Minutes of the Monetary Policy Meeting of the Reserve Bank Board

Hybrid – 4 May 2021

Members participating

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

Others participating

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

Anthony Dickman (Secretary), Penelope Smith (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 economic developments by noting that the global outlook had improved, and risks had become more balanced, because of progress in vaccinations and the provision of additional fiscal support. Growth in the global economy was expected to rebound solidly in both the current and the following year. Even so, the global recovery remained uneven. Output remained well below pre-pandemic levels in a number of countries because of recurring outbreaks of COVID-19, and in some emerging market economies, where financial conditions had tightened, there was limited scope for ongoing large-scale fiscal support. The level of output was expected to remain below its pre-pandemic trajectory in many economies over the forecast period, with the United States and China notable exceptions. Substantial spare capacity was likely to persist in most economies, including in the services sector, keeping underlying inflation pressures subdued for some time. However, members noted that the upswing in commodity prices would boost inflation readings in the near term, and that it was possible that supply bottlenecks for some goods would be more persistent than generally assumed.

Members observed that a significant share of the population had been vaccinated in only a small number of countries, notably the United States, United Kingdom and Israel. Some other countries where infection rates had been relatively low through the pandemic, including Australia and in east Asia, were expected to achieve high levels of inoculation by the end of 2021 or early 2022. However, vaccine supplies remained limited in many emerging market countries, hampering their economic recoveries. India had experienced a very serious surge in infections, accounting for a large share of new cases globally and prompting curfews and partial lockdowns in the worst-affected states. This would weigh on the Indian economy in the June quarter.

Members observed that the global fiscal policy response to the pandemic had been the largest since at least the Second World War, and that it continued to evolve. In the most acute phase of the pandemic, governments had prioritised direct fiscal support for health systems and households, and targeted measures aimed at reducing layoffs, such as wage subsidies for firms. The latter had limited the extent of economic scarring. The size and composition of the fiscal response had also varied considerably across countries, reflecting differences in health outcomes and the nature of automatic stabilisers already in place. Fiscal support had been particularly large in the United States. Fiscal policy was likely to remain supportive in most advanced economies for some time after the pandemic. In countries where health outcomes were becoming more favourable, the focus of this fiscal support was likely to turn toward boosting public and private investment and other longer-term priorities.

A key development in the global economy in recent months had been the rebound in commodity and producer prices. Highly expansionary fiscal and monetary policy settings, a surge in global demand for goods and a strong recovery in industrial production in China and elsewhere had contributed to a sharp increase in the prices of commodities and other inputs. In some cases, the rebound in global goods trade had outstripped the ability of global supply chains to cope, which had contributed to delays and upward price pressures for key components such as semiconductors; this in turn had hampered downstream production for a variety of goods, such as motor vehicles. Strong demand for steel in China and international supply disruptions had also pushed iron ore prices to their highest levels in a decade and boosted Australia's terms of trade. The increase in commodity and other input prices was expected to contribute to higher inflation globally in subsequent months, and members noted that inflation expectations in advanced economies had also increased to be closer to central banks' targets.

Domestic economic developments

In turning to the domestic outlook, members noted that the Australian economy was transitioning from recovery to expansion earlier and with more momentum than previously anticipated. The unique features of the pandemic and the policy response had seen the economy rebound much faster than in previous downturns. GDP was expected to have returned to its pre-pandemic level in the March quarter and there were more people employed in March than before the onset of the pandemic. In response to the stronger starting point and improved outlook further out, the forecast for GDP under the baseline scenario had been revised upwards. GDP growth of 4¾ per cent was expected over 2021 and 3½ per cent over 2022. If realised, this would leave the level of GDP a little below that forecast before the pandemic, mostly owing to lower population growth. Members noted that the release of the Australian Government Budget in May would contain further information relevant to the outlook for public demand.

Members agreed that an important source of uncertainty for the domestic outlook was the path for household consumption. In the baseline scenario, household consumption was expected to be supported by the further lifting of restrictions on services, a stronger outlook for employment and thus labour income, wealth effects from higher housing prices, and reduced uncertainty generally. In this scenario, households were assumed to treat the savings accumulated in the preceding year as wealth and therefore were expected to consume only a small share of these savings over the forecast period; the household saving ratio was also expected to decline further.

