Minutes of the Monetary Policy Meeting of the Reserve Bank Board
Sydney – 1 September 2015
Glenn Stevens (Governor and Chair), Philip Lowe (Deputy Governor), John Akehurst, Roger Corbett AO, John Edwards, Kathryn Fagg, Heather Ridout AO and Catherine Tanna
Nigel Ray (Deputy Secretary, Macroeconomic Group, Treasury) attended in place of John Fraser (Secretary to the Treasury) in terms of section 22 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)
The discussion of financial markets opened with members observing that the marked increase in financial market volatility over the past month had mainly been a response to concerns about the resilience of the global economy, stemming primarily from developments in China. Much of the volatility had occurred in equity markets, with fixed income and foreign exchange markets generally exhibiting less volatility.
Members discussed the implications of the changes in mid August to the manner in which the People's Bank of China (PBC) set the daily fixing rate for the renminbi (RMB) against the US dollar, which had resulted in that exchange rate depreciating by around 4½ per cent over the course of a few days. The Chinese authorities had indicated that the intention of the change was to make the RMB more market based. While the resulting depreciation of the RMB spot exchange rate against the US dollar was the largest since 1994, it was not out of line with short-term movements sometimes seen between the major freely floating currencies. Members noted that the depreciation had offset only a little of the sizeable appreciation of the RMB in trade-weighted terms that had occurred over the previous year in the face of a slowing Chinese economy, as the RMB had appreciated in line with the US dollar over that period.
After the initial depreciation, the RMB had been relatively stable against the US dollar. Members noted that the Chinese authorities had for some time been selling foreign exchange reserves to prevent the RMB from depreciating against the US dollar in the face of significant capital outflows. This contrasted with the experience in the previous decade, during which foreign reserves had been accumulated to limit the appreciation of the RMB in the face of capital inflows. Members noted that it was not clear which assets the Chinese authorities had sold as part of the recent intervention nor which assets were being bought by those taking capital out of China, but given the potential size of these flows, their effects on asset markets could be large.
To counter the liquidity drain from sales of foreign exchange reserves following the foreign exchange intervention, the PBC had reduced reserve requirements on Chinese banks by another 50 basis points in late August. The PBC had also lowered its benchmark lending and deposit rates by a further 25 basis points.
The depreciation of the RMB had had an immediate effect across much of Asia, with many Asian currencies depreciating and some central banks in the region reportedly intervening to stabilise their currencies. The Australian dollar had depreciated along with the RMB, but had quickly rebounded within a day or so. A few days later the Australian dollar fell very briefly to US$0.705, during a short-lived period of dislocation in foreign exchange markets. Over the course of August, the Australian dollar depreciated by 2½ per cent against the US dollar and by 1 per cent on a trade-weighted basis. The euro and yen had both appreciated notably against the US dollar over this period. The appreciation of the euro was somewhat at odds with other movements in financial prices, but appeared to reflect the closing out of carry trades that had been funded in euro.
Global equity prices experienced large swings over August and in net terms had declined sharply, mainly reflecting heightened concerns about China. Chinese equity prices had declined by more than 20 per cent over August – with very large daily and intra-day movements – and were more than 40 per cent below their peak in June, although still over 50 per cent above the levels reached in mid 2014.
The Australian equity market had also fallen sharply to around the levels of two years earlier, despite company profit results being consistent with expectations. Large falls in commodity prices over the past few years had resulted in the share prices of commodity producers falling to their lowest levels in a decade. In addition, share prices of financial sector entities had fallen substantially, particularly after two of the major banks announced substantial capital raisings.
Turning to the United States, commentary from Federal Reserve officials had been suggesting that a tightening of monetary policy in the United States could start at the September meeting of the Federal Open Market Committee. Members noted, however, that the recent volatility in global financial markets had led to market expectations of an increase in the federal funds rate receding substantially, with only a one-in-three chance of an increase at the September meeting and an increase not fully priced in until early next year. As noted at previous Board meetings, it was possible that the first increase in the federal funds rate in around nine years could have significant effects on financial markets despite the fact that it had been well telegraphed.
Members noted that, in stark contrast to the large movements in equity prices, yields on 10-year US Treasuries had changed little in net terms during the recent period of equity market volatility. Australian bond yields had moved broadly in line with US yields. Bond yields in some emerging markets, including Brazil, Indonesia and Malaysia, had risen sharply, but in others, such as Mexico, they were little changed.
