Minutes of the Monetary Policy Meeting of the Reserve Bank Board
Brisbane - 2 July 2013
Glenn Stevens (Chairman and Governor), Philip Lowe (Deputy Governor), Martin Parkinson PSM (Secretary to the Treasury), John Akehurst, Roger Corbett AO, John Edwards, Kathryn Fagg, Heather Ridout AO, Catherine Tanna
Guy Debelle (Assistant Governor, Financial Markets), Christopher Kent (Assistant Governor, Economic), Jonathan Kearns (Head, Economic Analysis Department), Anthony Dickman (Secretary), Peter Stebbing (Deputy Secretary)
Members opened their discussion with the observation that the main driver of financial markets over the past month had been the reappraisal by the markets of the future path of monetary policy in the United States. Following its policy meeting in June, the Federal Reserve had reiterated that it would not consider raising the federal funds rate as long as the unemployment rate remained above 6½ per cent and inflation expectations were well behaved. However, the Fed had added that if its forecast for the economy came to pass, it would expect to begin scaling back its rate of bond purchases later this year, and to end bond purchases completely in mid 2014. While there was little new in this statement, financial markets subsequently brought forward their expectation of the first increase in the federal funds rate to early 2015 from the end of that year.
Reflecting this assessment, US 10-year bond yields had risen by 40 basis points, following a 50 basis point rise in May. Volatility in fixed income markets had also increased, which had added further to the rise in yields by reducing the willingness to take risk. While the reaction to the Fed's statement may have been disproportionate to its news content, members observed that the level of US 10-year yields, at 2½ per cent, was still low by historical standards.
The shift in expectations about US monetary policy had affected most markets. Notably, mortgage rates in the United States (pricing of which tended to be linked to longer-term yields) had risen further, along with bond yields in all major markets apart from Japan, where the market had been relatively settled after the volatility in the previous month. Spreads between euro area periphery bonds and German Bunds had widened, with Spanish and Italian yields rising to around 5 per cent for a time.
The Australian 10-year bond yield had moved broadly in line with US yields and rose to more than 4 per cent at one point during June, the highest level in more than a year. Spreads on state government debt remained narrow, which was somewhat unusual given the heightened volatility in bond yields. The volatility in fixed income markets had been associated with limited issuance both globally and locally, including minimal new issuance by Australian banks over the past month.
Members noted that riskier asset markets, which had been the recipient of large capital inflows resulting from the accommodative monetary policy settings in the major economies, had been most affected by the shift in expectations about US monetary policy. Currencies and share markets of emerging market economies had fallen sharply, while sovereign bond yields in those countries had increased to their highest levels in around a year.
Another factor contributing to the volatility in financial markets was a tightening of short-term liquidity conditions in China. It appeared that the People's Bank of China was comfortable with some tightening in the interbank market to help rein in the pace of credit growth, particularly in the ‘shadow’ banking system where growth had been strong in the first half of 2013.
The rise in global bond yields had been mostly associated with weaker equity prices in the major economies, although the decline in the US equity market had been less than had occurred elsewhere. Japanese equity prices had fallen particularly sharply and reversed most of the gains since the Bank of Japan had introduced its new policy measures in early April. Chinese equity prices also experienced large declines, reflecting the tightening in financial conditions there, while Australian equity prices had reversed almost all of the previous gains over the year to date, with the biggest falls occurring in resources stocks.
Members noted that the US developments had led to a small decline in the US dollar on a trade-weighted basis, notwithstanding an increase in terms of most emerging market currencies and relative stability against the euro.
These global developments had also seen a further depreciation in the Australian dollar. On a trade-weighted basis, the Australian dollar was around 12 per cent below the high reached in early April and close to its lowest level since September 2010. Overall, domestic financial markets viewed the lower exchange rate as reducing the need for monetary policy to be eased further, with the market at the time of the meeting attaching a 25 per cent probability of a decline in the cash rate occurring in July, with only a single reduction expected by the end of the year.
International Economic Conditions
Members observed that the data released over the past month were consistent with growth of Australia's major trading partners remaining around average. Monthly indicators of economic activity continued to point to steady growth of the Chinese economy, with stable growth in investment and ongoing demand for new housing. It remained too early to tell how long the tightening in financial conditions in China would be sustained and what its effect on borrowing and economic activity might be.
The recovery in the United States appeared to be continuing at a moderate pace, notwithstanding some signs that fiscal consolidation was weighing on private demand. The pace of growth in household consumption had slowed a little in recent months and industrial production had been somewhat subdued. Against this, however, a wide range of indicators pointed to further improvement in the housing sector and total employment continued to grow at around the same pace as the average of the past year or so.
In Japan, economic activity had strengthened a little further in recent months but few details had been provided on the anticipated structural reforms. In the rest of east Asia, after softer-than-expected growth in the March quarter, data available for April and May pointed to improved growth in the June quarter.
The euro area economy remained weak, with GDP across much of the region likely to have declined again in the June quarter, although activity appeared to be more resilient in Germany than elsewhere.
