong demand. But, overall, members concurred that the outlook for inflation was very subdued. Both headline and trimmed mean inflation were forecast to bottom out below 1 per cent in 2021 before reaching 1½ per cent by the end of 2022.
Members briefly reviewed how the domestic economy had evolved over the preceding year relative to the Bank’s forecasts for GDP growth, unemployment and inflation, as had become the Board’s practice in preceding years. On this occasion, members acknowledged that economic growth had been well below what had been expected in the November 2019 forecasts, owing to the extraordinary economic contraction following the onset of the COVID-19 pandemic. While a global pandemic was a known risk, its timing could not be predicted. Members noted that new data sources and methods, and extensive outreach with other agencies and liaison contacts, had played a valuable role in informing the Bank’s forecasts during the period of heightened uncertainty over preceding months. These enhancements would assist the forecasting process in the future.
International Financial Markets
Members noted that global financial market conditions had remained very accommodative. Central banks were expected to maintain their highly accommodative policy settings for an extended period. Market pricing implied that some central banks, including the Bank of England, European Central Bank and Reserve Bank of New Zealand, were expected to lower policy rates further in coming months.
Central banks in most advanced economies had continued to purchase significant amounts of government debt in secondary markets. Government bond yields had remained very low across advanced economies partly as a result of these purchases and despite strong issuance by governments. This issuance had also been met by strong demand from private sector investors.
Corporate funding conditions had remained favourable in advanced economies, including Australia. Debt issuance had eased – after firms had raised large amounts of funding earlier in the year – and spreads on corporate debt had remained low. The number of corporate defaults had subsided over recent months. Equity prices had declined from recent highs, following rising COVID-19 cases in Europe and the United States. Nonetheless, the overall cost of equity had been low, which had supported high levels of equity issuance and corporate takeover activity.
In China, monetary policy had been less stimulatory than elsewhere because economic conditions had been more favourable and policymakers had been seeking to balance risks to the economy against risks to financial stability. Aided by higher interest rates and portfolio inflows, the renminbi had appreciated noticeably over the preceding few months.
Domestic Financial Markets
Domestically, in preceding weeks financial market participants had more strongly anticipated that the Bank would announce further monetary policy measures. Specifically, the Bank was expected to: reduce the cash rate target, the 3-year Australian Government bond yield target and the interest rate on drawings under the Term Funding Facility; reduce the interest rate paid on Exchange Settlement balances at the Bank; and implement a program of government bond purchases for the longer-maturity part of the yield curve (beyond the 3-year tenor).
Members noted that, in response, yields on Australian Government Securities (AGS) had declined across the curve. Yields on 10-year AGS had been high relative to the 10-year government bond yields of other advanced countries. They also observed that this was partly because the holdings of government debt by the Bank were relatively low as a share of GDP. The 10-year AGS yield had declined relative to US Treasury yields as market expectations for a government bond purchase program in Australia had firmed. The decline in Australian yields relative to those for other countries, along with lower commodity prices, had contributed to a depreciation of the Australian dollar of around 5 per cent since early September. Meanwhile, Australian equity prices had outperformed major overseas equity indices over the preceding month.
The Bank’s policy actions to date had kept Australian banks’ funding costs at historically low levels and had supported the availability of credit to households and businesses. Deposit rates had declined noticeably in March and April, and had continued to decline since then. The share of deposits paying interest rates close to zero had increased to be a little over one-quarter of the major banks’ (non-equity) funding, but a sizeable share of deposits was still paying rates of 1 per cent or higher. Lending rates for both housing and business loans had also declined noticeably following the Bank’s package of measures in March and had gradually moved lower since then.
Demand for housing finance had increased a little further in September (outside Victoria) in line with the pick-up in some indicators of housing market activity. Growth in housing credit to owner-occupiers had risen a little, while credit to investors in housing had expanded only modestly after having declined for much of the year. Some lenders had reversed some of the tightening in the availability of housing finance that had occurred earlier in the pandemic, which had mostly reflected the application of existing credit standards in the context of weaker economic conditions. By contrast, demand for business credit had remained weak and credit supply had tightened since March. Lending to small and medium-sized businesses had been little changed, while lending to large businesses had retraced most of the sharp increase earlier in the year, as precautionary lines of credit had been repaid.
Households had continued to pay off housing loans and increase balances in offset and redraw accounts at a faster rate than in early 2020, at the same time as lower interest rates had reduced their interest payments. Personal credit had also continued to decline as households paid off their credit card debts. Members noted that this behaviour was consistent with weak consumption growth and was likely to have been facilitated by the government’s income support programs as well as withdrawals from superannuation.
Considerations for Monetary Policy
In considering the policy decision, members observed that the global economy had been recovering from the initial virus outbreaks, with the recovery most advanced in China. Nevertheless, most economies were still well short of the output levels that prevailed prior to the pandemic and the recent virus outbreaks posed a downside risk to the outlook, particularly in Europe. Globally, inflation remained very low and below central bank targets.
In Australia, economic activity had contracted substantially in the early months of the pandemic and had since recovered some of that decline. With the restrictions on activity in Victoria having been lifted, the near-term outlook had improved a little. Fiscal and monetary policy support had been effective in preserving many jobs and firms through the period of restrictions and the Australian Government Budget had provided further stimulus. Nevertheless, the recovery was still expected to be protracted and the outlook remained dependent on successful containment of the virus. It would take some time for output to reach its pre-pandemic level, and it had become increasingly clear that an extended period of high unemployment was in prospect. The high unemployment rate and excess capacity across the economy more broadly were expected to result in subdued wages growth and inflation over coming years.