Conditions in the housing market had continued to strengthen. Housing prices had increased further in April. In recent months, the upswing in housing prices had become more broadly based across capital cities and regional areas. Turnover had also increased to around its highest level in a number of years, with many properties staying on the market for short periods of time. Strong demand was encouraging an increase in new listings, although the total stock of listings was below the average of recent years because new listings were being sold quickly. Rental markets had tightened in recent months but conditions remained uneven. Rents were increasing at a stronger pace for houses than for units, and in regional areas compared with capital cities. Rental vacancy rates remained high in Melbourne and, to a lesser extent, Sydney, depressing advertised rents there. In other capital cities, vacancy rates were low and advertised rents were increasing at a quicker pace.

The outlook for dwelling investment remained strong. Approvals for detached dwellings and alterations & additions had increased to record high levels in the March quarter, boosting the pipeline of construction activity over 2021. In addition to the support provided by low interest rates, the increase in approvals had been driven by the HomeBuilder program and other state-based grants; commencement of construction on many of the large number of projects being approved under these programs had only recently begun. Some construction firms in the Bank's business liaison program had reported cost pressures and delays to construction timelines owing to difficulties in securing materials and labour.

Members noted that the strong recovery in domestic activity and policy support had lifted the outlook for non-mining business investment, although this had followed a lengthy period in which it had been weak. Strong profitability and a reported increase in capacity utilisation and business confidence were expected to provide further support for machinery & equipment investment in the near term, following a strong response to the tax incentives provided by the Australian Government. Recent indicators, such as building approvals, pointed to a more gradual recovery in private non-residential construction activity. The forecast profile for mining investment had been revised upwards a little, but there were few signs that major mining firms were planning to expand iron ore-related investment in response to higher prices.

Members discussed the continued improvement in labour market conditions. Employment and total hours worked in March were higher than before the pandemic, underemployment had returned to pre-pandemic levels, and the decline in the unemployment rate to 5.6 per cent in March had occurred considerably faster than expected earlier. Employment growth was expected to remain firm in the months ahead, given the solid momentum in activity and buoyant forward indicators of labour demand. Some surveyed firms were reporting a lack of available labour as a constraint on output. While job losses from the end of the JobKeeper program were likely, these were expected to be more than offset by demand for labour elsewhere in the economy.

Further out, the stronger forecast profile for growth in output and employment was expected gradually to reduce spare capacity in the labour market. In the baseline scenario, the unemployment rate was expected to continue to decline to around its pre-pandemic level of 5 per cent by the end of 2021 and to 4½ per cent by mid 2023. This lower forecast unemployment rate was expected to put some modest upward pressure on wages growth over time. Led by private sector wages, growth in the Wage Price Index was expected to pick up to a little under 2 per cent over 2021 and to around 2¼ per cent by mid 2023.

Despite the strong recovery in economic activity, the recent Consumer Price Index (CPI) confirmed that inflation pressures remain subdued in most parts of the Australian economy. The forecast for inflation had been revised upwards slightly, in line with the stronger outlook for activity, but inflation was still expected to increase only gradually. In the baseline scenario, underlying inflation was expected to increase from 1½ per cent over 2021 to close to 2 per cent by mid 2023. Headline inflation was expected to spike above 3 per cent over the year to June 2021, partly as the effect of COVID-19-related one-off price changes dropped out of the calculation, before declining back below 2 per cent over the remainder of the forecast period.

Members noted that the extent of spare capacity in the economy at the end of the forecast period was uncertain, which meant that the gradual increase in inflation could be slower or faster than envisaged in the baseline scenario. Wage and price inflation were at much lower levels than over the preceding decade, and, because of inertia in wage- and price-setting practices, it was possible that price pressures could be slow to build even if spare capacity were absorbed more quickly than expected. Alternatively, higher commodity prices, persistent supply chain bottlenecks and firms' reduced ability to address labour shortages through access to workers from abroad could mean that wages growth and inflation picked up earlier and more rapidly than expected as the economy continued to expand.

Although households had been adjusting well to the tapering of fiscal and other temporary support measures, members concluded their discussion of the domestic economy by considering 2 alternative scenarios based on different assumptions for household consumption.

A stronger economic trajectory than the one envisaged in the baseline scenario was possible if households increased spending by more than expected. This could be in response to stronger wealth effects and a decline in uncertainty, which boosted households' willingness to consume out of earlier savings and recurring labour income. As a result, private investment and employment would be stronger. The unemployment rate would decline at a faster pace and to a lower level, around 3¾ per cent, compared with the baseline. In this upside scenario, inflation would increase to around 2¼ per cent by mid 2023.

