Minutes of the Monetary Policy Meeting of the Reserve Bank Board

Sydney – 2 March 2021

Members present

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

Others participating

Luci Ellis (Assistant Governor, Economic), Christopher Kent (Assistant Governor, Financial Markets), David Jacobs (Deputy Head, International Markets and Relations, International Department)

Anthony Dickman (Secretary), Ellis Connolly (Deputy Secretary), Alexandra Heath (Head, International Department), Bradley Jones (Head, Economic Analysis Department), Marion Kohler (Head, Domestic Markets Department)

International economic developments

Members commenced their discussion of international developments by reviewing the cross-country experience with COVID-19 vaccine rollouts. Israel's progress in administering vaccines was the most advanced, with a small number of countries, including the United Kingdom and the United States, likely to achieve widespread inoculation during the June quarter. Others, including Australia, Japan and countries of the European Union, were likely to achieve high levels of inoculation a little later in the year. However, many emerging market economies were unlikely to have sufficient access to vaccine supplies to achieve widespread inoculation for around a year or more.

Members noted that the global economy was set to regain momentum over coming months, after a slowdown around the turn of the year induced by a resurgence in coronavirus infections in some countries. That said, the restrictions on activity reintroduced late in 2020 had resulted in less severe effects than those imposed in response to the pandemic earlier in 2020. With widespread inoculation likely to be achieved in a number of advanced economies in coming months and substantial further fiscal support in the United States in prospect, downside risks to the global growth outlook had receded. Members agreed that the prospects for a sustained global economic recovery were better than a few months earlier, although the path ahead was likely to remain bumpy and uneven.

Members noted that the rebound in the demand for goods globally and the upturn in industrial production, particularly in China and elsewhere in east Asia, had continued to support commodity prices. Iron ore prices remained at high levels and the prices of many other commodities, including oil, coal and base metals, had increased strongly in recent months. The rebound in energy prices had been supported by cold weather in the northern hemisphere and the strong recovery in industrial production; base metals prices had also benefited from the rebound in global industrial activity. Other input costs, such as those for shipping, had also risen sharply in preceding months.

Members discussed the role that fiscal stimulus around the world had played in supporting the rise in commodity prices and the more recent increase in inflation expectations. It was considered highly likely that the US Congress would pass another significant stimulus bill in the near term. As a result, some forecasters were anticipating that inflation pressures could begin to emerge in the United States within the following couple of years. In contrast, fiscal settings in some economies were expected to turn less accommodative in the second half of 2021.

Members discussed the prospects for recent increases in commodity and other input costs to translate into a sustained increase in consumer price inflation. This was considered unlikely for as long as substantial spare capacity remained in labour markets and wages growth remained subdued. The international experience prior to the pandemic had underscored that a sustained period of tightness in labour markets would be needed in order to generate increases in wages growth, and, even then, would put only limited upward pressure on consumer price inflation. Even if wages growth did pick up, it was also possible that corporate profit margins in some economies could absorb an increase in labour costs before firms passed such costs through to final consumer prices.

Domestic economic developments

Turning to the domestic economy, members noted that employment had continued to recover to be around ½ per cent below its pre-pandemic level. Full-time employment had also continued to recover. Much of the increase in employment in preceding months had been in Victoria following the easing of pandemic-related restrictions there in the December quarter. Nationally, there had been a sharp decline in total and average hours worked in January, which reflected more people than usual taking annual leave in January following unusually low numbers of people taking leave during 2020. Members welcomed the further decline in the unemployment rate to 6.4 per cent in January. The participation rate had remained high in January and, for most age cohorts, participation rates had been near or above pre-pandemic levels.

Members noted that the recovery in domestic activity and labour market conditions had continued to be supported by highly expansionary fiscal and monetary policies. The recovery would be further supported by the rollout of the domestic vaccination program. However, in the near term there was some uncertainty relating to the effect that the end of the JobKeeper program would have on labour market conditions. There was limited international experience to draw on in this regard; New Zealand had been the only country to have wound down its wage subsidy program, and very few people had been reliant on it when that program ended. Members also noted that a durable recovery from the pandemic would require a strong and sustained pick-up in business investment.

Members discussed the near-term outlook for the unemployment rate. The end of the JobKeeper program was seen as unlikely to result in a sustained increase in the unemployment rate. A number of considerations informed this assessment. The number of people working zero hours in Australia had declined significantly in recent months to be close to pre-pandemic levels. In addition, some JobKeeper recipients, including the self-employed, were more likely to suffer a decline in income than lose employment at the end of the program. Information from liaison contacts had suggested that many firms in receipt of JobKeeper subsidies had already reduced the size of their workforces and were not planning on another large round of lay-offs. Against this, it was likely that some jobs that had been maintained because of the wage subsidy provided by JobKeeper would cease when the subsidy ended. Members also took note of the increases in forward-looking indicators of labour demand, such as job advertisements and vacancies. These indicators had suggested that the ongoing recovery in labour market conditions could be broadly sufficient to offset the job losses arising after the end of the JobKeeper program.

