Minutes of the Monetary Policy Meeting of the Reserve Bank Board
Videoconference – 7 April 2020
Members Participating
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 Participating
Michele Bullock (Assistant Governor, Financial System), Luci Ellis (Assistant Governor, Economic), Christopher Kent (Assistant Governor, Financial Markets)
Anthony Dickman (Secretary), Ellis Connolly (Deputy Secretary), Alexandra Heath (Head, Economic Analysis Department), Jonathan Kearns (Head, Financial Stability Department), Marion Kohler (Head, Domestic Markets Department)
International Financial Markets
Members commenced their discussion with a review of the information available on the spread of the novel coronavirus disease (COVID-19). The outbreak was first and foremost a public health issue, but was also having very large adverse effects on economies and financial systems around the world. Financial conditions had been highly volatile in March, reflecting the deterioration in the economic outlook, increased uncertainty and a substantial increase in demand for cash over other assets. Central banks had responded forcefully with a wide range of policy measures. In response to these measures and sizeable responses from fiscal authorities, financial conditions had stabilised but remained fragile.
Central banks had taken actions to lower risk-free rates across the yield curve. Policy rates had been reduced where there was scope to do so, and were at ¼ per cent or lower in all of the major advanced economies. Purchases of government bonds had been scaled up significantly. As a result of these purchases, central bank balance sheets had expanded rapidly in March.
Central banks had also sought to accommodate increased demand for cash and support market functioning. They had increased the provision of liquidity to the financial system by increasing the size and extending the maturity of their regular open market operations. Many central banks had also sought to improve market functioning – particularly of key bond markets that provide important pricing benchmarks – by directly purchasing securities in secondary markets. The US Federal Reserve had acted to help meet demand for US dollars from non-US entities, most notably by activating and extending its network of bilateral swap lines with other central banks, including the Reserve Bank of Australia.
There had been a range of actions to support the supply of credit, particularly to businesses. Central banks were introducing or expanding term funding schemes to provide low-cost funds to banks and encourage them to continue supplying credit to businesses and households. Prudential measures had made it easier for banks to expand their balance sheets. These measures had complemented actions by governments to assist business borrowers directly.
Members noted that the actions taken by central banks in sovereign bond markets had helped to support market liquidity and put downward pressure on yields. Liquidity conditions in the market for US Treasuries (as reflected in bid-ask spreads) had improved since mid March, but had not yet fully normalised. Declines in longer-term yields had been limited as market participants were factoring in the prospect of significantly higher volumes of bond issuance to fund large fiscal deficits over the period ahead. Nevertheless, sovereign bond yields across the advanced economies remained at low levels. Spreads between Italian and Spanish yields and those of German Bunds had widened in early March as the COVID-19 outbreaks in those countries had intensified, and amid concerns about conditions in the banking systems and the sustainability of their public finances. However, the new asset purchase program established by the European Central Bank had helped to contain the widening of these spreads.
Conditions in US dollar funding markets had tightened significantly, although stresses in these markets had eased since mid March. Spreads in short-term unsecured US dollar funding markets had risen, reflecting increased demand for liquidity and limitations on the capacity of financial institutions to intermediate these markets. In response, the Federal Reserve had implemented several policy measures to increase the supply of US dollars, which had helped to stabilise or narrow spreads in some markets. The bilateral swap lines between the Federal Reserve and other major central banks had been utilised extensively to provide US dollar liquidity to financial institutions, particularly in Europe and Japan. In contrast, there had not been much demand for US dollar funding from Australian financial institutions.
Members noted that funding markets remained strained for corporations, particularly those whose revenues were most exposed to the economic impact of the measures to contain COVID-19 or were highly leveraged. Corporate bond spreads had risen, but overall borrowing costs were still modest by historical standards, reflecting the historically low levels of government bond yields. Market conditions in primary corporate bond markets had been mixed. Corporations with high credit quality had issued record volumes of debt in March to build cash reserves. In contrast, issuance of high-yield debt had largely ceased. Other risky asset classes, such as equities, remained volatile.
