Minutes of the Monetary Policy Meeting of the Reserve Bank Board

Sydney – 4 February 2020

Members Present

Philip Lowe (Governor and Chair), Guy Debelle (Deputy Governor), Mark Barnaba AM, Wendy Craik AM, Ian Harper, Steven Kennedy PSM, Carol Schwartz AO, Catherine Tanna

Members granted leave of absence to Allan Moss AO in terms of section 18A of the Reserve Bank Act 1959.

Others Present

Luci Ellis (Assistant Governor, Economic), Christopher Kent (Assistant Governor, Financial Markets), Alexandra Heath (Head, Economic Analysis Department)

Anthony Dickman (Secretary), Ellis Connolly (Deputy Secretary), Bradley Jones (Head, International Department), Rochelle Guttmann (Acting Head of Section, Macroeconomic Modelling, Economic Analysis Department)

International Economic Conditions

Members commenced their discussion of the global economy by noting the International Monetary Fund's forecast for global growth to pick up in 2020 and 2021. The easing in trade tensions between the United States and China, and ongoing stimulus delivered by central banks, had supported a modest improvement in the growth outlook for a number of economies. Global manufacturing and trade indicators, notably export orders, had continued to show signs of stabilising in late 2019. Inflation had remained low and below most central banks' targets. Members also discussed the coronavirus outbreak, which was a new source of uncertainty regarding the global outlook.

In China, a range of activity indicators had picked up in the December quarter, which suggested that targeted fiscal and monetary easing had been working to stabilise economic conditions. In east Asia, the growth outlook had been supported by signs of a turnaround in the global electronics cycle and more stimulatory fiscal and monetary policies in some economies in the region. On the other hand, the outlook for output growth in India had been revised lower given the broad-based slowing in economic activity there.

In major advanced economies, indicators for manufacturing and services activity had ticked up slightly and tight labour markets had supported growth in consumption. In the United States, lower interest rates had supported a pick-up in residential investment. Business investment intentions had stabilised. Japanese economic activity had slowed as expected following the increase in the consumption tax in October 2019, but the fiscal stimulus that had been announced was expected to support growth. In the euro area, survey indicators of conditions in the manufacturing sector appeared to have bottomed out, but investment had remained weak.

The progress in addressing the US–China trade and technology disputes had alleviated an important downside risk to global growth. However, given the nature of the ‘phase one’ deal and the potential for tensions to re-escalate, this risk had not been eliminated.

Members discussed the coronavirus outbreak, noting that it was a new source of uncertainty for the global economy. With the situation still evolving, members observed that it was too early to determine the extent to which growth in China would be affected or the nature of the international spillovers. It was noted that previous outbreaks of new viruses had had significant but short-lived negative effects on economic growth in the economies at the centre of the outbreak. Members observed that it was difficult to know how representative these earlier episodes could be. China now accounted for a much larger share of the global economy and was more closely integrated, including with Australia, than in 2003 at the time of the SARS outbreak. The economic effects would depend crucially on the persistence of the outbreak and measures taken to contain its spread.

Some commodity prices, notably for industrial metals, iron ore and oil, had fallen on concerns that the coronavirus outbreak would disrupt production in China and reduce Chinese commodity demand in the near term. By contrast, rural prices had been little changed.

Domestic Economic Conditions

The Australian economy had grown modestly in the September quarter. While growth in public demand and exports had been relatively strong, growth in household spending and investment had remained weak. The output of the farm sector had also subtracted from growth over the preceding year, reflecting the effects of ongoing drought conditions. Members noted that the recent bushfires had devastated some regional communities and that this was expected to have reduced GDP growth over the December and March quarters. The effects of the coronavirus outbreak were also expected to subtract from growth in exports over the first half of 2020.

Overall, economic growth was expected to be weaker in the near term than had been forecast three months earlier, partly because of the effects of the bushfires and the coronavirus outbreak. However, GDP growth was still expected to pick up over the forecast period, supported by accommodative monetary policy, a pick-up in mining investment, and recoveries in dwelling investment and consumption. The recovery from the bushfires was expected to add to growth in the second half of 2020. The central forecast for growth remained unchanged since November, at 2¾ per cent over 2020 and around 3 per cent over 2021.

