Minutes of the Monetary Policy Meeting of the Reserve Bank Board
Sydney – 3 July 2018
Philip Lowe (Governor and Chair), Guy Debelle (Deputy Governor), Mark Barnaba AM, John Fraser, Ian Harper, Allan Moss AO, Carol Schwartz AM
Members granted leave of absence to Wendy Craik AM and Catherine Tanna in terms of section 18A of the Reserve Bank Act 1959.
Luci Ellis (Assistant Governor, Economic), Christopher Kent (Assistant Governor, Financial Markets), Alexandra Heath (Head, Economic Analysis Department), Jonathan Kearns (Head, Financial Stability Department)
Anthony Dickman (Secretary), Andrea Brischetto (Deputy Secretary)
Domestic Economic Conditions
Members commenced their discussion of the domestic economy by noting that GDP growth had picked up to be 3.1 per cent over the year to the March quarter, which was above estimates of trend growth. The quarterly growth rate of 1 per cent had been a little stronger than the Bank's forecast of three months earlier. Non-farm GDP had increased by 3.6 per cent over the year to the March quarter, while growth in domestic final demand had continued its upward trend since 2013.
Consumption growth had been fairly subdued in the March quarter, following strong growth in the previous quarter. Members noted the volatility in recent quarterly outcomes but that, over the year, household consumption had increased by close to 3 per cent. Consumption of goods had been stronger than consumption of services. Growth in the value of retail sales had been moderate in April and liaison with retailers suggested that underlying trading conditions had been stable.
Members observed that, compared with the average of the preceding 20 years, growth in household income had remained subdued over the most recent couple of years, with growth in all components of income remaining below average. Nevertheless, growth in labour income had increased to its highest rate since 2012, in line with solid growth in employment. Measures of growth in average hourly wages had also increased. Nonetheless, wages growth remained low, consistent with ongoing spare capacity in the labour market and some structural forces that had also been evident in other economies. Growth in other sources of household income, including income from government assistance, investments and rent, had continued to be weak, as over the prior couple of years.
Turning to the housing market, members noted that data from the national accounts suggested dwelling investment had peaked in late 2016, although residential construction cycles had differed significantly across the states. In New South Wales, dwelling investment in higher-density projects had remained at a high level since the beginning of 2016. Liaison contacts had suggested there were capacity constraints in Sydney, which meant that, given the large amount of work in the pipeline in New South Wales, construction activity was likely to remain at a high level for some time. Dwelling investment in Victoria was also likely to remain at a high level for some time. Members noted that more of this activity had been in detached dwellings and that ‘greenfield’ land sites had generally been more readily available in Victoria. By contrast, the construction cycle for apartments had clearly passed its peak in Queensland, while detached housing construction in Western Australia might have reached a trough.
In established housing markets, housing prices had declined in Sydney and Melbourne following significant increases in previous years. Housing prices had fallen by almost 5 per cent in Sydney over the preceding year. Members observed that prices in Sydney and Melbourne had fallen the most for more expensive properties, while prices of lower-priced properties had been little changed, consistent with the typical pattern of larger fluctuations in prices at the higher end of the market. In the other state capitals, housing prices had been fairly steady, with the exception of Hobart, where prices had picked up markedly given strong demand and supply constraints.
In the labour market, employment growth had moderated from the very strong rates recorded in 2017 and the participation rate had declined a little from its recent peak. Members noted that most of the jobs created over the preceding year had been in the private sector. Much of the strength in employment growth over recent years had been in the health and social assistance industry, where about three-quarters of people work in the private sector. In recent quarters, employment had expanded in a broader range of industries, including construction, manufacturing and professional, scientific and technical services. The unemployment rate had ticked down to 5.4 per cent in May and had remained in a narrow range around 5½ per cent over the preceding year. This suggested that there continued to be excess capacity in the labour market, as did indicators such as the underutilisation rate.