Members agreed that the Board’s policy measures were continuing to support the Australian economy by underpinning very low borrowing costs and the supply of credit to households and businesses. There was a very high level of liquidity in the Australian financial system and the mid-March policy package had helped to lower funding costs. Authorised deposit-taking institutions had drawn down $83 billion of low-cost funding through the Term Funding Facility and had access to a further $104 billion under the facility. Members noted that the Australian banking system, with its strong capital and liquidity buffers, had remained resilient and was helping the economy traverse the current difficult period.
The Board discussed the outlook for the economy and concluded that, despite somewhat better recent outcomes in Australia, the recovery was expected to be protracted and uneven. The outlook implied a large shortfall in activity and employment from levels that would be consistent with full employment. To provide additional support for the recovery and complement the significant support from fiscal policy, the Board resolved to introduce a further package of monetary measures, namely:
- a reduction in the target for the cash rate to 0.1 per cent
- a reduction in the interest rate on Exchange Settlement balances held by financial institutions at the Bank to zero
- a reduction in the target for the yield on the 3-year Australian Government bond to around 0.1 per cent
- a reduction in the interest rate on new drawings under the Term Funding Facility to 0.1 per cent
- the purchase of $100 billion of government bonds of maturities of around 5 to 10 years over the following 6 months.
Under the program to purchase longer-dated bonds, members agreed the Bank would purchase nominal bonds issued by the Australian Government and by the states and territories, with an expected 80/20 split. These bonds would be purchased in the secondary market through regular auctions conducted by the Bank, with the first auction to be conducted on 5 November. The Bank would not purchase bonds directly from the government, and so the purchase of bonds by the Bank would not constitute government financing. The longstanding separation of monetary policy and fiscal financing in Australia would therefore remain in place. The Australian Government and the states and territories fund themselves in the market and their bond auctions had been heavily oversubscribed over recent months, notwithstanding the significant increase in the size of these auctions.
The Bank remained prepared to purchase bonds in whatever quantity is required to achieve the 3-year yield target. Any bonds the Bank needs to purchase to support the 3-year yield target would be in addition to the $100 billion program.
In considering the case for the further monetary measures, the Board recognised that the complementary nature of the measures meant that it would be desirable for them to be implemented as a package. In particular, interest rates further along the yield curve capture expectations about the path of short-term rates, so lowering short-term rates would also lower rates at the long end of the yield curve. The Board concluded that the combination of government bond purchases and lower interest rates across the yield curve would assist the recovery by lowering financing costs for borrowers; contributing to a lower exchange rate than otherwise; and supporting asset prices, which would help to strengthen balance sheets.
Members discussed the merits of targeting a bond yield around 5 years but decided against this and to continue with the 3-year yield target. Members judged that a yield target is most effective when its maturity is consistent with the Board’s forward guidance on the cash rate. The Board expects the cash rate to remain at its current level for at least 3 years, but beyond that members have less confidence about the path of interest rates. Moreover, members acknowledged that other factors can have a greater influence on yields at longer horizons.
Members considered whether to implement the package at this time or to wait for further information. The Board concluded that it was the appropriate time to implement the package, as it had become clearer that unemployment would remain high and inflation subdued for an extended period, and that further information in coming months was unlikely to change that assessment. The Board viewed addressing the high rate of unemployment as an important national priority. The package would add to the substantial monetary stimulus already provided earlier in the year and would complement the significant steps taken by the Australian Government, including in the recent Budget, to support jobs and growth. It was also likely that having the various arms of policy all taking steps in the same direction would deliver a greater impact than the sum of the individual parts. This would be especially so during a period in which the economy is opening up and people are more willing and able to spend.
Members also discussed the effect of lower interest rates on those who rely on interest income and acknowledged the difficulties that low interest rates generate for these households. While the effect of monetary easing falls unevenly across the community, in aggregate lower interest rates boost disposable incomes for the household sector, which stimulates spending and supports employment. Lower interest rates also have broader stimulatory effects on the economy through other channels, including the exchange rate and asset prices. Members noted that very low interest rates were a global phenomenon, reflecting the high level of the supply of savings relative to the demand to use those savings to invest in productive capital. This had reduced returns for savers, particularly in low-risk assets.
Members discussed the effect that the further monetary measures would have on financial and macroeconomic stability. The further easing was expected to reduce financial stability risks by supporting employment, private sector balance sheets and the broader economy. The Board weighed this benefit against the risks inherent in investors searching for yield in a low interest rate environment, including risks linked to higher leverage and asset prices, particularly in the housing market. On balance, the Board concluded that there were greater financial stability benefits from a stronger economy, while acknowledging the importance of closely monitoring risks in asset markets.
Members agreed that, with the cash rate target at 10 basis points and the interest rate on Exchange Settlement balances at zero, interest rates would have been lowered as far as it made sense to do so in the current environment. They considered that there was little to be gained from short-term interest rates moving into negative territory and continued to view a negative policy rate as extraordinarily unlikely.
Given the outlook for both employment and inflation, the Board considered that monetary and fiscal support will be required for some time. The Board remains committed to not increasing the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range. For this to occur, wages growth would have to be materially higher than recent levels. This would require significant gains in employment and a return to a tight labour market. Given the outlook, the Board does not expect to increase the cash rate for at least 3 years. The Board remains of the view that it would be appropriate to remove the yield target before the cash rate itself were increased.
Members agreed that the focus over the period ahead will be the government bond purchase program. At its future meetings, the Board will closely monitor the effects of the bond purchases on the economy and on market functioning, as well as the evolving outlook for jobs and inflation. The Board is prepared to do more if necessary.
As I noted recently, announced QE tends to mark the bottom for yields not the top as markets discount in advance then start looking for inflation.
The latter isn’t coming, as usual, but for now all that matters is the vaccine-led recovery and inflation hopium so we’ll go through some more fakeflation in yields before sanity returns.
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