Alternatively, members noted that a weaker path for the economy could eventuate if households chose to consume a smaller share of their income and accumulated savings than assumed in the baseline scenario. In this downside scenario, spending would be stimulated by less than implied by historical wealth effects, with households assumed to continue strengthening their balance sheets, including by paying down debt. Subdued consumption and private business investment would contribute to the unemployment rate remaining relatively high in this downside scenario, with inflation remaining around 1½ per cent over much of the forecast period.

International financial markets

Members observed that financial market conditions had been broadly stable over the preceding month. Longer-term sovereign bond yields had settled around pre-pandemic levels in most advanced markets after increasing noticeably earlier in the year in response to the improving economic outlook. Most of the increases in bond yields had reflected increases in expected inflation to levels that were consistent with or below central banks' targets. Members noted that the increase in inflation expectations had been most marked in the United States.

Corporate bond issuance had remained robust in advanced economy markets and spreads on corporate bonds had declined to low levels in expectation that the improved economic outlook would moderate the rise in default rates seen over the preceding year. Equity prices had also increased further in prior months and in most of the major markets were above pre-pandemic levels. Members noted that equity issuance, particularly initial public offerings by so-called ‘blank-cheque’ financing vehicles in the United States (which raise funds to invest in private companies to take public) had eased in recent weeks, having been very strong earlier in the year.

Major central banks had reiterated that their policy settings would remain highly accommodative until sustained progress towards their employment and inflation objectives had been attained. The Bank of Canada had upgraded its economic projections and updated its expectations for the timing of the first increase in its policy rate, which was closely aligned with market expectations that the first increase would occur in the second half of 2022. Market pricing suggested that policy rates were expected to begin to increase in New Zealand in late 2022 or early 2023, and in the United States and United Kingdom in the first half of 2023. The Bank of Canada had also announced a reduction in the pace of its government bond purchases. This change had been anticipated and there had not been a significant market reaction to the announcement.

The US dollar had depreciated as bond markets had stabilised over the prior month to be back around its levels against other major currencies at the start of the year. The Australian dollar had continued to trade in a relatively narrow range, and was slightly above its levels at the start of the year on a trade-weighted basis and against the US dollar.

In emerging market economies (EMEs), financial conditions had generally stabilised in line with developments in the advanced economy markets. Flows into EME bond and equity funds had resumed, following some outflows during the period of heightened market volatility earlier in the year. Financial conditions in China had remained accommodative, although concerns about a large state-owned financial firm had seen spreads widen on bonds issued into offshore markets by Chinese firms.

Domestic financial markets

In the domestic market, the Bank's policy measures had continued to underpin very low interest rates and the provision of credit. The yield on the 3-year Australian Government bond had remained around 10 basis points and no further purchases had been required to support the Bank's yield target over the preceding 2 months. Nevertheless, yields on other 3-year financial instruments had increased since the start of 2021, and were consistent with market participants expecting the cash rate to begin increasing from its current level during 2023.

Yields on longer-dated Australian government bonds had moved roughly in line with US Treasuries over the prior month and the spread between 10-year yields in the respective markets had remained close to zero. The Bank's bond purchase program had continued to run smoothly and in early April the Bank concluded the initial $100 billion of purchases under the program. The second $100 billion of bond purchases was scheduled to be completed in September. Projections suggested the Bank would hold around 30 per cent of outstanding Australian government bonds and 15 per cent of bonds issued by the semi-government authorities by the conclusion of the program in September.

Bank funding costs and lending rates had remained at historic lows. Drawings on the Bank's Term Funding Facility had increased as the 30 June deadline for accessing the 3-year funding program approached. Liaison had indicated that many banks would take up most, if not all, of their remaining allowances. Demand for housing finance had continued to pick up, driven by owner-occupiers, although new lending to investors had also increased. Members noted that there had been a pick-up in issuance of residential mortgage-backed securities by non-banks at favourable spreads, which had been accompanied by an increase in their share of the household lending market. Lending to businesses had also increased a little in preceding months, reflecting a pick-up in lending to large businesses.