Financial market pricing indicated that the domestic cash rate was expected to remain unchanged at the current meeting.
International Economic Conditions
Members noted that growth in the GDP of Australia's major trading partners had eased in the June quarter as a result of weaker conditions in Japan and other east Asian economies, but remained close to its long-run average. Growth in industrial production, including in China, had eased further over recent months, while economic conditions in the United States and the euro area continued to improve. Globally, core inflation had generally been stable, but at levels below the targets of most central banks, and monetary conditions remained very accommodative. Weaker demand for commodities from China had resulted in falls in the prices of bulk commodities and base metals over the course of the year to date.
In China, data on economic activity in July suggested that growth had continued to ease. Members noted that this presented a downside risk to the overall outlook for growth in China over the coming year, although they recognised that it was too early to assess accurately the effect of several recent policy changes designed to support activity. Members also observed that growth in retail sales had been relatively stable and monthly data contained relatively little information about service sectors, which were becoming increasingly important for growth of the Chinese economy. Growth in fixed asset investment had continued to decline and, although conditions in some segments of the property sector had improved, it was likely to be some time before the existing stock of newly constructed dwellings was sold and residential property investment picked up. Production of many industrial products, including steel, had declined since the previous year, but iron ore imports from Australia had nonetheless continued to increase. Inflation remained below the central bank's target level, which provided scope for further policy easing should that be required. Members noted that the recent volatility in Chinese equity markets was not expected to have a significant direct effect on the near-term economic outlook.
In Japan, output contracted in the June quarter and core inflation had remained steady. While inflation was still below the Bank of Japan's 2 per cent target, it had increased over the past two years and was likely to continue to be underpinned by further modest growth in base wages, which in turn reflected very tight labour market conditions. GDP growth had fallen in other east Asian economies in the June quarter, with trade volumes contracting and business investment growth slowing. Some of the weakness in trade values could be attributed to falls in intra-regional trade, part of which owed to the effect of lower oil prices. Indian GDP continued to grow at a solid pace and CPI inflation remained below the Reserve Bank of India's target for 2015.
The US economy appeared to have grown at an above-average pace around the middle of the year, which was consistent with further increases in employment and reductions in spare capacity in the labour market. Growth in household consumption had picked up to an above-average pace over the year to the June quarter, while growth in business investment had eased, in part reflecting weaker conditions in the oil sector. Core inflation in the United States appeared to have been increasing on an annualised basis since the start of the year.
Growth in the euro area economy had picked up a little over the past few quarters, although there was significant spare capacity across Europe and inflation remained well below the target of the European Central Bank.
Domestic Economic Conditions
Members noted that the June quarter national accounts would be released the day after the meeting. Following the strong outcome in the March quarter, GDP growth in the June quarter was expected to be weak, partly reflecting a fall in resource export volumes as a result of temporary disruptions to production. GDP growth was expected to remain below average in year-ended terms, but members recognised that a number of indicators of domestic economic activity had shown some improvement over recent months.
Members began their discussion of the recent economic data by considering indicators of business conditions. Surveys of business conditions generally had shown further improvement over recent months and conditions were clearly above average levels in the household and business service sectors. Although survey measures suggested that business profits had increased to above-average levels, ABS data showed that, relative to nominal GDP, mining profits had declined further following falls in commodity prices and non-mining profits had remained relatively stable.
The ABS capital expenditure survey had suggested a further fall in mining investment in the June quarter and investment intentions in that sector implied a further sizeable fall in 2015/16, which was consistent with the Bank's current forecasts. Members discussed the implications of the recent emphasis on cost cutting in the mining sector, noting that it would probably lead to mining investment eventually stabilising at a lower level than had previously been expected. The capital expenditure survey also pointed to a decline in non-mining investment in 2015/16, but by less than implied by the survey taken three months earlier. Approvals for non-residential building also remained weak.
Members noted that differences in business conditions across the services and goods-related sectors of the economy were apparent in surveys as well as a range of other indicators of activity. In particular, above-average conditions in the household and business service sectors were consistent with the growth in employment and investment in those sectors. In contrast, although surveys of business conditions had improved for sectors related to the production and distribution of goods to be at around average levels, employment and investment in those industries had been little changed for some time. In addition, firms in these industries had indicated that they expected further falls in their overall investment over the year ahead.