In emerging market economies, government bond yields had risen sharply, equity prices had fallen and exchange rates had depreciated. There had also been substantial capital outflows. The tightening in financial conditions partly reflected concerns about the impact of COVID-19 on output growth in these economies, particularly for commodity exporters and countries that had recently received finance in large part via foreign capital and/or in foreign currency. A number of emerging market and low-income economies had engaged in discussions with international organisations about accessing emergency financing facilities. In contrast, financial conditions in China had been stable in recent weeks, and Chinese equity prices had been relatively resilient.
Movements in currencies had reflected strong demand for US dollars in the middle of March, with the US dollar appreciating against currencies of both advanced and emerging economies. Particularly large moves had been observed in the exchange rates of commodity exporters. Since the start of the year, the Australian dollar had depreciated against the US dollar through to mid March to its lowest level since the early 2000s before partly retracing, to be around 15 per cent lower in net terms.
Domestic Financial Markets
Members reviewed the implementation of the package of policy measures announced by the Bank on 19 March and its initial effects on domestic financial conditions. The package included a reduction in the cash rate target to 0.25 per cent and introduction of a target for the yield on 3-year Australian government bonds of around 0.25 per cent. The Bank had also announced that it would be prepared to purchase government bonds across the yield curve to ensure the smooth functioning of government bond markets. In addition, the package included a term funding facility (TFF) for authorised deposit-taking institutions (ADIs), offering collateralised funding of at least $90 billion for three years at an interest rate of 25 basis points, with additional amounts available to institutions that increase their lending to businesses, especially to small and medium-sized businesses. Finally, Exchange Settlement balances at the Bank would be remunerated at 10 basis points, rather than zero as would have been the case under the previous corridor arrangements.
The three-year government bond yield fell noticeably on the announcement of the policy package, from around 60 basis points to around 30 basis points, and declined a little further in response to bond purchases by the Bank, to be at the target of around 25 basis points. In addition to purchases of Australian government bonds at around three years, the Bank had also purchased government bonds across the yield curve, including state and territory government bonds. The Bank had purchased in aggregate around $36 billion of government bonds in secondary markets. This had contributed to generally improved functioning of these markets, including a reduction in bid-ask spreads and achievement of the three-year yield target. Furthermore, the Australian Office of Financial Management (AOFM) and state and territory government borrowing authorities had issued securities, consistent with market conditions having improved.
Alongside these purchases, the Bank had injected around $50 billion of liquidity into the financial system through its daily open market operations to support credit and maintain low funding costs in the economy. The Bank had provided this liquidity at longer terms than usual, with the average maturity of the Bank's repurchase agreements increasing from around 30 days to 70 days. As expected, the high level of Exchange Settlement balances had seen the cash rate decline below 25 basis points, to be around 20 basis points at the time of the meeting. Market participants expected the cash rate to be around 15 basis points for an extended period, a little above the 10 basis point deposit rate on Exchange Settlement balances.
The package of policy measures was putting downward pressure on bank funding costs, offsetting the effects of higher spreads in some wholesale funding markets. The reduction in the cash rate and the increase in Exchange Settlement balances had helped to lower short-term benchmark rates for bank funding. In addition, funding was available through the TFF at substantially lower than market rates. ADIs had started to draw down their allocations under the TFF on 6 April. The TFF was being complemented by other policy measures to support lending to small and medium-sized businesses, including the government's guarantee of 50 per cent on new loans for working capital. In addition, the AOFM had begun purchasing asset-backed securities as part of its program to support lending by non-ADIs and small ADIs.
The Bank's package of policy measures, along with other announced initiatives by the federal and state governments and the Australian banks, was allowing households and businesses to access credit on considerably more favourable terms than otherwise. Banks had reduced interest rates for small business borrowers markedly, and small business customers affected by the COVID-19 outbreak would be able to defer interest and loan payments for six months. For households, a large proportion of the monetary policy easing since May 2019 had flowed through to mortgage rates paid. Lenders had reduced their interest rates on variable rate housing loans by 25 basis points following the reduction in the cash rate on 3 March. While most lenders did not reduce their standard variable rates following the further cut in the cash rate on 19 March, they had announced a reduction for interest rates on fixed rate loans and measures to defer interest and loan payments for distressed households.