Members noted that wages growth had remained low, at 1.4 per cent over the year to the December quarter. Some earlier wage cuts had been reversed sooner than expected, which had boosted wages growth in the December quarter, but this was concentrated in a limited number of industries. Stripping out the effects of temporary pay cuts and their subsequent reversal in the December quarter, wages growth remained very subdued. Indeed, wages growth remained around historical lows in many industries, consistent with there being spare capacity across the labour market. The share of firms in the Bank's liaison program with wage freezes in place had remained high, and most firms had continued to report limited upward pressure on wages despite anecdotal reports of labour shortages in small segments of the labour market. Public sector wages growth over the year to December was the lowest on record, and was unlikely to pick up noticeably given the caps on wages growth in place. Members agreed that a materially lower unemployment rate would be needed to generate wages growth in excess of 3 per cent, which in turn would be required to ensure inflation was sustainably in the 2 to 3 per cent target range.

Members discussed the uneven recovery in household spending patterns arising during the pandemic. Expenditure on some goods, such as cars, had increased to a higher level than before the pandemic, catching up from an earlier period of weakness. The consumption of other goods, such as household equipment, had been very strong early in the pandemic, reflecting substitution from services consumption, but was now easing back towards earlier trends. Other types of consumption, including for some services that had been especially constrained by the restrictions on activity, had returned to around or a little below pre-pandemic levels, but were unlikely to expand much further in the near term. Members agreed that careful analysis of the different forms of spending would continue to be required to inform assessments of the sustainability of recent trends.

Members noted that, following the declines in housing prices observed earlier in the pandemic, momentum in the housing market had picked up and price increases had become more broadly based. Price growth and overall housing conditions had been especially strong in the detached housing sector in outer metropolitan and regional areas. This had partly reflected strong demand from owner-occupiers seeking more space and from first-home buyers. Advertised rents had also picked up across the country. However, conditions in the apartment rental market in Sydney and particularly in Melbourne had remained subdued, with additional supply still being added to the stock of apartments. Members concurred that housing market conditions warranted close monitoring in the period ahead. In particular, it was important that lending standards remain sound in an environment of rising housing prices and low interest rates.

Alongside lower interest rates, national housing market conditions had been supported by the recovery in the labour market and fiscal policy measures that had boosted household income and incentives for housing construction. Residential building approvals for detached housing had been supported by the Australian Government's HomeBuilder program and other state-based programs, which would boost housing supply. However, approvals were expected to decline from high levels in the period ahead as these stimulus programs were wound down. Once these buildings are completed, there could be a significant decline in construction activity, particularly given very low population growth. Meanwhile, approvals for high-density housing construction had remained weak and there were few signs of a pick-up in the near term.

Members noted that unusual population trends during the pandemic had materially affected national housing market conditions and other parts of the economy, and would continue to do so for some time. Net overseas migration was expected to be negative into 2022, mostly because of the projected sharp decline in the number of foreign students and other temporary residents. As temporary residents typically live in the larger cities, their absence had especially dampened demand for apartments in Sydney and Melbourne. Members also noted data on domestic migration in Australia showing that the population flow from capital cities to regional areas had picked up. Net domestic migration to Melbourne had also turned sharply negative as fewer people moved there during the pandemic. Members agreed that developments in net overseas and domestic migration would continue to affect conditions in the housing market and the economy more broadly for a considerable period.

International financial markets

Members commenced their discussion of global financial markets by considering the factors behind the recent rise in sovereign bond yields. Longer-term yields on advanced-economy bonds had increased significantly over preceding months, including for Australia. This had reflected growing optimism about the economic outlook associated with the rollout of COVID-19 vaccinations, a decline in COVID-19 cases in most economies and upward revisions to the expected size of US fiscal stimulus measures. The more recent rapid rise in yields had been accompanied by an increase in the volatility of yields and a decline in bond market liquidity, particularly in the United States.

The rise in longer-term government bond yields in advanced economies over preceding months had predominantly reflected an increase in compensation for future inflation. Members noted that the increase in market participants' inflation expectations had been to rates closer to, though no higher than, central banks' targets, following an earlier period where financial market pricing had indicated little prospect of inflation targets being met. More recently, there had also been some increase in real yields in most advanced economies.

Although central banks had not announced any material changes to their asset purchase plans or guidance on policy rates since the previous meeting, market participants had brought forward their expectations for an increase in policy rates in a number of economies, including Australia. In many advanced economies, the first increases in policy rates were expected to occur as early as late 2022, according to money market interest rates. Members noted that this change appeared to be sooner than implied by market participants' own inflation expectations and the forward guidance from central banks that they would not increase policy rates until inflation had increased to be sustainably consistent with targets.

