Minutes of the Monetary Policy Meeting of the Reserve Bank Board
Sydney – 6 May 2014
Glenn Stevens (Chairman and Governor), Philip Lowe (Deputy Governor), Roger Corbett AO, John Edwards, Kathryn Fagg, Martin Parkinson PSM (Secretary to the Treasury), Heather Ridout AO, Catherine Tanna
Members granted leave of absence to John Akehurst in terms of section 18A of the Reserve Bank Act 1959.
Guy Debelle (Assistant Governor, Financial Markets), Christopher Kent (Assistant Governor, Economic), Jonathan Kearns (Head, Economic Analysis Department), Anthony Dickman (Secretary), Peter Stebbing (Deputy Secretary)
International Economic Conditions
Members were briefed that the staff forecast for growth of Australia's major trading partners was little changed since the February Statement on Monetary Policy, with growth in 2014 and 2015 still expected to be around its long-run average pace. They noted that the slight moderation in growth of Australia's major trading partners in the March quarter was expected to be temporary.
In China, GDP growth and other indicators of activity eased a little in early 2014; however, in year-ended terms, growth was still consistent with the government's annual target of 7½ per cent. There were some signs that the recent slowing could be temporary, with real fixed asset investment growing at a similar pace to recent quarters and the authorities indicating a willingness to support investment growth, if needed, to achieve the target for output growth. Members also noted that the flow of new total social financing had remained lower than over most of 2013, consistent with the authorities' efforts to place financing on a more sustainable footing.
Chinese steel prices remained below the average of recent years, notwithstanding a slight increase over the past month. Lower steel prices were consistent with some easing in Chinese steel demand, as well as some apparent tightening in credit conditions for steel production and the use of iron ore as collateral for borrowing.
In Japan, economic activity appeared to have increased strongly in the March quarter, prior to the increase in the consumption tax in April, but recent surveys had pointed to a subsequent decline in business conditions. It remained uncertain whether the planned fiscal stimulus measures would offset the expected decline in household expenditure following the consumption tax increase. After rising earlier, consumer price inflation had stabilised in recent months, but early indicators confirmed that April would see a sharp, temporary rise in inflation in response to the tax increase.
In the rest of east Asia, output growth appeared to have been around its decade-average pace and exports had been growing at a similar rate to recent years.
The US economy was showing signs of moderate growth. While the economy recorded negligible GDP growth in the March quarter, primarily because of the effect of adverse weather, more recent monthly indicators had been consistent with further economic recovery. Members noted, in particular, that the labour market had continued to improve, with a large increase in non-farm payrolls recorded in April. Over the past six months, non-farm payrolls employment had increased at a touch above the average pace of the past few years and the participation rate had increased a little.
Economic activity in the euro area was picking up gradually, although spare capacity remained substantial. Members observed that inflation had declined further over recent months to rates that were below the European Central Bank's target in all countries. This remained a concern for policymakers, even though price declines in some of the periphery economies had helped to improve their competitiveness.
Domestic Economic Conditions
Members noted that the inflation outcome for the March quarter was a little lower than most analysts had expected, following a surprisingly high outcome for the December quarter. The recent pattern of quarterly inflation appeared to overstate the changes in inflationary pressures and, in year-ended terms, underlying inflation in the March quarter was around 2½–2¾ per cent. Year-ended CPI inflation was slightly higher, at 2.9 per cent, with a little under ¼ percentage point due to the rise in the tobacco excise in December.
Over the past year as a whole, the increase in tradables prices was broadly consistent with the depreciation of the exchange rate over that period. Year-ended inflation in non-tradables prices had slowed to around 3 per cent, noticeably lower than the average of around 4 per cent over the past decade. This slowing had been influenced by the decline in wage growth over the preceding year or so and was more evident in the prices of market services, for which labour costs were a key determinant of prices.
Labour market conditions had shown some signs of improvement for a number of months, following the pick-up in economic activity from late 2013. The unemployment rate declined a little in March, although members noted that monthly movements in labour market data could be volatile. The participation rate appeared to have stabilised and employment growth had strengthened in recent months. Forward-looking indicators had also improved, but remained at low levels and were consistent with relatively moderate employment growth in coming months.
Overall, the pace of economic activity had increased over the previous six months, with the economy looking to have grown at around its long-run average pace in the March quarter, driven by especially strong growth of exports. With this pace of export growth unlikely to be sustained, output growth was expected to be somewhat slower over the next few quarters.
Following strong growth at the beginning of the year, retail sales growth appeared to have moderated somewhat more recently. Low interest rates and rising housing prices continued to support household consumption and, notwithstanding recent volatility, measures of consumer sentiment remained around long-run average levels.
The housing market continued to be an area of strength in the economy. Although the most recent data had indicated a decline, dwelling approvals remained at high levels and the flow-on to commencements pointed to strong growth in dwelling investment in the first half of 2014. Across Australia, housing price inflation had eased somewhat in recent months from the earlier rapid pace, with auction clearance rates edging back and housing loan approvals stabilising. Other indicators, such as turnover, first home owner grants and loan approvals for new housing, remained consistent with strong demand for both established and new housing.
The volume of iron ore and coal exports had risen strongly over recent months. Additional capacity for these commodities was still coming on line, although exports were expected to grow at a slower rate than in 2013.
Survey measures of business conditions that had become available over the previous month had been mixed, but a number of surveys suggested that business sentiment remained around average levels after increasing from the lows in the middle of 2013. Notwithstanding the decline in non-residential building approvals over recent months, the stock of work to be done was at a high level, suggesting that business investment in construction could pick up.