Financial Stability
Members were briefed on the Bank's regular half-yearly assessment of the financial system.
The COVID-19 outbreak had ended an extended period of low financial market volatility and low risk premiums, which had been underpinned by investors' expectations of continued benign economic and financial market conditions. Members noted that the current situation was very different from the global financial crisis, as the shock had not emanated from the financial system. As a result of regulatory reforms following the global financial crisis, banks were in a much stronger position than prior to the global financial crisis. Members noted that, rather than being a source of the shock, the financial system was well placed to mitigate the impact of the pandemic.
Existing risks to financial stability were being amplified by the pandemic: debt had increased to high levels in corporate and household sectors in some countries; some non-bank financial institutions had high leverage; and some European countries had weak banking systems and high sovereign debt. Banks were also facing increased operational risks given the need to operate from split sites and with most staff working remotely.
Members noted that the Australian banks were in a strong position to withstand the large economic shock from the COVID-19 outbreak and financial market volatility. The capital and liquidity positions of the banks had increased substantially since the global financial crisis. Banks' leverage ratios (the ratio of Tier 1 capital to non-risk-weighted assets) had also increased. The liquidity coverage ratios of banks were well above their regulatory minimums and had recently increased further as a result of the TFF. Banks had high profits, their return on equity prior to the COVID-19 outbreak was well above their cost of equity, and they had low rates of bad and doubtful debts. The expected contraction in economic activity would, however, result in a rising proportion of non-performing loans. But banks were well placed to absorb these, given their strong capital buffers. The Australian Prudential Regulation Authority had noted that the banks were able to access these buffers to sustain credit growth in the economy.
The decline in asset prices had had a significant effect on superannuation fund returns and some funds would face additional withdrawals in the period ahead.
Following the COVID-19 outbreak, banks and other financial institutions in Australia had implemented their business continuity plans. This involved large numbers of staff working from home and split sites to ensure there was redundancy in critical operations. This had required significant adaption of their continuity plans to the specific nature of the pandemic, but to date this had proceeded without major incident. Banks' changed operating environments and their resulting reduced capacity to take on risk had affected the functioning of some markets. There were also increased risks from failures of legacy IT systems and cyber attacks.
Prior to the outbreak of COVID-19, business balance sheets in Australia were generally in a healthy state, as most companies had relatively low levels of gearing and sufficient liquid assets to weather a moderate shock to their income. Australian companies had generally deleveraged since the global financial crisis. However, the contraction resulting from the COVID-19 outbreak would be a very large shock to many businesses, particularly in industries most exposed to the fall in economic activity. The potential to reduce outlays through measures such as wage subsidies and rent re-negotiations, along with access to credit, were important measures to ensure the viability of as many businesses as possible through the current crisis.
Most households with mortgages had significant buffers of accumulated prepayments, with around half of these loans having prepayments that exceeded six months of payments; the share of mortgages that may not have a buffer of liquid assets was around 15 per cent. Measures of household financial stress had been at relatively low levels prior to the COVID-19 outbreak. Members were informed that, at the time of the meeting, banks had reported that around 5 per cent of households had enquired about deferring mortgage repayments.
Risks from residential property markets had diminished over the course of the preceding year as increases in housing prices in Sydney and Melbourne had led to a reduction in the share of households at risk of having negative equity on their housing assets. Nationally, around 3 per cent of mortgages had negative equity positions, with most of these in Western Australia. The more recent economic contraction, uncertainty and social distancing measures were likely to result in very little turnover in the housing market. It remained unclear how this would affect residential property prices.
Members noted that conditions in commercial property markets were deteriorating. This followed several years of commercial property price growth in excess of growth in rents. Prior to the COVID-19 outbreak, parts of the retail property market were facing challenging conditions owing to weak consumer spending and heightened competition. Following the outbreak, some retail tenants had been seeking suspensions in rent payments or large rent reductions. Members noted that the risks in commercial property markets warranted close monitoring.
