Minutes of the Monetary Policy Meeting of the Reserve Bank Board

Hybrid – 7 December 2021

Members present

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

Members granted leave of absence to Carolyn Hewson AO in accordance with section 18A of the Reserve Bank Act 1959.

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 economy had continued to recover, supported by expansionary monetary and fiscal policy settings and increased vaccination coverage. Conditions were in place for a sustained expansion, although the new Omicron variant of COVID-19 posed additional uncertainty for the near-term outlook. The recent increase in cases of the Delta variant in some countries had led to a moderate rise in hospital admissions and a tightening of restrictions on activity. So far, however, the economic effects had generally been limited. In the United States, another large fiscal support package had been passed by Congress. In China, economic activity stabilised early in the December quarter following an earlier period of regulatory tightening. Domestic demand elsewhere in Asia had started to rebound after COVID-19 outbreaks and associated lockdowns in the June and September quarters had restrained activity.

Members noted that the recovery in household consumption had been strong in advanced economies. Consumption of services had rebounded, supported by an easing in restrictions following high vaccination coverage, and spending on goods remained at high levels. Growing COVID-19 case numbers had prompted some European countries to reimpose restrictions on mobility in recent weeks, but across the continent as a whole the effect on population mobility and the consumption of services had so far been limited. In east Asia, measures of domestic mobility had returned to pre-pandemic levels as case numbers declined and restrictions were eased; this was expected to support a recovery in the consumption of services.

Ongoing strength in the global demand for goods continued to exert pressure on supply chains. Capacity constraints in global goods markets had been more persistent than initially envisaged and bottlenecks were holding back sales of some goods, especially motor vehicles. Alongside a run-up in energy prices, these capacity constraints had contributed to the upswing in inflation in major advanced economies over recent months. Nevertheless, some timely indicators of price pressures in global supply chains, including shipping costs and prices for key intermediate inputs, had shown signs of stabilising of late.

Members noted that core inflation had increased to its fastest pace in many years in North America, the euro area and the United Kingdom. Together with a sharp increase in goods and energy price inflation, services price inflation had increased to a little above pre-pandemic rates in major advanced economies; a rise in housing-related costs had contributed to this. In contrast to the pick-up in inflation in major advanced economies, goods price inflation remained low in high-income east Asian economies, where fiscal support had been targeted more at firms than households.

Members discussed the continuing improvement in labour market conditions in advanced economies. Employment growth remained strong and unemployment rates had continued to decline. However, participation rates and wages growth continued to vary widely across countries. In economies where participation had been slow to recover and case numbers during the pandemic had been high, such as in the United States and the United Kingdom, nominal wages growth was running at its fastest pace in some years. However, similar to the Australian experience, nominal wages growth had remained subdued in the euro area and in Canada.

Domestic economic developments

Turning to the domestic economy, members noted that activity was rebounding strongly from the setback in the September quarter induced by the Delta variant of COVID-19 and associated lockdowns. Timely indicators suggested that economic activity, particularly household consumption, was recovering strongly in parts of the country where restrictions had eased over the preceding two months or so. In states that had avoided extended lockdowns, activity had continued to expand at a solid pace. Business sentiment had also improved. Non-mining firms had upgraded their investment intentions over prior months, and the Bank's liaison program suggested that firms' investment intentions were at, or above, average levels for most industries. International border restrictions had been eased for vaccinated Australians and for some inbound travel, but the Omicron variant had led to some delays in a further reopening of the international border.

Members noted that the contraction in economic activity in the September quarter had been significant, although the decline in domestic demand had been smaller than expected. As in earlier lockdowns, household consumption accounted for most of the decline in GDP because spending opportunities had been reduced in large parts of the country; in states that were unaffected by extended lockdowns, consumption had increased. Spending on services remained well below pre-pandemic levels, suggesting there remained considerable scope for the consumption of services to increase in the period ahead. Household income in the September quarter had been boosted by a substantial increase in social assistance (including COVID-19 disaster payments) and higher labour income in states that were largely free of lockdowns. This, combined with reduced opportunities for consumption, saw the household saving ratio increase sharply to a historically high level of around 20 per cent. This added further to the large amount of savings accumulated since the onset of the pandemic.

Private and public investment activity had been surprisingly resilient in the September quarter, particularly in Victoria. Restrictions on construction activity had been less disruptive than envisaged. Dwelling investment had been steady in the quarter and non-mining non-residential construction had increased. Members noted that the outlook for construction activity was strong, with the value of work in the pipeline at a high level for both residential and non-residential building activity; in the case of residential construction, the outlook for detached housing and alterations and additions remained positive, even after the Homebuilder application period ended earlier in the year. Public investment and consumption had risen further in the September quarter; very strong growth in public consumption had been supported by pandemic-related spending.

