Minutes of the Monetary Policy Meeting of the Reserve Bank Board

Sydney – 3 December 2019

Members Present

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

Others Present

Christopher Kent (Assistant Governor, Financial Markets), Alexandra Heath (Head, Economic Analysis Department), Jonathan Kearns (Head, Financial Stability Department)

Anthony Dickman (Secretary), Ellis Connolly (Deputy Secretary), Lynne Cockerell (Deputy Head, Economic Analysis Department)

Financial Markets

Members noted that interest rates were very low around the world, with a number of central banks having eased monetary policy over recent months in response to downside risks to the global economy and subdued inflation. Market expectations for further policy easing by central banks had been scaled back over previous months, with concerns about the downside risks receding a little. The US Federal Reserve had indicated that any further reduction in the federal funds rate would require a material change in the economic outlook. Reflecting these developments, market pricing had pointed to a narrowing in the degree of uncertainty around the expected path for the federal funds rate. Globally, long-term government bond yields had remained at very low levels, but had risen slightly in recent months as the prospects for further easing in monetary policy had diminished.

Financing conditions for corporations remained very accommodative. Robust demand for corporate debt had seen spreads narrow between corporate bond yields and government benchmarks. US equity prices had risen to new highs over the prior month, and had increased significantly since the start of the year relative to corporate earnings. Australian equity prices had also increased over the month, with the ASX 200 returning to the highs reached in July.

Foreign exchange rates had been little changed over the previous month. The People's Bank of China had continued to implement targeted easing measures to support financing conditions, while remaining conscious of the need to contain financial stability risks. More broadly in emerging markets, central banks had eased monetary policy in recent months. However, political unrest remained a source of volatility for certain markets.

Members discussed the transmission mechanisms for monetary policy in Australia through financial markets. They noted that the reductions in the cash rate this year had been transmitted to broader financial conditions in ways that were consistent with the historical experience. Government bond yields had declined across the yield curve by more than 1 percentage point over the year, which had flowed through to lower funding costs across the economy. The Australian dollar had depreciated by around 6 per cent on a trade-weighted basis over the previous year and remained at the lower end of its range over recent times. The depreciation reflected the reduction in the interest differential between Australia and the major advanced economies, and had occurred despite an increase in the terms of trade over this period.

The recent reductions in the cash rate had been reflected in reduced funding costs for banks, and had flowed through to lower borrowing rates for households. Average variable mortgage rates had declined by around 65 basis points since the middle of the year, as competition for high-quality borrowers had remained strong and households continued to switch away from interest-only loans towards principal-and-interest loans at lower interest rates. These trends were expected to continue.

Consistent with lower mortgage interest rates and improved conditions in some housing markets, housing loan commitments had been increasing over the preceding few months, particularly for owner-occupiers. Growth in credit extended to owner-occupiers had also increased a little in recent months, while lending to investors had still been declining.

Members noted that data from lenders and information from liaison suggested that only a small share of borrowers had actively adjusted their scheduled mortgage payments following the reductions in interest rates. This was consistent with historical experience in the months immediately following a reduction in the cash rate. However, the available data indicated that, even over the longer term, as interest rates had declined borrowers had not been paying down their home loans more quickly than in the past. Mortgage payments as a share of aggregate household income had remained steady over recent years, although were slightly lower than in the first half of the decade.

Interest rates on loans to businesses had also declined to historically low levels. Despite the accommodative funding conditions for large businesses, growth in business debt had slowed, suggesting that demand for finance had softened. Lending to small businesses had been little changed over the preceding year, and access to finance for small businesses remained restricted.

Financial market pricing implied that market participants were expecting a further 25 basis point reduction in the cash rate by mid 2020.

Members discussed longer-term developments in the banking sector, including the strengthening of prudential requirements and the opportunities and challenges presented by advances in technology. Increased capital and liquidity after the financial crisis had made banks safer, but had also raised the relative attractiveness of some forms of market-based finance. Members discussed how advances in technology opened up new opportunities for banks, while also introducing potential new competitors.

International Economic Conditions

Members observed that there had been little change in the global outlook over the previous month, but that some of the downside risks had receded. The near-term uncertainty around US trade policy had diminished because some of the previously planned tariff increases had been postponed and there was some prospect of an initial agreement between the United States and China. In addition, a ‘hard Brexit’ was assessed to be less likely.