Members discussed the staff forecasts for the domestic economy, noting that average GDP growth over the forecast period was little changed from the February Statement on Monetary Policy. Over 2014/15, GDP growth was expected to be a bit below trend, with the effects of monetary stimulus partly offset by the downturn in mining investment and planned fiscal consolidation. Growth was subsequently expected to pick up to an above-trend pace over 2015/16, with both non-mining business investment and LNG exports forecast to contribute to growth. Although employment growth was anticipated to strengthen, this was not likely to exceed population growth consistently for some time as the improvement in the labour market was expected to be relatively protracted.
Members observed that the forecast for underlying inflation had been little changed and that underlying inflation was expected to remain consistent with the target over the forecast period. This outlook reflected the effect of two opposing influences. Domestic inflationary pressures were likely to remain subdued, reflecting spare capacity in labour and product markets weighing on labour costs and profit margins for some time. Working in the other direction, with the exchange rate remaining lower than a year earlier, higher import prices were expected to exert an upward influence on inflation for several years, albeit by a bit less than had been anticipated a few months earlier.
Members opened their discussion of financial markets with the observation that the past month had been largely uneventful, with little change in government bond yields and share prices in the major economies and stability in most exchange rates. Volatility in many asset classes was at multi-year lows.
At its April meeting, the US Federal Reserve had continued the process of scaling back its asset purchases, reducing monthly purchases by a further US$10 billion to US$45 billion. The Fed reiterated that it expected the federal funds rate to remain unchanged for a ‘considerable period’ after asset purchases were anticipated to end later this year, and financial markets continued to expect the first increase in the policy rate to occur around mid 2015. The European Central Bank also kept policy unchanged at its meeting in early April, as well as indicating a preparedness to use additional measures – asset purchases and a negative deposit rate – if the medium-term outlook for inflation subsequently softened or financial conditions tightened. The Bank of Japan left its rate of asset purchases unchanged during April and was now buying more assets each month than the Fed, while also foreshadowing another increase in purchases if necessary to achieve its 2 per cent inflation target.
While government bond yields in the major markets were little changed over the past month, yields on government bonds in euro area periphery countries had fallen further to multi-year lows. Greece had raised €3 billion of five-year debt. This was Greece's first issuance of long-term debt in four years and the issue was around seven times oversubscribed. Emerging market government bond yields generally fell over April, as capital flows to these countries resumed. In Australia, government bond yields also declined over the past month, partly in response to the lower-than-expected inflation data.
Members noted that credit market conditions were very favourable in most markets, with corporate spreads in Australia approaching pre-crisis levels. In the case of recent issuance of residential mortgage-backed securities in Australia, several securities involved mortgages written by non-bank originators.
Equity prices in advanced economies, including Australia, had been a little higher over the past month, whereas equity prices in most emerging markets had increased strongly, with Russia a notable exception.
Members observed that the major currencies had changed little over April, with volatility at multi-year lows. The Australian dollar had also shown little change over the past month and remained around 6 per cent higher in trade-weighted terms than in late January, although it was still around 10 per cent lower than a year earlier. The Chinese renminbi had depreciated further, to be around 5 per cent lower in trade-weighted terms than earlier in the year. Chinese foreign exchange reserves recorded another strong rise in the March quarter.
The funding composition of Australian banks had changed little over recent months, though members noted a switch from term deposits to at-call deposit accounts. Secondary market spreads on covered and other bonds issued by the major banks had also changed little in April, and these remained around their lowest levels since 2007/08. The marginal cost of new wholesale debt issuance by the major banks declined over the month and remained relatively low, while the average outstanding spread was broadly unchanged.
Members noted that money market rates in Australia continued to imply that no change in the cash rate was expected at this meeting and over the rest of the year.
Considerations for Monetary Policy
Members noted that there had been little change in the outlook for the global economy, with growth of Australia's major trading partners in the year ahead still forecast to be around average. The latest data received on the domestic economy had evolved much as expected, with further indications that growth had picked up a little over the past two quarters. This had been driven by very strong exports as well as an increase in the growth of consumption and dwelling investment. However, the Board noted that overall growth in coming quarters was likely to be below trend given expected slower growth in exports, the decline in mining investment and the planned fiscal consolidation.
While a range of indicators suggested that conditions in the labour market had improved in recent months, the demand for labour remained subdued and was likely to remain so for some time. This had led to lower wage growth, which in turn had seen inflation decline for non-tradable items whose prices were more sensitive to labour costs. This was being offset by stronger inflation for tradable items as a result of the depreciation of the exchange rate over the previous year. Inflation was consistent with the target and was forecast to remain so over the next couple of years.
At recent meetings, the Board had judged that it was prudent to leave the cash rate unchanged. The expansionary setting of monetary policy continued to have the expected effects on economic activity. Notably, a sustained increase in dwelling investment was in prospect, consumption had strengthened a little and business conditions were around average levels. Recent developments had indicated that the economy had evolved broadly in line with earlier expectations, resulting in little change in the updated forecasts for activity and inflation. With growth in activity expected to pick up only gradually, and spare capacity in the labour market consequently remaining for some time, growth in domestic costs was forecast to remain contained, which would help to offset the ongoing effect on prices from the depreciation of the exchange rate over the past year. Given this outlook for the economy and the significant degree of monetary stimulus already in place to support economic activity, the Board considered that the current accommodative stance of policy was likely to be appropriate for some time yet.
The Board decided to leave the cash rate unchanged at 2.5 per cent.