Minutes of the Monetary Policy Meeting of the Reserve Bank Board
Sydney – 4 August 2015
Glenn Stevens (Governor and Chair), Philip Lowe (Deputy Governor), John Akehurst, Roger Corbett AO, John Edwards, John Fraser (Secretary to the Treasury), Heather Ridout AO and Catherine Tanna
Members granted leave of absence to Kathryn Fagg in terms of section 18A of the Reserve Bank Act 1959.
Christopher Kent (Assistant Governor, Economic), Guy Debelle (Assistant Governor, Financial Markets), Alexandra Heath (Head, Economic Analysis Department), Anthony Dickman (Secretary), Peter Stebbing (Deputy Secretary)
International Economic Conditions
Members noted that economic growth in Australia's major trading partners had remained close to its long-run average, although growth had eased a little in the June quarter. The forecast for growth in 2015 and 2016 had been revised down slightly, but growth was expected to remain around its long-run average. The increase in global industrial production had slowed over the past year or so, particularly in the Asian region, and this had contributed to lower commodity prices. Members noted that, as a result, the forecast for Australia's terms of trade had been revised down since that presented at the May meeting. Globally, core inflation had been stable in year-ended terms over recent months at rates below the targets of most central banks. Monetary conditions had remained very accommodative.
In China, GDP growth had picked up in the June quarter to be 7 per cent in year-ended terms. However, growth in a range of other indicators of activity had moderated in the first half of 2015. The outlook for Chinese steel demand remained subdued. This had contributed to lower forecasts for iron ore prices, although they were expected to remain above levels seen earlier in the year. Members reviewed evidence that showed conditions in the residential property markets in China had improved further in recent months, but noted that this had not translated into a pick-up in residential property investment outside the largest cities. They observed that downside risks stemming from the weak property market and constraints on local government funding for infrastructure investment had receded somewhat, partly in response to policy measures designed to address these areas. The recent volatility in Chinese equity markets was not expected to have a significant direct effect on consumption, given the relatively limited direct exposure of households to equities.
Economic activity in Japan appeared to have been recovering gradually, but had yet to surpass the levels seen before the increase in the consumption tax in 2014. Nevertheless, the labour market remained relatively tight, wage growth had been higher than a year earlier and the Bank of Japan expected inflation to pick up to the 2 per cent target by around mid 2016. Across the rest of east Asia, output growth looked to have been below average in the June quarter, owing to weakness in both domestic demand and exports. In India, growth in industrial production had strengthened over the past year and a range of indicators pointed to further growth in investment.
In the United States, the economy had returned to moderate growth in the June quarter, following temporary weakness earlier in the year. Business investment was around average as a share of nominal GDP and recent indicators were consistent with above-trend growth in consumption in the period ahead. Members observed that lower oil prices should have a net positive effect on output growth in the United States, while recognising that the oil and gas sector had been adversely affected by the lower prices for its output and that households had saved some of the gains from lower fuel prices. Employment growth had strengthened in the June quarter and the unemployment rate had continued to trend lower, while wage growth had been surprisingly low and underlying inflation remained below the Federal Reserve's target.
The gradual recovery in the euro area had continued, supported by very accommodative monetary policy and low oil prices. Output growth appeared to have picked up in the first half of 2015 and unemployment rates in most countries continued to record modest falls. Members noted that there was considerable variation in outcomes across the euro area; sentiment had been rising in a number of countries but had declined in others, most notably Greece. Core inflation had stabilised in year-ended terms, but remained well below the target of the European Central Bank (ECB). Developments in Greece appeared to date to have had little effect on economic conditions or confidence in the region as a whole.
Domestic Economic Conditions
The Board's discussion of the domestic economy commenced with the observation that GDP growth over the next couple of years was expected to be slightly lower than forecast in May, although the revision was minor relative to the usual range of uncertainty. A downward revision to population growth had contributed to lower forecast growth in consumption and non-mining business investment. The forecasts for growth in public demand and business investment had been revised lower in light of new data. In contrast, the recent exchange rate depreciation had led to an upward revision to net exports. Aggregate growth was expected to remain moderate for a time before strengthening. Members recognised that the period of significant structural change for the Australian economy associated with the winding down of the mining investment boom would continue for some time.
Members noted that labour market conditions had been a little better than expected over the previous few months, although spare capacity still remained. The unemployment rate had been around 6 per cent in June, after having stabilised over the course of the past year, in contrast to earlier expectations that the unemployment rate would continue to drift higher. This stabilisation was consistent with both stronger-than-expected demand for labour and lower-than-expected population growth. Members discussed the role that low wage growth had played in the pick-up in the employment-to-population ratio over the past year. They noted that the ABS measure of firms' job vacancies was consistent with the unemployment rate remaining around current levels or even declining a little further in the months ahead. Other forward-looking indicators suggested moderate growth in employment in the near term.
