Minutes of the Monetary Policy Meeting of the Reserve Bank Board

Videoconference – 2 February 2021

Members participating

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

Others participating

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

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

International economic developments

Members commenced their discussion of international economic developments by noting that the outlook for the global economy had improved following the successful development and early stage rollout of COVID-19 vaccines. Fiscal and monetary policy settings remained highly expansionary and in some economies additional fiscal stimulus was in prospect. Growth forecasts for the global economy and Australia's major trading partners had been revised a little higher as a result. However, the brighter outlook did not change members' assessment that the global recovery was still likely to be bumpy and uneven, with most economies expected to be well short of their pre-pandemic trajectories at the end of the forecast period. Labour markets were therefore likely to have considerable spare capacity for some time, resulting in subdued inflationary pressures. The spread of the virus and the speed of vaccine distribution remained key determinants of the outlook.

Members noted that the global recovery had lost some momentum around the turn of the year as restrictions on mobility in some economies were tightened following a resurgence of COVID-19 infections. This continued a pattern observed in the preceding year of highly variable growth outcomes across economies. China and some other economies in east Asia had experienced relatively strong recoveries, with GDP in the current year likely to be tracking at levels expected before the pandemic. Favourable health outcomes and a surge in manufactured goods exports had contributed to this. Many economies were expected to have recovered their pre-pandemic levels of GDP by the end of the year, but still be short of levels expected prior to the onset of the pandemic. In a smaller number of economies, including some in Europe that had experienced severe health outcomes, GDP was expected to still be below pre-pandemic levels at the end of 2021.

Members noted that the strength of the global demand for goods, the faster-than-expected recovery in global economic activity and the improved outlook had contributed to a strong rebound in commodity and other key input prices. Oil prices had recovered much of their decline early in the pandemic, while base metals prices were above pre-pandemic levels. Iron ore prices had also risen further in recent months, to trade at their highest levels in many years. High iron ore prices had been supported by ongoing supply disruptions in Brazil and strong demand from Chinese steel producers. The higher commodity prices had supported a marked rise in Australia's terms of trade, which was expected to reach its highest level in nearly a decade in the March quarter. Members also noted that other important global input prices, such as those for semiconductors, had risen above levels prevailing before the pandemic, reflecting strong global demand for electronics and other goods that use semiconductors as inputs.

Members noted that several vaccines had already been approved for use internationally, and that more were likely to be available in the near future. Some countries, including those with well-functioning public health systems and ample initial vaccine supplies, had been able to meet or exceed their early targets for the rollout of their vaccine programs, while other countries had fallen short of their targets. Distributing and administering vaccines on such a large scale and under intense time pressure was presenting significant logistical and administrative challenges for many countries.

In concluding their discussion of the international economy, members discussed the significant fiscal responses to the pandemic. Additional fiscal support had been announced in a number of economies that were affected by second or third waves of infections. The wide variation in public debt levels prior to the pandemic, and in health outcomes over the preceding year, helped to explain some of the cross-country differences in fiscal responses.

Domestic economic developments

Turning to the domestic economy, members noted that the recovery in the second half of 2020 had been faster than initially expected, in line with the pattern observed internationally. Favourable health outcomes in Australia had enabled the lifting of restrictions and boosted activity. Consumption had rebounded quickly as health-related restrictions on activity had been eased, suggesting that supply-side constraints were key to driving the spending patterns observed during the pandemic; households had also adapted their consumption habits. Business investment had fallen, but by less than expected. More broadly, the rapid bounce-back in domestic activity had also been supported by additional fiscal measures announced by the Australian and state governments in the latter part of 2020. This had enabled a faster recovery in labour market conditions than expected a few months earlier, with the unemployment rate in the December quarter declining more quickly than even the upside scenario presented in the November 2020 Statement on Monetary Policy.

In discussing the outlook for activity and the labour market, members noted that the forecasts under the baseline scenario had been upgraded relative to 3 months earlier. This upward revision incorporated the stronger starting point for the forecasts and improved outlook. GDP and employment were now expected to reach their pre-pandemic levels over the course of 2021, around 6–12 months earlier than previously expected.

Members noted that the lowest rate of population growth since the First World War would continue to have a significant bearing on the outlook. The level of GDP was not expected to return to its previous trajectory over the forecast period, largely because population growth would be so much lower than assumed prior to the pandemic. Lower population growth would continue to weigh on both aggregate demand and labour supply in the period ahead, although the effects on labour supply and wages would be partly limited by foreign students tending to have a lower participation rate than the domestic working-age population. Low population growth, reflecting reduced net overseas migration in particular, was also expected to affect high-density residential investment for some time to come. Members noted that overall dwelling investment would have been lower had the HomeBuilder program and other state government incentives been less effective in stimulating activity in the detached housing sector.