Members observed that some indicators of demand for labour were at high levels. The Australian Bureau of Statistics measure of job vacancies had reached its highest level as a share of the labour force since the late 1970s, when the series commenced, and measures of firms' hiring intentions from business surveys had been strong. However, there had been less momentum in leading indicators of labour demand based on job advertisements. Overall, leading indicators of labour demand pointed to above-average employment growth over the second half of 2018. Consistent with this, members noted that wage pressures had been building in some parts of the economy but had not yet become broadly based.
The public sector had continued to contribute noticeably to GDP growth in the March quarter. Public investment had increased strongly over the year, supported by spending on transport infrastructure, and the pipeline of work to be done had increased. Public consumption had also grown, partly reflecting spending associated with implementation of the National Disability Insurance Scheme. The consolidated budget balance for the federal and state governments indicated slightly smaller cash deficits over the coming two years than had been expected six months previously.
Private non-mining business investment had increased in the March quarter, to be 10 per cent higher over the year. Growth in machinery and equipment investment had picked up, and information from the Bank's liaison program had suggested that the current and prospective strength in public infrastructure investment had improved the investment outlook for many private sector firms in the construction industry. Members noted that private infrastructure investment, including investment in telecommunications and renewable energy, had also increased in the March quarter. Data on approvals in recent months suggested that construction of non-residential buildings was likely to make a smaller contribution to growth in non-mining business investment in future. Mining investment had declined further in the March quarter, as construction work at some liquefied natural gas (LNG) projects neared completion. However, investment in machinery and equipment in the mining sector had increased, following a period of cost-cutting that had led to deferral of some investment. Recent survey measures of business conditions had continued to be at levels well above average.
Export volumes had increased strongly in the March quarter. Coal export volumes had rebounded following resolution of earlier supply disruptions and LNG exports had risen strongly as projects in Western Australia ramped up production. In April, volumes of LNG, iron ore and thermal coal exports had increased, while the volume of coking coal exports had declined as a result of weather-related disruptions to supply.
Australia's terms of trade had risen by 3.3 per cent in the March quarter, which was a little more than had been expected a few months earlier. The prices of coking and thermal coal had increased since the previous meeting, supported by higher demand from Asia and various constraints on supply in some of the largest exporting economies. Iron ore prices had been little changed over the previous month and were within their range of the preceding few years. Members noted that wool prices had increased significantly, but that wool represented quite a small share of Australia's total exports. Base metals prices had declined over the previous month in response to heightened trade tensions. Most other commodity prices had been little changed since the previous meeting.
Members held a detailed discussion of the high level of household debt in Australia, informed by a special paper prepared for this meeting. Household debt has increased by more than household income over the preceding three decades in many countries, but particularly so in Australia. Two key drivers of this trend across countries have been the decline in nominal interest rates, predominantly reflecting lower inflation, and financial deregulation, both of which have increased households' access to finance. Members noted that a distinguishing feature of the Australian housing market is that the bulk of dwellings are owned by the household sector. This has contributed to greater borrowing for housing by households in Australia compared with other countries, where the corporate sector owns a larger proportion of rental properties. Another feature of the Australian housing market that has contributed to greater borrowing by households is the higher cost of housing in Australia on account of a larger share of the Australian population living in urban centres, typically in large detached dwellings.
Survey data indicate that much of Australian household debt is owed by higher-income and middle-aged people, who tend to have more stable employment and often larger savings buffers. However, members recognised that a material share of household debt is held by lower-income households, which generally have higher debt relative to their income. Household assets in aggregate are valued at around five times the value of household debt and total assets exceed the value of debt for most households. Members noted, however, that most household assets are housing and superannuation, and that both of these are illiquid.
Members noted that high levels of household debt could affect economic outcomes. For example, households with high debt levels are more vulnerable to economic shocks and therefore more likely to reduce consumption in the face of uncertainty about their future income. Members also noted that changes in interest rates have a larger effect on disposable income for households with high debt levels, but that these households may be less inclined to borrow more at times when interest rates fall. Accordingly, members agreed that household balance sheets continued to warrant close and careful monitoring.
