Minutes of the Monetary Policy Meeting of the Reserve Bank Board

Videoconference – 1 September 2020

Members Participating

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

Members granted leave of absence to Wendy Craik AM in terms of section 18A of the Reserve Bank Act 1959.

Others Participating

Luci Ellis (Assistant Governor, Economic), Christopher Kent (Assistant Governor, Financial Markets)

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 noting that the global economy had started to recover around May as containment measures were eased and the extensive fiscal and monetary support had begun to take effect. However, more recently the global recovery had slowed and become more uneven, with infection rates rising again in some countries; further fresh outbreaks of the virus had been seen in Japan, South Korea, some countries in Western Europe and New Zealand. This had led to a targeted tightening in restrictions, and some renewed signs of precautionary behaviour. Consistent with this, mobility indicators had flattened out. Members noted that the future path of the global recovery would remain highly dependent on containment of the virus.

The first half of 2020 had seen the largest contraction in global economic activity in many decades. The extent of the declines in GDP varied significantly across economies, depending on the severity of the pandemic and the intensity of the containment measures. Some countries had experienced contractions of around 20 per cent in the first half of the year, although the decline in output in Australia was expected to have been less severe.

In turning to labour market outcomes in advanced economies, members noted that total hours worked remained 5–10 per cent below pre-pandemic levels, despite having increased recently. The extent to which lower total hours worked had been accounted for by reductions in average hours and/or employment depended in large part on the scope of wage subsidies and other fiscal support schemes. It was noted that in the United States most of the decline had been in the form of fewer employees rather than lower average hours worked. This was because, unlike in most other advanced economies, income support in the United States had mostly comprised increased unemployment benefits rather than wage subsidies.

Members discussed the severe disruptions to global trade flows that had been experienced since the outbreak of the pandemic, as seen in the sharp contraction in exports and imports in many economies. This had also been evident in Australian trade volumes. While the shock to aggregate demand had been central to the decline in global trade flows, disruptions to supply stemming from health measures had also affected the ability of some economies to produce exports. China had been less affected than most economies in this regard, with production and exports both having rebounded strongly.

Members noted that in China production had rebounded much more strongly than consumption, which had not been the typical pattern of recovery observed in other economies. Differences in the emphasis of fiscal policy support had largely accounted for this. In China, policy support had been aimed mainly at supporting businesses and stimulating investment; income transfers to households had been modest. As a result, fixed asset investment and industrial production had returned to pre-pandemic levels, while consumption had recovered at a slower pace. In advanced economies, household income transfers had featured much more prominently in fiscal support packages, which had supported household disposable income and consumption to a greater extent than production.

Recent inflation outcomes around the world had reflected a combination of factors. In addition to the effects of a large negative aggregate demand shock, these outcomes reflected a significant shift in demand towards goods, lower demand for services and disruptions to supply. The net of these factors had been subdued overall inflationary pressure. However, prices for some goods, such as food, motor vehicles & parts and household furnishings, had risen at a solid pace in some countries.

Members also noted that large shifts in the demand for and supply of commodities had been occurring. Of most relevance to Australia, iron ore prices had been around multi-year highs. Demand for iron ore from China had been strong given that steel-intensive activity such as construction had bounced back quickly. Ongoing supply issues in Brazil had also supported iron ore prices. Gold prices had recently traded at all-time highs, partly reflecting increased investment demand in an environment of low global interest rates. By contrast, coal prices had been around multi-year lows, reflecting lower demand in India and elsewhere, and abundant global supply. In terms of key resource export volumes, members noted that Australian exports of iron ore to China had remained resilient in recent months.

Domestic Economic Developments

Members commenced their discussion of domestic economic conditions by noting that the contraction in June quarter GDP in Australia was expected to be less severe than in many other countries and broadly in line with projections in the August Statement on Monetary Policy. However, it was expected that the national accounts (scheduled for release the day after the meeting) would confirm the economy had experienced its largest single-quarter contraction in the history of the quarterly national accounts.

Recent data indicated that non-mining business investment in the June quarter had not been as weak as earlier feared, particularly spending on machinery & equipment. However, non-mining and mining investment intentions for 2020/21 had been little changed from three months prior, and had continued to indicate a very weak outlook for capital expenditure overall.

