Minutes of the Monetary Policy Meeting of the Reserve Bank Board
Sydney – 4 March 2014
Glenn Stevens (Chairman and Governor), Philip Lowe (Deputy Governor), John Akehurst, Roger Corbett AO, John Edwards, Kathryn Fagg, Martin Parkinson PSM (Secretary to the Treasury), Heather Ridout AO, Catherine Tanna
Guy Debelle (Assistant Governor, Financial Markets), Malcolm Edey (Assistant Governor, Financial System), Christopher Kent (Assistant Governor, Economic), Luci Ellis (Head, Financial Stability Department), Jonathan Kearns (Head, Economic Analysis Department), Anthony Dickman (Secretary), Peter Stebbing (Deputy Secretary)
International Economic Conditions
Growth of Australia's trading partners in late 2013 was close to its average pace of the past decade. Inflation in the major economies remained low.
The Board noted that recent data suggested that the US economy may have slowed a little from the strong growth recorded late last year, although at least some of this reflected the effects of particularly adverse winter weather across much of the country. Payrolls data suggested slower growth in employment over the previous two months, although the household survey showed much stronger growth and a further decline in the unemployment rate in January. Consumption and investment indicators were at higher levels in January than in earlier months, while the pace of recovery in the housing market appeared to have moderated.
There were further signs of a gradual recovery in the euro area, with a modest expansion in activity in the December quarter resulting in positive growth over the course of 2013. Output had increased in most euro area countries in the quarter. Measures of consumer and business confidence were around their long-run average levels, although unemployment rates remained elevated across much of the region.
In Japan, GDP growth was a little lower than expected in the December quarter, in part reflecting weakness in exports. Growth in domestic demand had remained strong, particularly in consumption ahead of the consumption tax increase in April. There was a small decline in inflation in January, and energy prices had stabilised so were not expected to add to inflation in coming months, although inflation would be boosted for a time by the effects of the tax increase. In the rest of east Asia, growth had picked up a little in the December quarter. In contrast, output growth in India remained relatively subdued and inflation was still high despite moderating recently.
For China, the recent data were more difficult to interpret at this time of the year owing to the Chinese New Year holiday. The limited data available suggested that growth may have moderated a little in early 2014. In particular, the manufacturing PMIs declined in January, suggesting that conditions in the manufacturing sector had softened somewhat. Even so, merchandise imports rose strongly in January, including imports from Australia. The Board was briefed about longer-run trends, which suggested that, while the working-age population was close to peaking, urbanisation was expected to continue in China for some time. Combined with likely increases in the size and quality of housing, this could underpin high levels of new urban residential construction over coming years.
Global commodity prices had been mixed over the month. Increases in the prices of base metals, gold and oil were offset by declines in iron ore and coal prices, which had drifted lower in recent months.
Domestic Economic Conditions
Members began their discussion of the domestic economy with the labour market. They noted that wage growth remained subdued, in line with the weak conditions in the labour market and relatively low consumer and union inflation expectations. The wage price index rose by 0.7 per cent in the December quarter, to be 2.6 per cent higher over the year, the lowest year-ended outcome since the series began in the late 1990s. Wage growth in the public sector over 2013 was around its slowest pace since 2000, consistent with ongoing fiscal restraint. Business surveys indicated that wage growth in the March quarter was likely to remain subdued, which was consistent with liaison reports that firms were having little difficulty finding suitable labour.
The unemployment rate had increased to 6 per cent in January, continuing its gradual increase of the past 18 months, while the participation rate had declined significantly since the middle of the previous year, largely because of a decrease in male participation. The level of employment was little changed over the past year, although total hours worked had increased. Members noted the recent high-profile announcements of future job losses against the backdrop of the 400,000 to 450,000 people who leave employment each month and the similar number who take up employment. They discussed the potential for the extensive coverage of these job losses adversely to affect consumer confidence. At the same time, there was evidence that forward-looking indicators of labour demand had stabilised, following earlier declines to low levels.