Members observed that recent indicators of consumer sentiment and retail sales had been consistent with some increase in consumption growth. They also noted that conditions in the housing market overall had remained strong and that housing price inflation nationally had risen since the beginning of the year, notwithstanding regional disparities. In particular, the strength in housing price inflation had been concentrated in Sydney and Melbourne, mainly for detached houses, whereas housing price inflation had been modest in other parts of the country and negative in some market segments. Members noted that rapid growth in the construction of new apartments had helped to hold down inflation of their prices.
There had been a notable decline in the growth in lending for investment housing in July. Recent revisions to data submitted by two major banks implied that growth in credit for investment housing over the year to June had been stronger than earlier reported and growth in credit for owner-occupied housing commensurately weaker. Dwelling investment appeared to have declined slightly in the June quarter, but had been strong over the year. Forward-looking indicators had generally suggested further strength in the coming months.
Employment continued to grow strongly in July and the employment-to-population ratio had increased to its highest level since 2013. Nevertheless, spare capacity remained in the labour market – the increase in the unemployment rate in July had been accompanied by a pronounced increase in the participation rate, particularly among females. Forward-looking indicators of labour market conditions had been mixed; some were consistent with the unemployment rate remaining around current levels or even falling a little, while others pointed to a slight rise over coming months.
Indicators of wage inflation in the June quarter remained soft. The wage price index had been consistent with the Bank's forecast for a prolonged period of low wage inflation. Wage growth in all industries had been well below their decade averages, but there had been signs that wage growth may have stabilised somewhat in service sectors.
Considerations for Monetary Policy
Members noted that the key news internationally over the past month had been developments in the Asian region. The weakening in Chinese economic activity combined with developments in Chinese financial markets had led to sharp declines in global equity prices. So far, this volatility had not impaired the functioning of other financial markets and funding remained readily available to creditworthy borrowers. Moreover, several recent policy measures designed to support activity in China had not yet had their full effect. Economic conditions in the United States and euro area had continued to improve, monetary policies globally remained very stimulatory and lower oil prices would support economic activity in most of Australia's trading partners. Overall, international economic developments had increased the downside risks to the outlook, but it was too early to assess the extent to which this would materially alter the forecast for GDP growth in Australia's trading partners to be around average over the next couple of years.
Domestically, the national accounts were expected to show that output growth had been weak in the June quarter, following a strong outcome in the March quarter partly as a result of temporarily lower resource exports. Over the past year, resource exports had grown strongly and further growth was in prospect as the production of liquefied natural gas ramped up. The depreciation of the Australian dollar in response to the significant declines in key commodity prices was also expected to support growth, particularly through a larger contribution from net service exports.
Recent data on investment intentions suggested that mining investment would continue to decline and non-mining business investment would remain subdued in the near term, despite survey measures of aggregate business conditions being above average. However, non-mining business investment was still expected to pick-up over time as a result of the depreciation of the exchange rate over the past year and a further gradual rise in household expenditure.
Members noted that very low interest rates would continue to support growth in dwelling investment and household consumption. There were indications that the measures implemented by APRA had slowed the growth in lending for investment housing. Dwelling prices continued to rise strongly in Sydney, though trends had been more varied across other cities. The Bank was continuing to work with other regulators to assess and contain risks that may arise from the housing market. Prices in most other asset markets had been supported by lower long-term interest rates, while equity prices had moved lower and been more volatile recently, in parallel with developments in global markets.
Although the demand for labour had improved, particularly in service sectors, members noted that spare capacity remained and wage pressures continued to be weak. As a result, domestic cost pressures were likely to remain well contained and offset the expected rise in the prices of tradable items over the next couple of years. Inflation was forecast to remain consistent with the target over the next one to two years.
Given these considerations, the Board judged that it was appropriate to leave the cash rate unchanged. Information about economic and financial conditions would continue to inform the Board's assessment of the outlook and whether the current stance of policy remained appropriate to foster sustainable growth and inflation consistent with the target.
The Board decided to leave the cash rate unchanged at 2.0 per cent.