Weak trade outcomes had continued to restrain growth in output, particularly for export-oriented economies. Survey indicators of manufacturing activity and export orders had stabilised, although they remained at low levels. Surveyed conditions in the services sector had declined as weaker external demand conditions had spilled over to sectors other than manufacturing. Members noted that even though geopolitical tensions had lessened recently, ongoing uncertainty had adversely affected the confidence and spending decisions of businesses. In the euro area, investment indicators had remained weak and business confidence had declined further since September. In the United States, consumer spending had been solid and employment growth had strengthened. Recently, some survey measures of manufacturing and services activity had increased a little, although industrial production and surveyed investment intentions had declined further in recent months.

Slower growth in China and India, largely unrelated to trade tensions, had also continued to be a feature of the recent pattern of global growth. In China, indicators of activity had been weaker in October. The real levels of retail sales and fixed asset investment had declined in October and the output of a broad range of industrial products had remained subdued. Members noted that, in response to slowing growth, Chinese authorities had eased minimum equity capital requirements for a variety of infrastructure projects (including port, road, rail, logistics and ecological protection projects). In India, the extended monsoon season had exacerbated existing weakness in the economy.

Inflation remained low in the major advanced economies and was below target despite tight labour markets and higher wages growth. Members observed that inflation had generally declined in Asia. In China, although headline consumer price inflation had increased, reflecting higher pork and other meat prices, core consumer price inflation had remained broadly unchanged at a relatively low rate.

Movements in commodity prices had been mixed since the previous meeting. The announcement of further measures to support steel-intensive economic activity in China had supported iron ore prices. At the same time, reports of a tightening in coal import controls in China had weighed on coking and thermal coal prices. Base metals prices had generally been lower since the previous meeting. Supply developments had continued to support the prices of some rural commodities.

Domestic Economic Conditions

A number of indicators suggested that growth in Australia had continued at a moderate pace since the middle of the year.

Members discussed survey measures of business confidence and conditions, and consumer sentiment. Business confidence had been below average and below its recent high levels in 2017 and early 2018, with the decline broadly based across industries. In contrast, survey measures of current business conditions had remained around average in recent months. Members noted that, historically, business conditions had been a better indicator of current economic activity than measures of business confidence, although its main advantage was timeliness rather than adding information not present in other indicators.

Growth in household disposable income had been weak over recent years, in both nominal and real terms. Members noted the importance of income growth as a key driver of consumption growth, although the earlier downturn in the housing market had also had a noticeable effect. The recent recovery in the established housing market was expected to be positive for consumption growth in the period ahead. Retailers in the Bank's liaison program had suggested that nominal year-ended sales growth had been little changed in October and November.

Households' expectations about future economic conditions had declined significantly since June. Members noted that the prolonged period of slow income growth had affected both consumer sentiment and growth in household consumption. Members observed that the decline in sentiment had coincided with an increasingly negative tone in news coverage of the economy. Notwithstanding this, households' assessment of their own financial situation relative to a year earlier had remained broadly steady and somewhat above average. Historically, households' assessments of their own finances generally have mattered more for household consumption decisions than their expectations about future economic conditions.

Conditions in established housing markets had continued to strengthen over the previous month. Housing prices had increased further in Melbourne and Sydney and this experience had been broadly based across both cities. Growth in housing prices had increased in Brisbane, Adelaide and regional areas, and housing prices had increased in Perth for the first time in two years. Non-price indicators had also pointed to a strengthening of conditions in the established housing market: auction clearance rates had remained high in Sydney and Melbourne, and auction volumes had picked up, albeit from a very low base.

By contrast, conditions in the new housing construction market had remained subdued. Residential construction activity was expected to continue to contract for several quarters, despite conditions in established housing markets having strengthened. Although there had been tentative signs of an improvement in conditions in some of the earlier stages of building activity, most indicators had remained weak, and most developer contacts in the liaison program were yet to report increased sales of new housing.

Business investment appeared to have eased in the September quarter. Information from the ABS Capital Expenditure (Capex) survey and preliminary non-residential construction data suggested that non-mining investment had decreased in the quarter, led by a marked decline in machinery & equipment investment. The Capex survey had provided the fourth estimate of investment intentions for 2019/20. Non-mining investment in 2019/20 was expected to be weaker than previously envisaged, while the survey continued to suggest that mining investment would contribute to growth over time, as firms invested to sustain – and in some instances expand – production.