An increase in mining investment was expected in the near term and a turnaround in dwelling investment was expected by the end of 2020. However, the recovery in consumption was less certain and more consequential for overall demand. There was also uncertainty around estimates of the effects of the bushfires and the coronavirus outbreak: it was difficult to assess potential indirect effects on activity from these events and relevant data were yet to be published.

Household consumption had been lower than expected in the September quarter despite strong growth in household disposable income, supported by the receipt of tax offset payments and lower interest payments following the recent reductions in the cash rate. Information from the ABS retail sales release and the Bank's liaison program had suggested that retail sales volumes were likely to have grown only modestly in the December quarter; although nominal retail sales had increased strongly in the month of November, much of this increase was likely to have been purchases brought forward to take advantage of ‘Black Friday’ sales. Measures of consumer sentiment had declined over recent months, but consumers' views on their personal financial situation, which historically have had a stronger link to consumption, had been little changed.

Members noted that a number of factors had contributed to the slowdown in consumption growth since mid 2018. The downturn in the housing market had reduced households' wealth, and the extended period of weak growth in household income had probably lowered expectations of future income growth. Members observed that the prolonged period of slow growth in income was expected to continue to weigh on consumption over coming quarters. Furthermore, recent data had suggested that households were directing more income to saving and reducing their debt.

Looking ahead, the Bank's forecast was for growth in consumption to increase gradually, sustained by moderate growth in household disposable income and the recovery in the housing market. Growth in housing prices had picked up in most capital cities and parts of regional Australia over recent months. Prices had increased very strongly in Sydney and Melbourne in recent months. Higher housing prices and the associated increase in housing turnover were expected to support consumption and dwelling investment.

Dwelling investment had continued to decline in the September quarter, however, and was expected to decline further in the near term. Nonetheless, leading indicators were consistent with the forecast of a trough in dwelling investment towards the end of 2020, followed by a recovery through 2021. Private residential building approvals had increased in the December quarter. Contacts in the Bank's business liaison program had reported an increase in sales of new homes and greenfield land in recent months.

Business investment declined in the September quarter, with both mining and non-mining investment weaker than expected as at November. Mining investment had been considerably lower because work on new liquefied natural gas plants had continued to wind down. Information from business liaison contacts and the recent ABS capital expenditure survey continued to support the view that mining investment was passing through a trough. Non-mining investment was expected to be subdued in the near term, but then to increase modestly, consistent with the expected pick-up in domestic activity. Public investment had been stronger than expected in the September quarter and information from government budgets had suggested public spending would continue to support growth in the near term, including through funding of initiatives for bushfire recovery and drought relief.

The unemployment rate had declined slightly to 5.1 per cent in December. Employment growth had moderated in the December quarter, but had remained at 2.1 per cent over the year. All the growth in the quarter had been in part-time employment. The Bank's forecast of employment growth had been revised downwards for the first half of 2020, reflecting the overall signal from leading indicators and the downward revision to forecast GDP growth in the near term. The unemployment rate was expected to remain in the 5–5¼ per cent range for some time before declining to around 4¾ per cent in 2021, as GDP and employment growth picked up.

Members noted that the inflation data for the December quarter had been in line with expectations. Headline CPI inflation had been 0.6 per cent in the quarter and 1.8 per cent over 2019. Trimmed mean inflation had been 0.4 per cent in the quarter and 1.6 per cent over 2019. Housing inflation had continued to be a significant drag on overall inflation, with little change in rents both in the quarter and over the year. New dwelling prices had risen in the December quarter following earlier declines because smaller discounts had been offered by developers.

Inflationary pressures were expected to remain subdued. Underlying and headline inflation were expected to increase a little to around 2 per cent over the following couple of years as spare capacity in the economy declined. Wages growth was expected to be largely unchanged over the following couple of years because mild upward pressure on growth in the wage price index would likely be offset by downward pressure from the increase in the superannuation guarantee from mid 2021.