Measured in foreign currency terms, most global commodity prices had declined in recent months. Spot prices for bulk commodities had declined further, while prices for base metals and oil had also fallen to around their mid-2012 levels. Members observed, however, that, in Australian dollar terms, Australia's commodity export prices had changed little over recent months because of the recent exchange rate depreciation.
Domestic Economic Conditions
The national accounts for the March quarter were released the day after the June Board meeting and confirmed the Bank's expectation that GDP had continued to grow at a pace a bit below trend in recent quarters. Members noted that consumption was weaker than had been implied by the relatively strong pick-up in retail sales in the March quarter, while business investment declined and dwelling investment was flat. Exports increased further in the quarter, particularly resources, while imports fell sharply in line with the decline in mining investment.
More timely indicators of economic activity had been broadly consistent with growth remaining below trend. Retail sales were flat in April, though the Bank's liaison contacts suggested that sales rose modestly in May and June. Measures of consumer sentiment were close to long-run averages, although consumers' concerns about unemployment had been high and increased in June.
Members noted that conditions in the housing sector continued to improve gradually. Overall, dwelling investment was flat in the March quarter as continued growth in investment in new dwellings was offset by lower spending on alterations and additions. Forward-looking indicators for new construction continued to be favourable, with the number of building approvals increasing strongly in April and loan approvals rising noticeably over recent months, including for new dwellings. Dwelling prices increased over the June quarter and auction clearance rates remained high by historical standards. This was consistent with the Bank's liaison with builders, which suggested that housing conditions had improved further in most states.
Survey-based measures of business conditions improved in May, but were still a little below long-run average levels. Over the past few months, measures of sentiment had improved for some industries, including construction and business services, and declined slightly for other industries, most notably mining and manufacturing. While the volume of resources exports had risen further, and was expected to continue to grow with the addition of new capacity for bulk commodities, the decline in commodity prices over the past year or so had weighed on the resources sector. Members noted that while mining investment remained at a high level, planning and development work related to future projects had declined significantly since the previous year. Even so, given the considerable volume of firmly committed work, mining investment was likely to remain high for some quarters.
Members were briefed that the Bank's liaison suggested that the near-term outlook for non-mining business investment remained modest, in line with a range of other indicators and survey measures. At the same time, however, the depreciation of the exchange rate over the past two months was expected to provide more supportive conditions for the tradable sector.
Labour market conditions remained somewhat subdued. While changes in employment had been volatile from month to month, year-ended growth, at a little over 1 per cent, continued to be below population growth. Overall, unemployment had been on a gradual upward trend over the past year or so, even though the unemployment rate ticked down to 5.5 per cent in May. Average hours worked declined further in May and were at a two-year low. Over the past few months, employment growth had been strongest in New South Wales and South Australia. Employment had been flat to declining in Queensland and Western Australia, consistent with a decline in demand associated with mining-related activity in those states. Forward-looking indicators of labour demand implied only modest growth in employment in the months ahead.
There had been little new data on prices or wages during the month. The national accounts measure of average earnings per hour fell in the March quarter, although this measure is typically quite volatile from one quarter to the next. While measured productivity growth had also slowed a little of late from a high rate, members observed that unit labour costs had actually declined over the year.
Considerations for Monetary Policy
Overall economic activity in Australia's major trading partners appeared to have been growing at close to its long-run average over recent months, and while commodity prices continued to decline, they were little changed in Australian dollar terms over the past two months because of the exchange rate depreciation.
Recent data suggested that domestic economic activity continued to grow at a below trend pace. The outlook for both mining and non-mining business investment remained uncertain. Mining investment was likely to remain high for some quarters given the considerable volume of firmly committed work, even though it looked to be close to, if not past, its peak. At some time beyond that, however, mining investment was expected to decline more rapidly, partly reflecting a significant decline in the planning and development work that is a precondition for new projects. Resources exports were expanding at a strong rate and this was expected to continue as projects currently under construction began production. The outlook for investment in the non-mining business sector remained for moderate growth, but near-term indicators for investment were still somewhat subdued.
The effects of lower interest rates were apparent across a range of indicators and, given the lags involved in the transmission of monetary policy, this process had further to run. The effects to date were most evident in the housing market and were expected to be apparent in further growth in dwelling investment.
The news in recent months had generally been consistent with the outlook for growth being a little below trend and inflation remaining consistent with the medium-term target. The most significant change had been the depreciation of the exchange rate, though members noted that it remained at a high level. The depreciation was expected to add a little to inflation over time, but the forecast was for inflation to remain consistent with the target. Members noted that it was possible that the exchange rate would depreciate further over time as the terms of trade and mining investment declined, which would help to foster a rebalancing of growth in the economy.
Given the exchange rate adjustment that was occurring, and with the substantial degree of monetary stimulus already in place, members assessed the current stance of policy to be appropriate for the time being. The Board also judged that the inflation outlook, although slightly higher because of the exchange rate depreciation, could still provide some scope for further easing, should that be required to support demand.
The Board decided to leave the cash rate unchanged at 2.75 per cent.