International Economic Developments
Members commenced their discussion of the global economy by noting that the measures needed to contain the COVID-19 outbreak would result in an economic contraction that would have been unimaginable a few months earlier. The exact size of the contraction would depend on each economy's industry structure and the public's responses. The lockdown and other containment measures were expected to remain in place for at least a couple of months in most countries, although there was considerable uncertainty about the extent of this, as well as the variability of the measures across countries.
Most official data for advanced economies had not yet captured the full effects of domestic containment measures. Nonetheless, business surveys of conditions in the services sector had fallen considerably across most advanced economies in March and labour market indicators had also deteriorated. In the United States, employment had fallen sharply and new claims on unemployment insurance had increased rapidly; the unemployment rate had increased around 1 percentage point by the time of the survey in mid March, but this was likely to have escalated significantly by the end of March.
Monthly indicators of industrial production in China had fallen sharply in January and February, consistent with more timely indicators, such as coal consumption by power plants, which had remained low following the Lunar New Year holiday. Retail sales had also fallen sharply and property markets had effectively shut. Through March, there had been signs of a recovery in a range of timely indicators, consistent with some easing in containment measures, although members noted that the return to more normal conditions had been more gradual than previously expected.
The decline in economic activity following the containment measures in many economies had been exacerbated by declines in trade and second-round income and demand effects. Accordingly, GDP was projected to contract by at least 10 per cent in the United States, the euro area and China over a couple of quarters. The contractions in some of Australia's other trading partners, particularly in Asia, were likely to be smaller, but still significant. These estimates were in line with those of international agencies. A number of emerging and low-income economies were in particularly vulnerable situations because they had less capacity in their health systems and they had been experiencing capital outflows; there had been growing concerns that a flight of capital could trigger a deeper economic contraction in those countries.
A recovery was expected once the COVID-19 outbreak was contained, but members noted that the timing and speed of that recovery was highly uncertain and the possibility of renewed outbreaks presented an additional downside risk. The recovery would be assisted by the very large responses of both monetary and fiscal policy. The fiscal responses had been designed to sustain the productive capacity of economies during the containment measures by reducing business failures, preserving employment and providing a level of replacement income for people who become unemployed or have their work hours reduced. The fiscal policy measures included: expanded unemployment benefits; direct payments to individuals; funding for small businesses; incentives to maintain employment; and deferments of tax payments and other payment obligations. The fiscal response in many countries had been much larger than during the global financial crisis.
Most commodity prices had fallen noticeably in anticipation of weaker global demand, although prices of the bulk commodities most significant for Australia's export revenues had been relatively resilient. The sharp decline in oil prices in preceding weeks had been partly a response to the decline in demand associated with the COVID-19 outbreak. But it had also partly been an independent shock, because some major producers had boosted supply for strategic reasons. For most economies, including Australia, lower oil prices were expected to be disinflationary in the short run and would flow through to the price of liquefied natural gas (LNG) exports over the course of the following few quarters. The lower oil prices had also meant that some LNG projects were now unlikely to go ahead within previously expected timeframes.
Domestic Economic Developments
Members observed that most of the available domestic economic data pre-dated the COVID-19 outbreak and had been consistent with a gradual improvement in the Australian economy over 2020. In February, the unemployment rate had declined to 5.1 per cent and there had been a jump in private sector building approvals. Housing prices had also risen strongly over February and had increased over March, although market conditions deteriorated over the second half of the month.
In March, the Australian Government had announced three packages of policies focused on providing assistance to households and business. The largest package had been the JobKeeper payment announced on 30 March, which would provide a wage subsidy for businesses that had experienced a significant fall in turnover. The government had also announced that it would provide cash-flow support to small and medium-sized businesses, and investment incentives to businesses with turnover of up to $500 million. By supporting employment, these policies were expected to provide a safety net for households, helping them maintain their spending on necessities and other obligations. The government had also announced that it would provide some direct transfers to households, including a temporary increase in the JobSeeker payment.