The unemployment rate was expected to be a little lower than previously forecast, despite the revised growth profile, partly because the unemployment rate had been lower than expected in the June quarter, and partly because the revision to forecast aggregate demand had been broadly matched by a revision to forecast growth of the economy's productive capacity as a result of lower population growth. However, members noted that there would always be uncertainty about the balance between the growth of aggregate demand and supply.
Members noted that the key forces operating on the domestic economy had remained much as they had been for some time. Consumption growth had picked up a little since 2013 and the most recent data on retail sales and liaison information were consistent with the momentum in consumption growth being sustained. In addition, measures of consumer sentiment had remained around average levels. The forecast for consumption growth implied a further gradual decline in the saving ratio in an environment of continued low wage growth. The uncertainties around future consumption and saving decisions of households were discussed.
Housing market conditions had remained strong, supported by low interest rates. House price inflation continued to be strongest in Sydney and Melbourne, while price growth for apartments in these cities had been less rapid, consistent with increased construction of higher-density housing. Outside the two largest cities, housing price growth remained weak and prices had declined in some segments. Forward-looking indicators, such as building approvals and loan approvals for new dwellings, pointed to further strength in dwelling investment in coming quarters.
Housing credit growth had been stable over recent months at around 7 per cent on an annualised basis, while growth in credit to investors in housing had been steady at a bit above 10 per cent. Members noted that growth in credit to investors had been revised up as a result of a reclassification of one bank's loans, but that aggregate growth in housing credit had been unaffected. Members also noted that the Australian Prudential Regulation Authority (APRA) had announced an increase in the amount of regulatory capital the major banks and Macquarie Bank were required to hold for their residential mortgage exposures, to take effect in 2016. A number of banks had also announced increases in the standard variable rate for investor-related housing loans for new and existing borrowers of at least 25 basis points, and there had also been a tightening in lending conditions in this sector.
Non-mining business investment was expected to remain subdued for some time. Although little new information had been received since the previous meeting, survey measures of business conditions, confidence and capacity utilisation had been more positive. Members observed that survey measures of business conditions had been strongest for household and business services, which were also the sectors that had experienced the strongest employment growth over recent years. In contrast, business conditions and employment had been weaker in those sectors of the economy mainly involved in goods production and distribution. Members also noted that, on average, household services used significantly lower amounts of capital per worker than goods-related sectors and were not as well represented in the capital expenditure survey, which by itself implied a weaker forecast profile for non-mining business investment for 2015/16. Members acknowledged that there remained considerable uncertainty around the timing and strength of the recovery in non-mining business investment.
Export volumes appeared to have declined in the June quarter following a strong increase in the previous quarter. The weakness in resource exports partly reflected some temporary factors affecting coal and liquefied natural gas production, but a moderation in demand from China may have contributed to lower iron ore exports. Net service exports had made a strong contribution to output growth over the past year, supported by the earlier depreciation of the exchange rate.
Inflation in the June quarter had been broadly as expected and domestic inflationary pressures had remained well contained. The consumer price index had increased by 0.8 per cent in the June quarter (in seasonally adjusted terms) and by 1.5 per cent over the year. The quarterly outcome reflected a rebound in the price of fuel, although it was still around 10 per cent lower than a year earlier. The various measures suggested that underlying inflation was around ½ per cent in the June quarter and 2¼ per cent over the year.
Members noted that spare capacity in the labour market and the low growth of labour costs were reflected in low inflation for market services, while inflation in the cost of new dwellings had remained strong, particularly in Sydney. Domestic cost pressures were expected to remain contained over the forecast period. The prices of tradable items (excluding volatile items and tobacco) had declined modestly in the June quarter and over the preceding year. However, members observed that the recent depreciation of the Australian dollar would place further upward pressure on the final prices of tradable items over the next few years, which had led to a slight upward revision to the inflation forecast. Underlying inflation was expected to be around 2½ per cent over the forecast period, consistent with the inflation target.
The Board's discussion of financial markets commenced with a focus on the US Federal Reserve's monetary policy. While policy was unchanged at the July meeting of the Federal Open Market Committee, recent commentary from Fed officials continued to suggest that policy tightening could start at the September meeting, whereas financial markets had only fully priced in a rate increase by December. Members noted that when the Fed actually delivered its first interest rate increase in nine years, there was likely to be a sizeable market impact notwithstanding how well telegraphed the change in policy had been. It was likely that financial market volatility would increase and the US dollar could appreciate further, including against the Australian dollar and a number of other currencies in Asia.