In their discussion of the labour market, members observed that, in contrast to expectations 3 months earlier, the peak in the unemployment rate had probably already occurred. Notwithstanding a swift rebound in the participation rate, the firmer outlook for employment had resulted in a lower expected unemployment rate profile across the forecast period. Despite the end of the JobKeeper program in March creating some uncertainty for near-term labour market outcomes, the unemployment rate was expected to resume trending lower in the second half of the year. In the baseline scenario, the unemployment rate was expected to decline to around 6 per cent by the end of 2021, before reaching around 5¼ per cent by mid 2023. While the strong recovery and improved outlook for employment had reduced the prospects for substantial scarring effects in the labour market, the forecasts implied that there would still be spare capacity in the labour market at the end of the forecast period.

Members commenced their discussion of the household sector by noting that the rebound in consumption in the second half of 2020 had been supported by very strong growth in disposable income over the year. As temporary income support measures tapered or ceased, household income was expected to decline through to the middle of 2021, before resuming steady growth in line with recovery in the labour market. In the baseline scenario, consumption growth was expected to remain positive but moderate in the period ahead; in per capita terms, the level of consumption had rebounded strongly and, by 2022, was forecast to have returned to levels expected prior to the pandemic. The outlook for consumption was supported by many households strengthening their balance sheet and liquidity positions during the pandemic. Restrictions on consumption, precautionary behaviour and strong growth in incomes had contributed to households adding considerably to savings during the June and September quarters of 2020. Members noted the significant uncertainty around whether and how quickly the savings ratio would return to more typical levels, and how households would use the additional savings accumulated during 2020.

Members observed that conditions in the housing market had been more resilient than expected, which had assisted the economic recovery. Housing prices had recently been rising across most of Australia following an earlier period where conditions had been quite variable. This had returned the national housing price index to levels reached around 4 years earlier. Housing price increases had been larger in regional Australia than in the capital cities; price levels in some smaller capital cities had increased to new highs. Members noted that there were few signs of a deterioration in lending standards; however, lending standards would be monitored closely in the period ahead.

In their discussion of the outlook for wages growth and inflation, members noted that the forecasts under the baseline scenario had increased a little relative to 3 months earlier, in line with the lower expected unemployment rate. However, both wages growth and underlying inflation were expected to remain below 2 per cent over the forecast period, reflecting ongoing spare capacity in the economy.

Members observed that wages growth had been subdued for a number of years and had recently declined further, to the lowest levels in at least 2 decades. Firms had responded quickly in the early stages of the pandemic by delaying wage increases, imposing wage freezes and, in some cases, applying temporary wage cuts. Liaison contacts had suggested it could be some time before wage freezes were lifted. The improved outlook for activity and employment was expected to lift private sector wages growth a little over the forecast period. However, this was partly offset by the downward revision to the outlook for public sector wages growth, as some state governments had announced measures to cap wages growth at rates below those seen in recent years.

Turning to the outlook for inflation, members noted that underlying inflation pressures were subdued and expected to remain so in the period ahead. Although the outlook for underlying inflation had been revised up a little relative to 3 months earlier, ongoing spare capacity and low wages growth were expected to keep underlying inflation below 2 per cent over the forecast period. Members recalled the domestic and international experience prior to the pandemic, which suggested that a sustained period of labour market tightness would be needed to generate the faster wages growth required to see inflation return to the 2 to 3 per cent target range. Headline year-ended inflation was expected to increase temporarily to around 3 per cent in the June quarter 2021, largely reflecting swings in the prices of child care, automotive fuel and some other administered prices. It was then forecast to fall back below 2 per cent by the end of the year and stay below 2 per cent over the remainder of the forecast period.

Given the high degree of uncertainty around the outlook, members considered 2 plausible alternative scenarios around the baseline forecast. In the baseline forecast, no further significant outbreaks of the virus were assumed to occur in Australia, although there could be some smaller outbreaks on the scale seen in recent months. Restrictions on domestic activity were assumed to be eased over the course of the year. Australia's international borders were assumed to remain closed until at least the end of the year.

A downside scenario was considered by members, where further large outbreaks of the virus required the reimposition of restrictions on activity, although not the extended lockdowns contemplated in previous downside scenarios. Weaker activity would see the unemployment rate remain around 6¾ per cent for most of 2021 and then decline only gradually thereafter. The larger degree of spare capacity in the labour market would be expected to place further downward pressure on wages growth and keep inflation trending lower until mid 2022.