Members noted that household consumption had contracted significantly in the June quarter, with the decline in April having been particularly steep. Since then, consumption had started to recover, but was still well below pre-pandemic levels. Restrictions on activity had constrained spending in Victoria, with retail spending there much weaker than in the rest of the country. Business liaison and other higher frequency indicators suggested retail sales had declined significantly in Victoria in August. Members noted that spending on other services in Victoria would also be severely affected during the lockdowns. Overall, household consumption in Australia was still expected to increase in the September quarter, but this would only partly reverse the contraction that had been experienced earlier in the year.

In their discussion of the housing market, members noted that prices for established dwellings in Melbourne and, to a lesser extent, Sydney had declined in recent months, but price movements had been mixed elsewhere. The cumulative decline in established national housing prices in 2020 had been less than experienced two years earlier. Meanwhile, rental markets had remained weak. Rental supply had been boosted by short-term and holiday rentals being brought onto the long-term rental market, while demand had been depressed by the reduced flow of new migrants and a decline in the rate of household formation. Rental vacancy rates had risen recently, and members noted that downward pressure on rents was unlikely to dissipate in the near term in either Sydney or Melbourne.

Turning to the labour market, members observed that the increase in employment in July had been stronger than generally expected, but not enough to prevent a rise in the unemployment rate. The number of people who had left the labour force during the June quarter but were now actively searching for work had increased. This was expected to continue through the remainder of 2020 as restrictions on activity and health concerns eased and mutual obligations under the JobSeeker program were reinstated. Measures of labour underutilisation had eased, but remained very high. It was noted that around half of the contraction in total hours worked had been reversed in preceding months, with average hours picking up more quickly than employment. Many part-time workers had reverted to working their usual hours after having been on low or zero hours earlier in the year.

More timely payroll data suggested the number of jobs in the weeks up to early August had declined a little, with a notable drop in jobs in Victoria. The recent decline in Victoria had erased much of the recovery in jobs between April and June. Outside of Victoria, the recovery in jobs appeared to have slowed.

Members observed that the 1.8 per cent increase in the wage price index over the year to June was the lowest rate of growth in the history of the series. In discussing the subdued private wages growth outcomes in the June quarter, members noted that firms had responded more swiftly than in previous downturns to the weakening in demand by slowing the pace of wage increases. In some industries, such as construction, professional services and some other service industries, a small number of large wage reductions had contributed to a decline for the industry in aggregate. Business liaison contacts had also suggested that firms were more likely to have instituted wage freezes than in the past, and that it was not uncommon for senior managers and executives in some industries to have experienced temporary wage cuts. Wage and price pressures more generally were expected to remain subdued for some time.

Members noted the important role that fiscal policy had played in supporting the economy since the outbreak of the pandemic. Income transfers to households from the Australian Government had provided a substantial boost to household income and consumption, as well as to business cash flows. Members also noted that state and territory governments had played important roles in complementing these income transfers in the period ahead, mainly by increasing direct spending on goods and services and job creation. Governments at this level had considerable experience to draw on in service delivery, employment and implementing direct purchases of goods and services. They also accounted for a larger share of public demand than the Australian Government. Members noted that debt levels relative to the size of the economy were low for the Australian and state governments. Overall, public sector balance sheets in Australia were assessed as being strong. In an environment of record low borrowing rates and significant spare capacity in the economy, this meant fiscal policy was well placed to continue to support the recovery.

International Financial Markets

Members noted that global financial conditions had remained accommodative, supported by substantial policy stimulus. Central banks had continued to emphasise that they would maintain the current easy stance of monetary policies for some time and provide further stimulus if required. In August, the Reserve Bank of New Zealand (RBNZ) had increased the total size and extended the duration of its government bond purchase program. At the same time, the RBNZ had been considering a negative policy rate and an expanded term funding scheme.

The US Federal Reserve had announced that, following a comprehensive review of its monetary policy framework, it would now pursue a flexible average inflation target and increase the emphasis placed on achieving maximum employment. Most commentators had concluded that this implied the Federal Reserve would maintain a stimulatory monetary policy stance for longer than initially thought and until inflation was moderately above 2 per cent for a time.