Growth in household spending looked to have picked up slightly in the December quarter, although the pace of growth was expected to remain a little below average for a time. Liaison suggested that the stronger retail sales seen in the latter months of last year had continued into the early part of this year, though sales growth may have eased somewhat.
Members observed that conditions in the established housing market had remained strong. Housing price inflation had declined somewhat from the fast pace recorded in 2013, although the data were less informative around this time of year owing to relatively low turnover. Ongoing strength in the established housing market and low lending rates were expected to support new dwelling activity. Dwelling investment was expected to record a slight decline in the December quarter, but a strong increase in approvals for residential buildings over recent months – both for higher-density and detached dwellings – pointed to a substantial increase in dwelling investment in subsequent quarters. Loan approvals and first home buyer grants for new dwellings had also increased of late. Members noted that construction firms were optimistic about the outlook and had reported a pick-up in enquiries from prospective new home buyers.
Survey measures of business conditions had edged higher in January and remained at above-average levels. The improvement in business sentiment in recent months had been broad based across industries. Mining investment was estimated to have declined in the December quarter, as expected, and non-mining investment had remained subdued. In the first reading for 2014/15, the ABS capital expenditure data suggested that a small improvement was in prospect for non-mining business investment. Members noted that the ABS capital expenditure survey reported that mining investment was expected to decline sharply in 2014/15, which had already been embodied in the Bank's forecasts for some time.
The December quarter national accounts were scheduled to be released the day after the March Board meeting. Overall, growth of domestic demand was estimated to have remained well below its trend pace in the quarter. Exports grew strongly in the December quarter, with resource exports increasing at a rapid pace, particularly for iron ore as additional capacity came on line, while services exports had been supported by an increase in international tourism.
Conditions in financial markets had generally steadied over the past month as concerns about a number of emerging market economies had eased amid a general improvement in risk sentiment. Members noted, however, that some emerging market economies remained under pressure, while developments in Ukraine over recent days had weighed on general market confidence. In Russia, equities had fallen sharply and the rouble had depreciated, prompting an emergency rate increase and currency intervention by its central bank.
Sovereign bond yields in the major economies had shown little change through most of February, until late in the month when the situation in Ukraine led to falls in global bond yields. In Italy and Spain, yields had continued to fall, reaching their lowest levels since 2006.
Members also observed that global equity markets had rebounded in February, recovering most of the losses experienced around late January, with the US equity market recording new highs. The Japanese market was the notable exception, with equity prices recording further declines in an environment of heightened volatility. In emerging markets, equity prices had generally recovered part of their recent losses, while Australian equity prices had followed the major markets, rising by 4 per cent over February, underpinned by a solid reporting season.
In testimony to Congress in February, the new Chair of the US Federal Reserve indicated that a significant change to the outlook for the US economy would be required to change the Fed's intention to scale back its rate of asset purchases by $10 billion at each meeting. At this rate, asset purchases would end late in 2014. The first increase in the federal funds rate was not expected until late 2015. The European Central Bank also reiterated its expectation that its policy rate would remain at current or lower levels for an extended period, while the Bank of Japan (BoJ) announced an expansion in its bank lending schemes. The latter would provide little direct additional stimulus but nevertheless emphasised that the BoJ remained committed to providing additional stimulus, if required, to meet its 2 per cent inflation target in 2015.
In China, liquidity conditions in money markets had eased throughout February, after markets reopened following the week-long Chinese New Year holiday. The 7-day interbank repo rate fell to its lowest level since May 2013, despite the People's Bank of China withdrawing liquidity.
Members were informed that foreign exchange markets generally had been subdued over the month, with the major currencies broadly unchanged and most emerging market currencies appreciating somewhat following the sharp falls in the previous month. The Chinese renminbi had depreciated slightly. The Australian dollar had appreciated a little, although it remained around 14 per cent below its peak in early April 2013.
Members noted that money market rates in Australia currently implied an expectation of no change in the cash rate for some time.