A plausible upside scenario was also discussed by members, which assumed that a run of positive health outcomes domestically and abroad enabled a faster easing of restrictions on activity. This would boost household and business confidence and, with it, private spending and investment. The stronger profile for activity in this scenario would lead to a faster decline in the unemployment rate, which would fall to below 5 per cent by the end of 2022. Inflation would also rise a little faster in this scenario, but even still it would approach 2 per cent only by the end of the forecast period.

International financial markets

Members noted that global financial market conditions had remained very accommodative and monetary stimulus was expected to remain in place for some time. In the advanced economies, several central banks, including the US Federal Reserve, the European Central Bank, the Bank of Japan and Sweden's Riksbank, had recently indicated that they would increase the size and/or extend the timeframe of their asset purchase programs. A number of central banks had also introduced lending facilities or enhanced existing facilities to support the flow of credit to the real economy. Members observed that the size of the Bank's balance sheet relative to GDP remained lower than that of most other advanced economy central banks.

Long-term government bond yields had increased over the preceding couple of months in most advanced economies, reflecting the upgraded growth outlook related to the rollout of the COVID-19 vaccines and expected fiscal stimulus measures, notably in the United States. Much of the increase in bond yields had reflected an increase in the compensation for inflation sought by investors. Members observed that government borrowing costs had remained low across advanced economies and issuance had continued to be met by strong demand.

Corporate funding conditions had also remained highly accommodative and borrowing costs had remained around record lows. Investor confidence had been buoyed by the rollout of vaccines, new fiscal stimulus measures and sustained monetary stimulus, despite the challenges of rising COVID-19 cases in some countries. Credit spreads had narrowed further and equity prices had increased. US equity prices had increased by more than in many other countries, partly reflecting the higher share of technology-related stocks in US equity indices.

The US dollar had depreciated further in response to the improvement in the medium-term global growth outlook. Commodity prices had also increased against this backdrop and the Australian dollar had appreciated back to around 2018 levels in trade-weighted terms. Members observed that, nonetheless, the additional monetary policy stimulus as a result of the Bank's package of policy measures announced in November 2020 had contributed to the Australian dollar being noticeably lower than it would have been otherwise.

Domestic financial markets

In Australia, the Bank's package of policy measures announced in November 2020 had led to a further easing of financial conditions. The cash rate had declined to 3 basis points and other short-term money market rates had also declined to be close to zero.

The 3-year Australian Government bond yield had been at the target of around 10 basis points, supported by bond purchases on several occasions in mid November and early December. The Bank was halfway through the $100 billion bond purchase program. While longer-dated Australian Government bond yields had increased since early December, this largely reflected international developments and the yield differential to US Treasuries had been broadly stable over that period. Staff estimates suggested that longer-term Australian Government bond yields were around 30 basis points lower than otherwise as a result of the bond purchase program. Members noted that government bond markets in Australia continued to function smoothly for both Australian Government bonds and semis.

After drawing down the bulk of initial Term Funding Facility (TFF) allowances by the end-September deadline, banks had since drawn down only a small share of their additional and supplementary TFF allowances. Similar to the initial allowance period, further TFF drawings were expected to pick up towards the end of the remaining drawdown period, which would finish in June 2021.

Reductions in money market rates and retail deposit rates had further reduced banks' funding costs. Borrowing rates for households and businesses had also declined to new lows. Reductions in borrowing rates since November had mostly been for fixed-rate home loans and for business loans under the government's small and medium-sized enterprises loan guarantee scheme. The average rate paid on outstanding variable-rate housing loans had continued to drift gradually lower, reflecting ongoing competition for new high-quality borrowers and the effect of borrowers refinancing their loans.

Funding conditions for Australian non-financial firms had remained highly accommodative. Credit spreads had narrowed further and Australian firms had been able to increase the tenor of their bond issuance in 2020. Equity prices had increased a little further since early December. While the ASX 200 had risen noticeably since March 2020 – with a significant contribution from resource companies reflecting higher commodity prices – it had remained around 5 per cent below its peak early in 2020.

Demand for housing finance had continued to pick up over preceding months, especially from owner-occupiers. New housing loan commitments for owner-occupiers had increased to be well above the previous high in 2017. Investor housing loan commitments had also increased somewhat, but remained well below earlier peaks. Members noted that demand for new business loans had remained subdued, including for small and medium-sized enterprises.