The US dollar had appreciated over the past month, particularly against the currencies of commodity exporters, including those of Australia as well as Canada and New Zealand, where the central banks had eased policy in July. The Australian dollar had depreciated by 5 per cent against the US dollar and by 4 per cent on a trade-weighted basis over the past month, taking the exchange rate to around its lowest level since 2009 on both measures. The New Zealand dollar had also depreciated sharply against the US dollar to a level that was around 15 per cent lower than in late April.
In sharp contrast, the Chinese renmimbi had continued to be little changed against the US dollar. Chinese international reserves had declined by around 7 per cent in recent quarters to help achieve stability against the US dollar in the face of an outflow of capital. Chinese equity markets remained volatile, despite measures introduced by the Chinese Government in early July that had steadied the Chinese equity market for a time. Large falls in Chinese equity prices had occurred again more recently, resulting in cumulative falls from recent peaks being back around 30 per cent, although equity prices remained 70 per cent higher than a year earlier.
Equity prices in the advanced economies had generally been little changed over the past month. This included the euro area, where equity prices had been more volatile but had recovered their earlier falls when Greece had moved closer to an agreement with its creditors. Australian equity prices had risen since the end of June.
Turning to developments in Greece, members noted that the Greek Government and its official sector creditors had reached an agreement to start negotiations on a new three-year bailout program. Much of the program would be used to refinance existing obligations as they fell due, as well as to recapitalise the Greek banks. The Eurogroup had arranged a €7 billion bridging loan to enable Greece to meet its short-term commitments, including clearing its arrears at the International Monetary Fund and repaying a maturing bond held by the ECB. Greek banks had reopened on 20 July following the ECB's decision to increase its emergency lending assistance, but capital controls remained in place.
Government bond yields in the major economies had mostly fallen over the past month, mainly fluctuating alongside market concerns about Greece. Bond yields in Australia had largely tracked those in the United States over the past month. With state issuance of bonds projected at modest levels, spreads and yields on state government debt remained low.
Australian financial market pricing indicated no likelihood of an easing of monetary policy at the present meeting.
Considerations for Monetary Policy
Global economic conditions were expected to continue to be supported by the lower level of oil prices and accommodative global financial conditions. Global industrial production growth had eased further this year, particularly in the Asian region, and this had contributed to lower commodity prices. Growth of Australia's major trading partners was expected to be around its long-run average over the next two years. Members observed that the downside risks to the outlook for Chinese growth identified over the past year had receded somewhat, although the Government's policy response to the recent volatility in Chinese equity markets had clouded the medium-term economic outlook. Uncertainties arising from the expected start of monetary policy tightening in the United States had moved into sharper focus.
Domestically, economic activity had generally been more positive over recent months. Very low interest rates were continuing to support strong growth in dwelling investment and consumption, and the further depreciation of the Australian dollar was expected to impart stimulus to the economy through stronger net exports. Although surveys of business investment intentions and non-residential building approvals suggested that non-mining business investment would remain subdued for some time, members noted that non-mining business profits had increased, business conditions were clearly above average and businesses had been hiring more labour, partly encouraged by very low wage growth. As a result, employment had risen as a share of the working age population and the unemployment rate had been relatively stable, in contrast to earlier expectations of a further increase. The recent data on inflation were largely as expected.
Members noted that output growth was expected to pick up gradually from its below-average pace over the past year to exceed 3 per cent in 2017. The forecast for the unemployment rate had been revised lower since the previous forecasts had been presented. The further depreciation of the Australian dollar had resulted in a slight upward revision to the forecast for inflation. Nonetheless, inflation was expected to remain consistent with the target over the forecast period given that domestic cost pressures were likely to remain well contained.
Credit was growing moderately overall, with growth in lending to the housing market broadly steady over recent months. House prices continued to rise strongly in Sydney and Melbourne, but trends had been more varied in a number of other cities. Members observed that recent responses by banks to the suite of measures implemented by APRA in respect of lending to investors in housing, including a tightening in lending conditions, would be expected to reduce the risks relating to the housing market, although it was too early to gauge their full effects.
Members noted that an accommodative monetary policy setting remained appropriate given the forecasts, while observing that the Australian economy had been adjusting to the shift in activity in the resources sector from the investment to the production phase. This shift had been accompanied by significant declines in key commodity prices and was being assisted by the depreciation of the exchange rate over recent months.
In light of these considerations, the Board judged that it was appropriate to leave the cash rate unchanged. New information about economic and financial conditions would continue to inform the Board's assessment of the outlook and determine whether the current stance of policy remained appropriate to foster sustainable growth and inflation consistent with target.
The Board decided to leave the cash rate unchanged at 2.0 per cent.