International Economic Conditions
Conditions in the global economy had generally remained positive. Surveyed business conditions had been above average and growth in global industrial production and merchandise trade had been solid, although below the rates seen in 2017. Domestic demand had also remained quite strong in most regions, supported by varying combinations of accommodative monetary policy and increasingly stimulatory fiscal policy.
Some of the downside risks to the global growth outlook had increased over the prior month. Additional tariff measures had been confirmed in a number of economies in prior weeks and the prospect of further measures being introduced appeared to have become more likely. Members noted that trade tensions extended beyond the United States and China, and could escalate through non-tariff measures such as administrative delays. An escalation of trade tensions could harm global growth by undermining confidence and delaying investment decisions and could dampen international trade.
In China, indicators of economic activity had been mixed in May. Growth in retail sales had fallen sharply, while growth in some categories of industrial output had continued to strengthen. In particular, strong demand for steel had supported prices at high levels and encouraged production. This, in turn, had underpinned demand for Australian exports of coal and iron ore. Housing prices had been flat or falling in the largest Chinese cities, where restrictions on housing purchases have been most stringent, but had risen rapidly in smaller cities. Investment in real estate had picked up but most of this had been land purchases rather than construction. Infrastructure investment had weakened, which was likely in part to have reflected ongoing efforts to reform local government finances. Members noted that infrastructure investment activity could recover in coming months, given that many local authorities still have capacity to issue more bonds. Growth in total social financing had been steady in May and Chinese regulators had recently introduced additional measures to strengthen oversight of the banking sector.
In other east Asian economies, GDP growth had been robust in the March quarter. More recent data suggested this pace was likely to have continued in the June quarter. While exports had continued to contribute significantly to growth in the region, domestic demand factors had become increasingly important.
In the major advanced economies, GDP growth had remained above trend rates. In the United States and Japan, growth looked to have increased in the June quarter, following lower outcomes in the March quarter. In the euro area, however, some indicators of activity had softened further in recent months, suggesting a weaker near-term outlook than in the other two major economies. This slowing had been broadly based across euro area member countries.
Labour markets had continued to tighten across all three major advanced economies. Employment growth had been higher than growth in the working-age population for some time and unemployment rates had fallen to be well below estimates consistent with full employment in some economies. Wages growth had picked up gradually in response. This had supported the outlook for consumption growth in these economies and was expected to lead to rising inflationary pressures. Core inflation had been close to the Federal Reserve's target in the United States, where demand was likely to have been boosted by the effects of recent reductions in corporate and personal income tax rates. Core inflation had remained below target in both Japan and the euro area, although in the latter case higher oil prices had meant that CPI inflation was at the level targeted by the European Central Bank (ECB).
Members commenced their discussion of developments in financial markets by noting that overall global financial conditions remained supportive of economic activity. However, financial market participants remained focused on risks arising from international trade tensions, political developments in Europe and strains in some emerging market economies.
Members noted that the major central banks were at different phases of their monetary policy cycles. The Federal Reserve was most advanced in withdrawing monetary stimulus, consistent with the relative strength in economic activity and inflation in the US economy. By contrast, the ECB and Bank of Japan had continued to ease policy through ongoing asset purchases, further expanding their balance sheets. Moreover, both central banks had maintained negative policy rates.
In the United States, the Federal Open Market Committee (FOMC) had raised the federal funds rate by 25 basis points at its June meeting, as had been widely expected. The median of FOMC members' projections for the federal funds rate had been revised upwards slightly since the March FOMC meeting, implying a faster increase over 2018. While the federal funds rate was projected to move above FOMC members' estimates of its long-run neutral level by the end of 2019, sooner than in the previous projections, the median projection for the end of 2020 was unchanged at around ½ percentage point above the long-run neutral level. Members noted that market expectations for the federal funds rate remained below those of FOMC members.