Members noted that the policies should cushion the labour market adjustment and reduce the financial stress of households and businesses. However, they observed that it was unlikely that these policies would provide a strong boost to spending in the near term given the broadening shutdown of non-essential activities and the restrictions placed on household activities. The states and territories had also committed to a number of spending packages, predominantly targeted at small and medium-sized businesses, along with providing support to households.
Retail sales had increased in February, as strength in grocery sales had offset weakness in sales of clothing and some services. Members noted that liaison with retailers had highlighted a much larger shift in household spending patterns through March as social distancing measures were put in place. Household consumption spending was expected to be much lower than usual in the June quarter because specific types of spending, including on travel, dining out and certain recreational services, were not possible under the current restrictions. These estimates were in line with those for other advanced countries subject to similar restrictions, as well as with indications of spending patterns from business liaison and other private sector sources. Travel and other service exports, particularly education, were also expected to remain very low for some time, on the assumption that current border controls would be in place for a number of months.
Deferrals and cancellations of business investment plans had been a theme in discussions with liaison contacts, and recent survey indicators of business conditions had fallen sharply. These discussions had also highlighted that weaker demand conditions, including for short-term rental accommodation, were expected to extend the weakness in residential construction. These effects on GDP were expected to be partially offset by stronger public demand and the introduction of income support measures. In combination, these considerations suggested that GDP could fall significantly in the June quarter and remain subdued in the September quarter. Real estate, hospitality and tourism, along with many parts of retail, essentially would not operate while the current restrictions remain in place, while some industries, including health care, utilities and mining, would be less affected.
Members noted that there would be a very sharp decline in hours worked, which was expected to be associated with significant increases in both the unemployment rate and the number of people working reduced hours. Although the JobKeeper subsidy was expected to increase the number of people remaining employed, household incomes were expected to be much lower.
Considerations for Monetary Policy
In considering the policy decision, members noted that the coordinated monetary and fiscal response, together with complementary measures taken by ADIs and other businesses, would soften the expected economic contraction and help support the economy's recovery once the health crisis has passed and restrictions have been removed. These various responses were providing considerable support to Australian households and businesses through this very difficult period. Members noted that the Australian financial system remained resilient. It was well capitalised and in a strong liquidity position, with these financial buffers available to be drawn upon if required to support the economy.
The policy package announced by the Bank on 19 March had helped to lower funding costs and stabilise financial conditions, and would support the expected recovery. The package had contributed to an easing of strains in government bond markets and the three-year Australian government bond yield had declined to be at the target of around 25 basis points. The Bank would continue to do what was necessary to achieve the three-year yield target, with the target expected to remain in place until progress was being made towards its goals for full employment and inflation. The Bank would also continue to promote the smooth functioning of these important markets. Members noted that, if conditions continued to improve, it was likely that smaller and less frequent purchases of government bonds would be required.
The Bank had injected substantial liquidity into the financial system through its daily open market operations to support credit and maintain low funding costs in the economy. Given the substantial liquidity that was already in the system and the commencement of the TFF, daily open market operations were likely to be on a smaller scale in the near term. Members noted that operations at longer terms would continue, but the frequency of these operations would be adjusted as necessary according to market conditions.
The Board remained committed to supporting jobs, incomes and businesses as Australia responds to the COVID-19 outbreak.
The Decision
The Board reaffirmed the elements of the policy package announced on 19 March 2020, namely:
- a target for the cash rate of 0.25 per cent
- a target of 0.25 per cent for the yield on 3-year Australian government bonds
- a term funding facility to support credit to businesses, particularly small and medium-sized businesses
- an interest rate of 10 basis points on Exchange Settlement balances held by financial institutions at the Bank.
The Board confirmed that the target for three-year yields would be maintained until progress was made towards the Bank's goals of full employment and the inflation target, and that it would be appropriate to remove the yield target before the cash rate itself was raised. The Board would not increase the cash rate target until progress is made towards full employment and it is confident that inflation will be sustainably within the 2–3 per cent target band.