Considerations for monetary policy

In considering the policy decision, members observed that the global economy had continued to recover from the pandemic and the outlook was for strong growth in output in 2021 and the following year. Although the pace of COVID-19 vaccinations had been supporting the rebound in the global economy, the recovery remained uneven and some countries were yet to contain the virus. Global goods trade had continued to increase strongly and commodity prices were higher than at the beginning of 2021. Despite the more positive real economic conditions, in many countries wages growth and inflation remained low and below central banks' targets.

In preceding weeks, sovereign bond yields had been steady after rising earlier in the year in response to the positive news on vaccines and the additional sizeable fiscal stimulus in the United States. Inflation expectations had increased from around record lows to be closer to central banks' inflation targets, although central banks in major advanced economies had indicated no intention to dampen monetary stimulus until inflation outcomes were sustainably higher than currently.

The economic recovery in Australia had been stronger than expected and the central forecast for GDP growth had been revised upwards. The recovery had been especially evident in the strong growth in employment, with the unemployment rate expected to continue to decline from its current level of 5.6 per cent.

Despite the strong recovery in economic activity in Australia, wage and price pressures remained subdued. The recent CPI data confirmed that inflation pressures remained low in most parts of the economy. A pick-up in inflation and wages growth was expected, but this was likely to be only gradual and modest despite the lift in the forecast for output growth. Members noted that inflation would rise temporarily above 3 per cent in the June quarter before falling back below the target. Spare capacity in the economy and a strong focus on cost containment by businesses were both expected to contribute to continued subdued wage and price pressures. Members also noted that public sector wage policies were likely to restrain aggregate wage outcomes. It would take some time for spare capacity to be reduced and the labour market to be tight enough to generate wage increases consistent with achieving the inflation target. Moreover, it was likely that wages growth would need to be sustainably above 3 per cent, which was well above its current level.

Members noted that housing markets had strengthened further, with prices continuing to increase in all major markets. Housing credit growth had also strengthened, with strong demand from owner-occupiers, especially first-home buyers. Given the environment of strong demand for housing, rising housing prices and low interest rates, members agreed on the importance of maintaining lending standards and carefully monitoring trends in borrowing.

In discussing specific elements of the current monetary policy settings, members agreed that, at the July 2021 meeting, the Board would consider whether to retain the April 2024 bond as the target bond for the 3-year yield target or to shift to the next maturity, the November 2024 bond. Members agreed that a change to the target of 10 basis points was not warranted. Also at the July meeting, the Board would consider future bond purchases following the completion in September of the second $100 billion of purchases under the government bond purchase program. The Board remained willing to undertake further bond purchases if doing so would assist with progress towards the Bank's goals of full employment and inflation. Future policy decisions would be based on close attention to the flow of economic data and conditions in financial markets in Australia. Members agreed that a return to full employment is a high priority for monetary policy and would assist with achieving the inflation target. Consequently, monetary policy would be likely to need to remain highly accommodative for some time yet.

Members noted that the date for final drawings under the Term Funding Facility is 30 June 2021, that banks had drawn down $100 billion and that a further $100 billion was available. The facility provides funding for 3 years, which means it will continue to support low funding costs in Australia until mid 2024. In an environment where financial markets in Australia are operating well, the Board did not see a case for a further extension of this facility.

Members concluded their discussion by observing that the current package of monetary policy measures had continued to support the economy by encouraging an ample supply of credit to businesses and keeping financing costs very low, thereby strengthening household and business balance sheets. The 3-year government bond yield remained at the Board's target of around 10 basis points and lending rates on outstanding business and housing loans had continued to drift down from already low levels. As well as lowering domestic funding costs, the policy package had contributed to a lower exchange rate than would otherwise have been the case. The Australian dollar had moved within a narrow range since the start of the year, a period in which commodity prices had tended to increase. Together, monetary and fiscal policy had been supporting the recovery in aggregate demand and the pick-up in employment.

The Board remained committed to doing what it reasonably could to support the Australian economy, and would maintain highly supportive monetary conditions until its goals for employment and inflation were achieved. Members affirmed that the cash rate target would be maintained at 10 basis points, and the rate of remuneration on Exchange Settlement balances at zero, for as long as necessary. 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 would need to be materially higher than it is currently. This would require significant gains in employment and a return to a tight labour market. The Board viewed these conditions as unlikely 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 until 30 June 2021 of 0.1 per cent
  • the purchase of an additional $100 billion of government bonds at the same rate of $5 billion per week following completion of the first bond purchase program of $100 billion.