Government bond yields had remained historically low across advanced economies, although yields had increased a little over the preceding month. Market-implied inflation expectations had increased steadily to be around the levels last seen at the beginning of 2020. Accordingly, yields had declined in real terms over prior months and were at very low levels, consistent with very stimulatory policy settings.

Equity prices in major markets had increased further over August. This partly reflected the fact that the fall in corporate earnings in the first half of 2020 had been smaller than initially feared. Investors had also appeared to expect the declines in corporate earnings to be short-lived. The high level of equity prices had also reflected low discount rates, consistent with the low level of bond yields. Members noted that when total returns – which include dividend payments – were taken into account, Australian equities had performed similarly to equity markets in most other advanced economies, apart from the United States, where equity markets had outperformed.

Corporations across the major economies had continued to benefit from accommodative funding conditions in debt markets. Spreads on corporate bonds had remained low and bond issuance had been relatively strong in the United States. Business credit growth had been strong following the onset of the pandemic, but had eased over recent months. Members noted that there had been some tightening in banks' lending standards for business borrowers, and discussed the relative importance of demand and supply factors for business credit in the current environment.

In China, the authorities had indicated their comfort with the current stance of monetary policy and had re-emphasised their focus on managing medium-term financial stability risks, such as high leverage. The authorities had also signalled their concern about non-performing loans in the period ahead. The Chinese renminbi had been relatively stable, despite ongoing tensions between the United States and China.

Financial conditions in emerging markets had been relatively stable, particularly in Asia. Members noted, however, that some emerging economies, including Brazil, Russia, South Africa and Turkey, had experienced volatility in their financial markets and exchange rates in recent months; these economies had existing macroeconomic vulnerabilities before the COVID-19 pandemic.

The US dollar had depreciated significantly against the currencies of other advanced economies over recent months, including the Australian dollar. In part, this reflected an unwinding of the earlier appreciation of the US dollar related to an episode of financial market volatility in March and April during which investors had sought less risky investments. The appreciation of the Australian dollar had been consistent with the increase in commodity prices, particularly iron ore prices, over recent months. While members noted that the Australian dollar was broadly aligned with its fundamental determinants, a lower exchange rate would provide more assistance to the Australian economy in its recovery.

Domestic Financial Markets

In Australia, the Board's policy measures continued to underpin accommodative financial conditions. Reflecting the large amount of liquidity in the system, the cash rate had remained very low, at around 13 basis points, and investors expected it to remain at that level for some time. Similarly, money market rates had remained very low.

The Bank had purchased about $10 billion of Australian Government Securities (AGS) in August in support of the 3-year yield target for AGS of around 25 basis points. Following the Bank's purchases, the yield on the AGS bond maturing in April 2023, which is currently the bond with a maturity closest to three years, had declined to be closer to 25 basis points. Members noted that the focus of the yield target will increasingly shift to the April 2024 bond, which will become the bond with a maturity closest to three years in the second half of October 2020. Government bond markets had continued to function smoothly, with large issuance by the Australian Government and states met by consistently strong demand.

Banks' funding costs were at historic lows and banks had good access to funding. Take-up of the Reserve Bank's Term Funding Facility (TFF) had continued to pick up as the end-September deadline for drawing initial allocations approached. Banks had also continued to receive large inflows of deposits, another relatively low-cost source of funding. The increase in funding from the TFF and low-cost deposits had been partly offset by banks not replacing wholesale bond funding as it matured; much of the decline in bank bonds on issue this year had been concentrated in bonds issued offshore.

The cash rate reductions and other policy measures had flowed through to interest rates on business loans, which were historically low. Members observed that, nevertheless, demand for business loans had remained subdued, reflecting the weakness in economic conditions and the high level of uncertainty. Large businesses had repaid the bulk of the funds obtained from existing credit lines in March and April, while lending to small and medium-sized enterprises had been little changed for some time. Interest rates on housing loans had also been at historic lows. Over half of the decline in the cash rate since February had flowed through to variable rates, and fixed housing loan rates had declined by even more. There had been a large amount of refinancing activity, with a greater-than-usual share of borrowers moving to fixed-rate home loans.