The Bank of Canada and Bank of England were also expected by market participants to take further steps to withdraw some monetary stimulus in coming months, although if that came to pass their policy rates would remain accommodative. At its June meeting, the ECB Governing Council announced its intention to wind down its net asset purchase program by the end of 2018, which would bring an end to the ECB's easing cycle, while maintaining the current level of negative policy rates at least through the (northern hemisphere) summer of 2019.
Members observed that the cash rate in Australia was higher than the policy rates of the major central banks, with the exception of the Federal Reserve, and that the Reserve Bank's balance sheet had been little changed since the global financial crisis, compared with the significant balance sheet expansions undertaken by some other central banks over that period.
Long-term government bond yields in a number of the major markets had declined slightly over June, in part reflecting concerns about international trade policies. However, US long-term yields remained higher than at the end of 2017, consistent with continued robust growth and expectations of rising inflation and further removal of monetary stimulus in the United States.
In European markets, sovereign yield spreads over German bonds had declined in Spain, Portugal and Italy, following an easing in earlier political tensions. While spreads in Spain and Portugal had returned to levels observed in 2017, Italian spreads had remained elevated, reflecting ongoing market concerns about the expansionary fiscal plans of the new Italian government.
Concerns about rising international trade tensions had weighed on global equity prices, most noticeably in Asian markets. US equity prices had remained high, having risen substantially over 2017, reflecting continued strength in corporate profits.
Members noted that the US dollar had appreciated against a broad range of currencies over 2018 in the context of relatively strong US growth prospects and rising US interest rates as the Federal Reserve withdrew monetary stimulus. After appreciating in the earlier part of the year, the Chinese renminbi had depreciated in June, reflecting the broad-based strength in the US dollar as well as international trade tensions and a moderation in economic growth. The Australian dollar had depreciated over 2018, largely against the US dollar, but remained within the range it had traded in over the preceding couple of years.
Problems in a few emerging market economies had resulted in local financial market stresses, particularly in Argentina, Turkey and Brazil. Members noted that the International Monetary Fund had approved a larger-than-expected financial assistance package for Argentina. Stresses in other emerging markets had generally been limited, although capital outflows had picked up in the recent period. Members noted that volatility in financial markets, both in emerging economies and more generally, had risen a little in prior months but remained close to longer-run averages.
In China, authorities had continued to take measures to contain risks in the financial system and overall credit growth had eased further. Members noted, however, that the People's Bank of China had recently reduced banks' required reserve ratios to assist banks in making progress on debt-for-equity swaps or increasing lending to small and micro-sized enterprises.
Turning to domestic financial conditions, members noted that Australian long-term bond yields had moved broadly in line with developments in global markets in recent months and remained below US long-term bond yields. Money market rates in Australia had also been moving broadly in line with those in international markets earlier in the year, but in the weeks preceding the meeting had increased independently of other markets. Members observed that this was consistent with the recent pattern of rising funding pressures at the end of each calendar quarter, and noted that it was uncertain how persistent these pressures would be. As a result, funding costs for the major banks had risen a little over 2018, reflecting the higher bank bill swap rate over this period, but had remained low relative to history. Banks' net bond issuance in 2018 had been strong.
Housing credit growth had continued to slow in May. The slowing in housing credit growth over the prior year had been driven largely by slower growth in lending to investors, which had declined to the lowest rate since early 2016. Members discussed the important role that demand factors had played in slowing the pace of borrowing. A softening in demand for housing credit in the context of high household debt levels was consistent with the slowing growth, and in some markets outright falls, that had been seen in housing prices. Declines in advertised interest rates for new borrowers by some banks had also suggested some softening in demand for credit. Members noted, however, that there had also been some tightening in supply of credit as a result of tighter lending standards.
In recent months, the major banks had announced lower interest rates for some new loans, including some loan products for investors and interest-only loans. Some smaller banks had increased their advertised standard variable mortgage rates over the previous month. Members observed that, while changes in advertised housing lending rates had not been in a particular direction overall, lending rates for new and outstanding variable housing loans had drifted downwards over much of the prior year.