Considerations for monetary policy

In considering the policy decision, members observed that the outlook for the global economy had improved over prior months owing to the development of vaccines. At the same time, the global recovery had lost some momentum around the turn of the year, as COVID-19 cases had surged again in many countries. The global outlook remained dependent on the path of the pandemic and on significant fiscal and monetary support. The recovery was likely to remain bumpy and uneven, and most economies were expected to be well below their pre-pandemic trajectories for the level of output for some time. Inflation remained low and below central bank targets in many economies.

In Australia, the economic recovery was well under way and had been stronger than expected previously. There had been strong growth in employment and a welcome decline in the unemployment rate. These outcomes had been underpinned by Australia's success on the health front and the very significant fiscal and monetary support. An important near-term issue was how households and businesses would adjust to the tapering of some fiscal support measures and to what extent they would use their stronger balance sheets to support spending. Members agreed that, while the recovery was expected to continue, the level of output remained noticeably below its pre-pandemic trajectory. The high unemployment rate and considerable spare capacity were expected to result in subdued wages growth and inflation over coming years.

The Bank's policy actions to date had been working broadly as expected. Together, the bond purchases, the TFF and the targets for the 3-year bond yield and the cash rate were helping the economy by lowering financing costs for borrowers, contributing to a lower exchange rate than otherwise, supporting the supply of credit and supporting housing and business balance sheets. Since the start of 2020, the Bank's balance sheet had increased by around $160 billion and a further substantial increase was in prospect. The Bank had bought a cumulative $52 billion of government bonds issued by the Australian Government and the states and territories under the bond purchase program. The Bank had not purchased bonds in support of the 3-year yield target since early December 2020. Authorised deposit-taking institutions had drawn down $86 billion of low-cost funding through the TFF and had access to a further $99 billion under the facility. Members noted that the Australian banking system, with its strong capital and liquidity buffers, had remained resilient and was helping to support the economic recovery.

The Board remained committed to doing what it reasonably could to support the Australian economy, and decided to maintain the existing policy settings. Members concluded that very significant monetary support would be required for some time, as it would be some years before the Bank's goals for inflation and unemployment were achieved. Given this, it would be premature to consider withdrawing monetary stimulus.

Members discussed the bond purchase program, which was scheduled to be completed in mid April 2021. They considered 3 factors: the effectiveness of the bond purchases; the decisions of other central banks; and, most importantly, the outlook for inflation and employment. The Board assessed that the bond purchase program had helped to lower interest rates and had contributed to a lower exchange rate than otherwise. Australia's government bond markets continued to function well and further purchases were not expected to be a source of market dysfunction.

A number of central banks in other advanced economies had announced extensions of their bond purchase programs to at least the end of 2021, and there was a widespread expectation among market participants that the Bank's program would be extended in some way. Given this, if the Bank were to cease bond purchases in April, it was likely that there would be unwelcome significant upward pressure on the exchange rate. Members discussed the outlook for the economy and concluded that it would be some years before the goals for inflation and unemployment were achieved. In view of these considerations, and the fact that the cash rate was at its effective lower bound, the Board resolved to purchase an additional $100 billion of bonds issued by the Australian Government and states and territories following the completion of the existing bond purchase program in mid April. These additional purchases would be at the same rate of $5 billion per week, allocated on the same basis, namely around 80 per cent Australian Government Securities and around 20 per cent bonds issued by the states and territories. The decision to extend the bond purchase program would ensure a continuation of the Bank's monetary support for the Australian economy.

Members reviewed the operation of the TFF and agreed that it had worked as intended by reducing borrowing costs and supporting the flow of credit, including for small and medium-sized enterprises. The Board decided to maintain the existing terms of the facility. Banks will be able to draw on the facility until the end of June 2021, and continue to benefit from this low-cost funding through to mid 2024. The Board would consider extending the facility if there were a marked deterioration in funding and credit conditions in the Australian financial system. However, there had not been signs of such a deterioration recently.

Members also discussed the operation of the target for the 3-year Australian Government bond yield. This target had been effective in lowering short-term interest rates, which matter most for private borrowing and lending decisions. The target had also helped to anchor the Australian yield curve, and reinforced the Bank's forward guidance regarding the cash rate. The Board determined that the 3-year yield target would be maintained. Later in the year, the Board would need to consider whether to shift the focus of the yield target from the April 2024 bond to the November 2024 bond. In considering this issue, members would give close attention to the flow of economic data and the outlook for inflation and employment.

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

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

The decision

The Board reaffirmed the existing policy settings, namely:

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

The Board agreed to purchase an additional $100 billion of government bonds when the existing bond purchase program is completed in mid April 2021. These additional purchases will be at the same rate of $5 billion per week.