Growth in housing credit to owner-occupiers had eased in recent months to around 5 per cent on an annualised basis, while housing credit to investors had continued to decline. This largely reflected reduced demand from borrowers, given the weak and uncertain economic environment and its effect on the housing market. Housing loan commitments had increased over June and July, but had remained below their recent peak. Payments into offset and redraw accounts had increased substantially in July. This partly reflected the early release of superannuation funds to some households at the beginning of the new financial year, along with government payments and tax refunds. In locations where movement had been restricted, this had also reflected fewer opportunities for spending.

Members noted that, in addition to weak demand for household and business borrowing, the supply of credit had also tightened somewhat since earlier in the year, reflecting the uncertain economic outlook. Banks had been offering extensions of loan deferral periods where appropriate and generally had been encouraging borrowers to make repayments if they could afford to do so.

Considerations for Monetary Policy

In considering the policy decision, members observed that the global economy had been experiencing an uneven recovery after a very severe contraction in the first half of 2020. Some economies with high or rising COVID-19 infection rates had recently lost momentum. In contrast, economic growth had been relatively strong in China. The future path of the recovery was highly dependent on containment of the virus.

The Australian economy had been going through a very difficult period and was experiencing the biggest shock to economic activity since the 1930s. Nevertheless, members noted that the downturn had not been as severe as earlier expected and a recovery was under way in most of Australia. However, the recovery was likely to be uneven, with the COVID-19 outbreak in Victoria having a major effect on the economy. Uncertainty about the health situation and the future path of the economy was continuing to affect the spending plans of many households and businesses. Wage and price pressures remained subdued and this was likely to continue for some time.

Members agreed that the Board's policy package implemented in mid March was continuing to support the Australian economy. There was a very high level of liquidity in the Australian financial system and the policy package had helped to lower funding costs. Members noted that the Australian banking system, with its strong capital and liquidity buffers, had remained resilient and was helping the economy traverse this difficult period.

Over the prior month, the Bank had purchased AGS in support of the Board's 3-year yield target of around 25 basis points, and members agreed that further purchases should be undertaken as necessary to maintain the target. Government bond markets had been operating effectively, alongside a significant increase in issuance. The Bank stood ready to purchase AGS and semi-government securities in the event of a recurrence of market dysfunction.

Members reviewed the operation of the TFF, given the uncertain economic outlook and that the initial allowance of 3 per cent of credit had to be drawn down by the end of September 2020. They agreed that the TFF had worked as intended and that, given the economic outlook, an expansion of the TFF was appropriate. In particular, the Board agreed to increase the size of the TFF and allow drawing of funds up until June 2021. Under an expanded TFF, authorised deposit-taking institutions (ADIs) would have access to additional funding, equivalent to 2 per cent of their outstanding credit, at a fixed rate of 25 basis points for three years. ADIs would be able to draw on this extra funding until the end of June 2021. This extension would ensure that all ADIs continued to have access to the TFF after the end of September 2020. The availability of additional allowances associated with an ADI's growth of business credit would also be extended beyond the end of March 2021 to the end of June 2021. This further easing of monetary policy would bring the total amount available under this facility to around $200 billion. This would help keep interest rates low for borrowers and support the provision of credit by providing ADIs greater confidence about their continued access to low-cost funding.

Members recognised that the substantial, coordinated and unprecedented easing of fiscal and monetary policy in Australia was helping to sustain the economy through this difficult period. Members noted that public sector balance sheets in Australia were strong, which allowed for the provision of continued support. They considered it likely that fiscal and monetary support would be required for some time given the outlook for the economy and the labour market. The Board affirmed its commitment to supporting jobs, incomes and businesses in Australia. It agreed to maintain highly accommodative settings as long as required and to continue to consider how further monetary measures could support the recovery.

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
  • the 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 agreed to increase the size of the Term Funding Facility and make the facility available for longer.

The Board reaffirmed that the yield target for 3-year bonds would be maintained until progress is 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 is raised. The Board also reaffirmed that it 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.