Members noted that, although growth in Australian business debt had increased from a year earlier, it remained moderate as businesses tend to rely on internal funding for investment. On an accumulation basis, Australian share prices had generally moved in line with international markets over recent years but had outperformed other markets in June. Company profits were generally expected to continue growing, especially in the resources sector, which had benefited from higher commodity prices.
Financial market pricing implied that the cash rate was expected to remain unchanged for a considerable period.
Considerations for Monetary Policy
In considering the stance of monetary policy, members noted that the global economic expansion had continued. A number of advanced economies were growing at an above-trend rate and experiencing increasingly tight labour market conditions. Growth in the Chinese economy appeared to have moderated a little, and there was some uncertainty around how the authorities there would respond given the trade-offs involved in achieving the target for output growth and managing financial stability risks. Concerns about the direction of international trade policy in the United States and its effect on the global outlook had intensified over the prior month. Strains had continued in a few emerging market economies, largely for country-specific reasons, which had affected some financial market pricing, although spillovers to other markets had been limited. Concerns about political developments in several European countries had generally eased over the prior month, although concerns about political developments in Italy had remained.
There had been further evidence of rising wage pressures in the major economies where labour market conditions had been tight. Strong global growth had also contributed to higher commodity prices in early 2018, which had increased upstream inflationary pressures and boosted Australia's terms of trade. However, core inflation had remained below most central banks' targets, with the exception of the United States, where it had increased to be around the Federal Reserve's target.
Globally, financial conditions had remained expansionary, although they were gradually becoming less so in some economies. Given current and prospective economic conditions, the Federal Reserve was expected to increase the federal funds rate over 2018 and 2019; this had contributed to a broad-based appreciation of the US dollar. Against this background, the Australian dollar had depreciated a little, but remained within the range it had traded in over the previous two years.
The recent data on the Australian economy had been consistent with the Bank's central forecast for GDP growth to pick up to be a bit above 3 per cent over 2018 and 2019. Non-mining business investment had contributed significantly to growth in the March quarter, as had public infrastructure investment, and business conditions had remained positive. The outlook for consumption remained a source of uncertainty for the GDP forecasts, given that household income had continued to grow slowly and debt levels were high.
The outlook for the labour market had remained positive. Forward-looking indicators of labour demand continued to point to solid growth in employment; most notably, the vacancy rate had risen to a historically high level. These conditions were expected to lead to a gradual decline in the unemployment rate. Although wages growth was expected to remain low in the near term, stronger labour market conditions and growing skills shortages were expected to lead to wages growth picking up over time.
Housing prices had fallen moderately in Sydney and Melbourne, following significant growth over preceding years, and had been little changed over the preceding six months in other cities on average. Housing credit growth had declined, mainly because investor demand had slowed noticeably. Lending standards were tighter than they had been a few years previously and the Australian Prudential Regulation Authority's supervisory measures were helping to contain the build-up of risk in household balance sheets. Some further tightening of lending standards by banks was possible, although the average mortgage interest rate on outstanding loans had been declining for some time.
The low level of interest rates was continuing to support the Australian economy. Inflation remained low, reflecting low growth in labour costs and strong competition in retailing. Members continued to view the strengthening economy as likely to deliver further progress in reducing the unemployment rate and returning inflation to target. In these circumstances, members continued to agree that the next move in the cash rate would more likely be an increase than a decrease. However, since progress towards a lower unemployment rate and an inflation rate closer to the midpoint of the target range was likely to be gradual, they also agreed there was no strong case for a near-term adjustment in monetary policy. Rather, the Board assessed that it would be appropriate to hold the cash rate steady and for the Bank to be a source of stability and confidence while this progress unfolds.
Taking account of the available information, the Board judged that holding the stance of monetary policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time.
The Board decided to leave the cash rate unchanged at 1.5 per cent.