Conditions in the labour market and wages data had shown little change since earlier in the year. The unemployment rate had remained around 5¼ per cent in October. Employment had declined by 19,000 in October as both full-time and part-time employment had declined. This had followed a sustained period of stronger-than-expected employment growth, which had remained at 2 per cent over the year despite the most recent monthly decline. The employment-to-population ratio and the participation rate had both remained at high levels. Over the previous few months, measures of the number of job advertisements had not changed much and firms' near-term hiring intentions had remained broadly stable. Employment intentions among the Bank's liaison contacts had generally been moderate, but had been weakest for firms exposed to residential construction.

The wage price index (WPI) had increased by 0.5 per cent in the September quarter, to be 2.2 per cent higher in year-ended terms, which was broadly as had been expected. Private sector wages growth had been 2.2 per cent in year-ended terms, and had levelled out in recent quarters following its gentle upward trend of the previous couple of years. This was consistent with information from liaison that a larger share of firms expected wages growth to be stable (rather than increasing) in the year ahead compared with a year or so earlier. Growth in the private sector WPI measure including bonuses and commissions had risen to 3 per cent in year-ended terms, which was the highest rate of growth since late 2012. This was consistent with information from liaison indicating that firms had been using temporary measures to retain and reward employees rather than permanent wage increases. Public sector wages growth had slowed in the September quarter following the one-off boost from the large wage outcome for Victorian nurses and midwives in the June quarter.

Considerations for Monetary Policy

Turning to the policy decision, members noted that there had been little change in the economic outlook since the previous meeting. Globally, financial market conditions had been more positive, as market participants' concerns about downside risks had receded a little and a number of central banks had eased monetary policy. There were also signs of stabilisation in several recent economic indicators, particularly for the manufacturing industry.

Domestically, after a soft patch in the second half of 2018, the Australian economy appeared to have reached a gentle turning point. GDP growth in the September quarter was expected to have continued at a similar pace since the beginning of the year. Most of the partial data preceding release of the national accounts had been in line with expectations, although non-mining investment had been weaker and public spending a little stronger. The outlook for growth in output continued to be supported by lower interest rates, the recent tax cuts, high levels of spending on infrastructure, a pick-up in the housing market and the improved outlook in the resources sector. However, members noted that weak growth in household income continued to present a downside risk to consumer spending, and that a low appetite for risk could be constraining businesses' willingness to invest. The drought in many parts of Australia was another source of uncertainty for the outlook.

Members observed that labour market conditions had been broadly unchanged since earlier in the year. While this outcome had largely been in line with forecasts, it remained an area to monitor, both because an improving labour market was important for its own sake and also because a tightening in the labour market would put upward pressure on wages growth and inflation. It was noted that the current rate of wages growth was not consistent with inflation being sustainably within the target range, unless productivity growth was extraordinarily weak, nor was it consistent with consumption growth returning to trend.

Members discussed the transmission to the economy of the interest rate reductions since the middle of the year. They noted in particular that the available evidence suggested that more stimulatory monetary policy had been working through the usual channels of lower bond yields, a depreciation of the exchange rate and lower interest rates on mortgages. There had also been an effect on housing prices, increased housing turnover in the established market and some early signs of a stabilisation in housing construction activity. The upturn in the housing market was a positive development for the economy in the near term, but could become a source of concern if borrowing were to run too quickly ahead of income growth.

Members also discussed community concerns about the effect of lower interest rates on confidence, noting the decline in business confidence and consumer sentiment this year. This decline had coincided with heightened economic uncertainty globally, a period of softer growth in the Australian economy and weakness in household income growth, and the Board had responded to these factors in preceding months. While members recognised the negative confidence effects for some parts of the community arising from lower interest rates, they judged that the impact of these effects was unlikely to outweigh the stimulus to the economy from lower interest rates.

In assessing the evidence, members noted that monetary policy had long and variable lags and that indebted consumers may take some time before increasing their spending in response to a decline in their mortgage interest payments. More generally, the persistently low growth in household incomes continued to be a source of concern for the consumption outlook. Economic growth and the unemployment rate remained broadly consistent with the forecasts, but members agreed that it would be concerning if there were a deterioration in the outlook. As in other countries, there was no real concern of inflation rising quickly.

The Board concluded that the most appropriate approach would be to maintain the current stance of monetary policy and to continue to assess the evidence of how the easing in monetary policy was affecting the economy. Members agreed that it would be important to reassess the economic outlook in February 2020, when the Bank would prepare updated forecasts. As part of their deliberations, members noted that the Board had the ability to provide further stimulus to the economy, if required. Members also 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, including in the labour market, and was 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.