Members noted that the risks around the wage and price inflation forecasts were evenly balanced. Wages growth could pick up faster than expected if labour market conditions tightened by more than expected. The increase in the superannuation guarantee in 2021 was forecast to constrain wages growth for some wage earners, although the timing and extent of this was uncertain and broader measures of earnings growth could be expected to be boosted a little. Domestic inflationary pressures would depend on a range of factors, including how fast the economy recovered from the soft patch over the preceding year, the persistence of the effect of the drought on food prices, and developments in the housing market.

Financial Markets

Members noted that developments in global financial markets had reflected evolving perceptions of key risks.

Up until mid January, concerns over global downside risks had eased following stabilisation in a range of forward-looking indicators of growth, the passage of the ‘phase one’ US–China trade deal and improved prospects for an orderly Brexit. In response, long-term government bond yields and equity prices had risen. The US dollar and Japanese yen had depreciated a little, while the Chinese renminbi had appreciated. There had also been renewed capital flows into emerging markets.

However, since then these moves in financial markets had been partly reversed as market participants became concerned about the potential effect of the coronavirus on the prospects for global economic growth. In particular, government bond yields had declined noticeably to be back at very low levels. In Australia, the 10-year government bond yield had declined in line with movements abroad, to below 1 per cent. Also, the US dollar and Japanese yen had appreciated, while the Chinese renminbi had depreciated. The Australian dollar had also depreciated to be around its lowest level since 2009.

Overall, global financial conditions remained accommodative, in part because of ongoing stimulus delivered by central banks. After some easing of monetary policies in 2019, central banks in the major advanced economies had indicated that their current policy settings were likely to remain appropriate for some time. Central banks in the United States, Europe and Japan had recently left policy settings unchanged, noting that some downside risks had receded for the time being. However, they had also signalled that they were prepared to ease policy further if necessary, and markets were expecting some further easing in the United States, the United Kingdom and Canada in the year ahead. In China, the central bank had recently implemented targeted measures to support economic growth, including by providing additional liquidity to the financial system.

Corporate financing conditions had generally remained favourable, including in Australia. Credit spreads were at low levels and global equity prices had been higher over recent months, notwithstanding the volatility associated with the coronavirus outbreak. Members noted that equity market valuations were high relative to earnings in a number of economies, which could be explained partly by low long-term bond yields keeping overall discount rates low relative to history.

Domestically, the reductions in the cash rate in 2019 had seen bank funding costs and lending rates reach historic lows. The major banks were estimated to be paying interest of 25 basis points or less on a little over one-quarter of their deposit funding. Around 60 basis points of the 75 basis point reduction in the cash rate since mid 2019 had been passed through to standard variable mortgage rates. However, the actual rates that households were paying on their outstanding variable-rate loans had declined by more than this, with the average rate declining by almost 70 basis points over the same period. This additional decline reflected strong competition among lenders for high-quality borrowers and households continuing to switch from (more expensive) interest-only loans. If this were to continue, by around mid 2020 the average rate paid on outstanding variable-rate mortgages would have declined by around 75 basis points since May 2019.

Households' total mortgage payments increased in the December quarter, with a rise in principal and excess payments more than offsetting the decline in interest payments. Members discussed whether this increase reflected a change in behaviour by households and the potential for it to persist. They noted that some households were likely to be repaying their debts faster in response to low growth of their incomes and the earlier fall in housing prices. The process of balance sheet adjustment had been facilitated in part by the reductions in the cash rate as well as by the higher tax refunds for low- and middle-income earners, both of which had boosted disposable incomes.

Consistent with stronger conditions in some established housing markets, housing loan commitments had continued to rise. That had been driven largely by owner-occupiers, and growth in credit extended to owner-occupiers had increased to 5½ per cent on a six-months-ended annualised basis in December. Despite accommodative funding conditions for large businesses, growth in business debt had slowed over the six months to December.