Members were briefed on the Bank's half-yearly assessment of the financial system.
Developments in major advanced banking systems had been broadly favourable over the past six months, apart from the euro area, where profitability remained weak and asset performance continued to deteriorate. Credit growth across the advanced economies remained slow, in contrast to emerging Asia, where financial conditions remained quite buoyant, although carrying a different set of risks. Market concerns about vulnerabilities in some emerging markets had returned in late January, but largely focused on country-specific issues rather than representing an across-the-board retreat from risk-taking. Members noted that the prospect of direct financial contagion from emerging markets to advanced economies was limited, because major banking systems had little exposure to these markets. The ongoing fragilities in the euro area meant, however, that some spillovers could occur if investor sentiment were to deteriorate more broadly.
The Australian banking system continued to perform strongly and remained well capitalised. Banks' asset performance had improved further. In line with this, their bad debt charges had declined and this had supported profitability. The major banks therefore appeared well placed to use internal capital generation to meet the higher capital requirements that they would face from 2016, having been designated by APRA as domestic systemically important banks. There was, however, less scope for future profit growth to come from further declines in bad debts or other costs, as they were already at low levels.
Members noted that rising housing prices and household borrowing were expected results from the monetary easing that had taken place. While these factors were helping to support residential building activity, they also had the potential to encourage speculative activity in the housing market. Lending to housing investors had been increasing for some time in New South Wales, and over the past six months it had also picked up in some other states. While such a pick-up would be unhelpful if it was a result of lenders materially relaxing their lending standards, current evidence indicated that there was little sign of this occurring. Members noted that the recent momentum in households' risk appetite and borrowing behaviour warranted close observation, but agreed that present conditions in the household sector did not pose a near-term risk to the financial system. Members discussed the experience in other countries where macroprudential tools had been utilised to slow demand for established housing and their possible application in Australia.
The demand for credit by businesses remained soft but this sector was no longer deleveraging. Indicators of distress in the business sector continued to decline, particularly the amount of non-performing loans related to commercial property. Prices of CBD office property had been rising in a few cities despite softening rents, which was consistent with some investors searching for higher yields.
Members were briefed on the outcomes of the recent G20 meetings in Sydney and the objectives for Australia's G20 presidency year in the area of financial regulation. They were also briefed on other international regulatory developments, including changes to institutional arrangements in several countries.
Considerations for Monetary Policy
The pace of growth of Australia's major trading partners appeared to have remained around average. Domestically, timely indicators were consistent with some improvement in economic conditions over recent months, and there were further signs that the expansionary setting of monetary policy was having the desired effects. Indicators had been generally positive for consumption, housing investment, business conditions and exports. Mining investment had declined and was expected to fall further, while non-mining investment remained subdued and was expected to pick up gradually over time. Wage growth was at quite low rates, and if domestic costs remained contained some moderation in inflation for non-traded goods and services could be expected over time. These conditions would be expected to keep inflation consistent with the target even with lower levels of the exchange rate. While the labour market remained weak, forward-looking indicators of labour demand appeared to have stabilised.
At recent meetings, the Board had judged that it was prudent to leave the cash rate unchanged, while noting that the cash rate could remain at its current level for some time if the economy was to evolve broadly as expected. Developments since the previous meeting had supported that assessment. There were further signs that low interest rates were providing support to activity, with improved economic conditions evident across a range of household and business indicators. While the labour market was expected to remain subdued for a while and wage growth had declined, the Board observed that this was consistent with conditions in the labour market usually lagging changes in economic activity. The decline in the exchange rate seen to date would assist in achieving balanced growth in the economy, though members noted that the exchange rate remained high by historical standards.
In light of this assessment, the Board's judgement was that it would be appropriate to maintain the current stance of policy. The Board would continue to examine the data over the period ahead, with members noting that, if the economy was to evolve broadly as expected, then the most prudent course was likely to be a period of stability in interest rates.
The Board decided to leave the cash rate unchanged at 2.5 per cent.