Notwithstanding the rise in sovereign bond yields, global financial conditions had remained accommodative. Corporate borrowing costs had remained low and equity prices in advanced economies, including Australia, had increased since the start of the year, despite declines late in February. Equity prices had been supported by better-than-expected earnings results and upward revisions to corporate earnings forecasts over preceding months, consistent with the more positive economic outlook. At the same time, investment flows to emerging markets had remained strong.

In China, overall funding conditions had remained accommodative. The People's Bank of China had overseen a modest tightening in financial conditions in recent weeks, while having emphasised that this did not signal a material shift in its policy stance. The Chinese renminbi had appreciated slightly against the US dollar since the start of 2021, and had remained around its highest level since 2018.

Members also discussed the broader topic of China's evolving financial system and its global importance. China's policy response to the pandemic had placed more emphasis on avoiding a further rise in risks in the financial system compared with responses during earlier downturns. The crisis had also placed renewed focus on the authorities' long-running efforts to reconfigure the way the financial system supported the economy, with some elements having gradually become more market-based over recent years. Some investors had incurred losses on investments that they had assumed were guaranteed by the state. Also, there had been more flexibility in interest rates, capital flows and the exchange rate. Notwithstanding an increase in capital inflows, Chinese financial assets had remained a small share of foreign investors' holdings of foreign assets. Consistent with this, China's main influence on international markets continued to be through its large trade flows. Members also discussed how China's role in the global financial system might change in the years ahead. They noted that this would be affected by factors such as China's balance of savings relative to investment, the speed and extent of further easing in constraints on capital flows, and the extent to which the renminbi gained wider use in international trade and finance.

Domestic financial markets

Domestically, yields on longer-term Australian Government Securities (AGS) had also increased significantly, and the spread between 10-year AGS and US Treasury yields had widened to around 25 basis points. Members noted that the decline in liquidity in the AGS market, while noticeable, had not been as significant as that experienced during the period of market dysfunction in March 2020. Yields on shorter-term bonds had remained anchored, although members noted that there had been some upward pressure on Australian 3-year yields late in February. This had required the Bank to purchase bonds in support of the target for the 3-year Australian Government bond yield of around 10 basis points, which was for the April 2024 bond. At the same time, yields on the November 2024 bond had increased along with the increase in longer-term yields. Market participants had brought forward their expectations of an increase in the cash rate, which had also been reflected in the higher yield on the November 2024 bond.

The Australian dollar had appreciated since November 2020 alongside the significant increase in commodity prices. Members noted that this had followed the earlier depreciation of the Australian dollar, much of which appeared to have reflected anticipation of the Bank's package of policy measures introduced in November 2020. The Australian dollar was assessed as being lower than it would have been otherwise as a result of the Bank's policies.

The Bank had completed a little over two-thirds of purchases under the initial $100 billion bond purchase program. Bond purchases under this program had been brought forward in the week leading up to the meeting to assist with the smooth functioning of the market. The announcement following the February meeting of an additional $100 billion bond purchase program from mid April 2021 had had little lasting effect on yields, which was consistent with this extension already having been reflected in market pricing.

Domestically, low funding rates had continued to flow through to banks' funding costs. Some banks had drawn down further 3-year funding under the Term Funding Facility and many had indicated that they planned to draw down their allowances prior to the deadline at the end of June 2021. Also, borrowing rates for households and businesses had declined to new lows. Growth in housing credit had picked up a little further in January to be 4¼ per cent on a 6-month-annualised basis. Housing loan commitments had been strong, driven by demand from owner-occupiers. Lending to businesses had been little changed over the preceding few months, after having decreased over much of the second half of 2020.

Considerations for monetary policy

In considering the policy decision, members observed that the outlook for the global economy had improved over prior months. While the path ahead was likely to remain bumpy and uneven, there were better prospects for a sustained recovery. Global trade had picked up and commodity prices had increased over recent months. Nevertheless, the global outlook remained dependent on responses to the pandemic and the risks of further outbreaks of COVID-19 infection, and on the significant fiscal and monetary support around the world. Inflation remained low and below central bank targets in many economies.

Financial markets had responded to the positive news on vaccines and the prospect of further significant fiscal stimulus in the United States. Bond yields had increased considerably over February, including in Australia. This increase partly reflected inflation expectations lifting over the medium term to be closer to central bank targets. The changes in bond yields globally had been associated with higher volatility, though with considerably less spillover to other markets than in March and April 2020. The Australian dollar had remained at the upper end of the range of recent years.