Financial market pricing at the time of the meeting suggested that market participants expected a further 25 basis point cut in the cash rate by mid 2020.

Before turning to the policy decision, members reviewed the policy and academic discussions taking place around the world regarding the operation of macroeconomic policy and monetary policy frameworks in an environment where interest rates are low because of structural factors. These discussions focused on a range of issues, including: the appropriate level and specification of inflation targets; the cases for and against more aggressive monetary policy easing when policy interest rates are near the effective lower bound; the role of forward guidance and strategies for lowering long-term interest rates and their potential side-effects; and the role of fiscal policy. Members also reviewed the international discussions regarding possible changes in the monetary transmission mechanism at low interest rates.

Considerations for Monetary Policy

In considering the policy decision, members observed that the outlook for the global economy remained reasonable, with signs that the slowdown in global growth was coming to an end. The progress in addressing the US–China trade and technology disputes had reduced but not eliminated an important downside risk to global growth. The coronavirus outbreak was a new source of uncertainty. While it was too early to tell what the overall effect would be, the outbreak presented a material near-term risk to the economic outlook for China and for international trade flows, and thereby the Australian economy.

Global financial conditions remained positive. This partly owed to ongoing stimulus delivered by central banks, and financial market participants expected some further monetary easing in some economies. Long-term government bond yields were back at very low levels, including in Australia. Borrowing rates for households and businesses were at historically low levels, and there was strong competition among lenders for borrowers of high credit quality. Conditions in some established housing markets had strengthened, and mortgage loan commitments had also picked up. The Australian dollar had depreciated to be around its lowest level since 2009.

The outlook for the Australian economy was for growth to improve, supported by a turnaround in mining investment and, further out, dwelling investment and consumption. In the short term, the effects of the bushfires were temporarily weighing on domestic growth, but the recovery was likely to reverse the negative effects on GDP by the end of the year. The forecast recovery in consumption growth remained a key uncertainty for the outlook. Consumption had been weak, as households had been gradually adjusting their spending to the protracted period of slow growth in incomes and to the fall in housing prices. Although housing prices had been rebounding nationally, it was too soon to see the response to this in household spending, and it was unclear for how long the period of balance sheet adjustment would continue.

The unemployment rate had declined a little to 5.1 per cent and was expected to remain around this level for some time before declining further to a little below 5 per cent as economic growth picked up. Wages growth was expected to be largely unchanged over the following couple of years. Members agreed that a further gradual lift in wages growth would be a welcome development and was needed for inflation to be sustainably within the 2–3 per cent target range.

In the December quarter, CPI inflation had been broadly as expected at 1.8 per cent over the year. Inflationary pressures had remained subdued, held down by flat housing-related costs. Inflation was expected to increase gradually to 2 per cent over the following couple of years, in response to some tightening in labour market conditions.

Given this outlook, members considered how best to respond.

Members reviewed the case for a further reduction in the cash rate at the present meeting. This case rested largely on the only gradual progress towards the Bank's inflation and unemployment goals. Lower interest rates could speed progress towards the Bank's goals and make it more assured in the face of the current uncertainties. In considering this case, the Board took into account that interest rates had already been reduced to a low level and that there are long and variable lags in the transmission of monetary policy. The Board also recognised that the incremental benefits of further interest rate reductions needed to be weighed against the risks associated with very low interest rates. Internationally, concerns had been raised about the effect of very low interest rates on resource allocation in the economy and their effect on the confidence of some people in the community, notably those reliant on savings to finance their consumption. A further reduction in interest rates could also encourage additional borrowing at a time when there was already a strong upswing in the housing market.

The Board concluded that the cash rate should be held steady at this meeting. Members agreed that it was reasonable to expect that an extended period of low interest rates would be required in Australia to reach full employment and achieve the inflation target. The Board would continue to monitor developments carefully, including in the labour market, and remained prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time.

The Decision

The Board decided to leave the cash rate unchanged at 0.75 per cent.