In Australia, the economic recovery was well under way and had been stronger than expected previously. There had been strong growth in employment and a welcome decline in the unemployment rate to 6.4 per cent. The December quarter GDP data were expected to show that the recovery remained on track. An important near-term issue was how households and businesses would adjust to the tapering of some fiscal support measures. Members noted that there may be a temporary pause in the pace of improvement in the labour market, as many firms had already adjusted the size of their workforces.

Despite these generally positive developments, members agreed that wage and price pressures had been subdued and were expected to remain so for several years. The economy had been operating with considerable spare capacity and the unemployment rate had remained high. Further progress in reducing spare capacity was expected to occur, but it would take some time before the labour market would be tight enough to generate wage increases consistent with achieving the inflation target. There are likely to be relative price shifts due to changes in the balance of supply and demand during the pandemic, and the Board would look through these transitory fluctuations in inflation. While annual CPI inflation was expected to rise temporarily to 3 per cent around the middle of the year as a result of the reversal of some pandemic-related price reductions, in underlying terms inflation was expected to remain below 2 per cent over both 2021 and 2022.

Members discussed the rate of wages growth that would be needed for inflation to be sustainably within the 2 to 3 per cent target range. Assuming ongoing labour-productivity growth and a broadly stable profit share of national income, it was likely that wages growth would need to be sustainably above 3 per cent, which was well above its current level. The experience of other advanced economies over recent years had suggested that it would take a tight labour market and considerable time for higher wages growth to be sustained. The Board's judgement was that wages growth would be unlikely to be consistent with the inflation target earlier than 2024.

Since the start of 2020, the Bank's balance sheet had increased by around $175 billion and a further substantial increase was in prospect. The Bank had recently purchased bonds to support the 3-year yield target and would continue to do so as necessary. The Bank was prepared to make further adjustments to its purchases in response to market conditions. The Bank had bought a cumulative $74 billion of government bonds issued by the Australian Government and the states and territories under the initial $100 billion bond purchase program. A further $100 billion will be purchased following the completion of the initial program and the Bank is prepared to do more if that is necessary. Authorised deposit-taking institutions had drawn down $91 billion of low-cost funding through the Term Funding Facility and had access to a further $94 billion under the facility. Members noted that the Australian banking system, with its strong capital and liquidity buffers, had remained resilient and was helping to support the economic recovery.

The Bank's monetary policy settings had continued to help the economy by keeping financing costs very low, contributing to a lower exchange rate than otherwise, supporting the supply of credit to businesses and strengthening household and business balance sheets. Monetary and fiscal policy had supported the recovery in aggregate demand and the pick-up in employment. The Board remained committed to doing what it reasonably could to support the Australian economy, and would maintain stimulatory monetary conditions for as long as necessary. Members concluded that very significant monetary support would be required for some time, as it would be some years before the Bank's goals for inflation and unemployment were achieved.

Members discussed the operation of the 3-year yield target, to which the Board remained committed. Later in the year, members would need to consider whether to maintain the April 2024 bond as the target bond or shift the focus of the yield target to the November 2024 bond. The Board agreed that it would not consider removing the target completely or changing the target yield of 10 basis points. If the Board were to maintain the April 2024 bond as the target bond, rather than move to the next bond, the maturity of the target would gradually decline until the bond finally matured in April 2024. In considering this issue, members would give close attention to the flow of economic data and the outlook for inflation and employment.

Members also discussed the effect that low interest rates have on financial and macroeconomic stability. They acknowledged the risks inherent in investors searching for yield in a low interest rate environment, including risks linked to higher leverage and asset prices, particularly in the housing market. Members noted that lending standards remained sound and that it was important that they remain so in an environment of rising housing prices and low interest rates. The Board concluded that there were greater benefits for financial stability from a stronger economy, while acknowledging the importance of closely monitoring risks in asset markets.

Members affirmed that the cash rate would be maintained at 10 basis points for as long as necessary. They continued to view a negative policy rate as extraordinarily unlikely. The Board will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range. For this to occur, wages growth would need to be materially higher than it is currently. This would require significant gains in employment and a return to a tight labour market. The Board does not expect these conditions to be met until 2024 at the earliest.

The decision

The Board reaffirmed the existing policy settings, namely:

a target for the cash rate of 0.1 per cent
an interest rate of zero on Exchange Settlement balances held by financial institutions at the Bank
a target of around 0.1 per cent for the yield on the 3-year Australian Government bond
the expanded Term Funding Facility to support credit to businesses, particularly small and medium-sized businesses, with an interest rate on new drawings of 0.1 per cent
the purchase of $100 billion of government bonds of maturities of around 5 to 10 years at a rate of $5 billion per week following the Board meeting on 3 November 2020
the purchase of an additional $100 billion of government bonds when the existing bond purchase program is completed in mid April 2021 at the same rate of $5 billion per week.