In the established housing market, conditions had been somewhat mixed. Growth in housing prices had eased a little in Sydney and Melbourne, alongside an increase in new listings to above-average levels. Elsewhere, housing prices had been largely unchanged in Perth over the preceding two months, while growth in housing prices had remained strong in Brisbane, Adelaide and regional Australia. Housing turnover had remained high in most parts of the country. Advertised rents had continued to increase in the capital cities and regional Australia, but at a slightly slower pace than the preceding six months. Rental vacancy rates had declined in Sydney and Melbourne, but were still above their longer-run averages, while the vacancy rates in other cities and some regional areas had remained low.

Turning to the labour market, members noted that hours worked had stabilised in October and forward-looking indicators suggested employment would rebound strongly in the period ahead. While measured employment had declined further and the unemployment rate had increased in October, the labour force survey for that month had been conducted prior to the lifting of lockdowns in New South Wales and Victoria. Leading indicators of labour demand pointed to a strong recovery in labour market conditions in coming months, with job advertisements rising to a historically high level. Firms in the Bank's liaison program continued to report difficulties finding workers for certain roles, including in the construction, professional services, agricultural and hospitality sectors.

Members discussed the increase in job mobility over prior months following a sharp decline at the onset of the pandemic. Part of this increase reflected workers catching up on planned job changes that had been put on hold, as well as more workers feeling encouraged by strong labour market conditions to change jobs. It also reflected labour market adjustments to the uneven effects of the pandemic on labour demand. High-skilled jobs in professional and other business services sectors had experienced particularly sharp increases in job mobility, while job mobility rates in other sectors had remained in line with historical averages. The higher rates of voluntary job turnover in some sectors, especially in a tight labour market, could in time lead employers to offer higher wages to retain their workers. However, members noted that the experience in Australia had been different from that in the United States, where job resignation rates were at historically high levels and were coming at a time when labour force participation and employment remained considerably below pre-pandemic levels.

Members noted that private sector wages growth had increased in the September quarter, but only to around its pre-pandemic level. Only professional services had recorded wages growth in excess of 3 per cent. Public sector wages growth remained subdued. Wages growth was increasing more quickly for workers on individual agreements compared with other pay-setting arrangements. Information from the Bank's liaison program suggested that firms were generally expecting wage increases over the coming year of around 2½ per cent, broadly in line with surveys of unions' expectations; the distribution of firms' expectations for wages growth was also similar to the pre-pandemic pattern.

Members concluded their discussion of the domestic economy by noting that the staged reopening of the international border would support trade in services in the period ahead. The outlook for travel and education exports had improved somewhat on account of the international border reopening earlier than previously assumed. Education exports were expected to contribute to GDP growth over the coming years. However, the near-term outlook for travel services had been clouded by the emergence of the Omicron variant of COVID-19, as there was some risk that it would give rise to renewed restrictions or travel hesitancy.

International financial markets

Members commenced their discussion of international financial markets by noting that bond yields and equity prices had declined globally and become more volatile, as the identification of the Omicron variant of COVID-19 saw some renewed restrictions and increased uncertainty about the global economic outlook. However, inflation pressures and expectations about future central bank policy actions in many advanced economies meant that sovereign bond yields remained well above their levels of a few months earlier.

Some central banks – including the Reserve Bank of New Zealand, the Bank of Korea and Norges Bank – had increased their policy rates. Others, including the Bank of England and the Bank of Canada, were expected to withdraw some monetary stimulus over the coming year, as their labour markets tightened and their economic recoveries continued. Members observed that the US Federal Reserve had begun to taper asset purchases as announced in November and there was a possibility that net purchases would cease sooner than previously planned. This would be considered at the next meeting of the Federal Open Market Committee in December. In contrast, the European Central Bank was expected to continue asset purchases for some time and had emphasised that it was very unlikely to increase its policy rate in 2022 given muted wage pressures.

Corporate financing conditions remained favourable internationally and in Australia, although credit spreads had risen from their recent lows. Prior to the recent declines, equity prices had risen, supported by strong profit results related to the recovery in demand.

The US dollar had appreciated against a broad range of currencies as short-term US bond yields had risen relative to those of most other advanced economies. Members noted that this had contributed to a depreciation of the Australian dollar, which had declined to around its lowest level in 2021 in US dollar and TWI terms, notwithstanding a rise in commodity prices and interest rates in Australia relative to other large advanced economies over the year to date.

In China, some property developers had remained under stress. Members noted that spillovers to wider financial conditions had been limited and actions had been taken to manage the risks of disorderly defaults among stressed property developers. The People's Bank of China had reduced required reserve ratios by 50 basis points to provide additional modest support to growth.

Domestic financial markets

In Australia, expectations for the cash rate implied by market prices had been little changed over the preceding month after increasing in late October following the release of the September quarter Consumer Price Index (CPI) and market participants' increased expectations of the removal of the yield target. Current market pricing implied the cash rate was expected to be close to 1 per cent by the end of 2022, before rising to a little below 1¾ per cent by the end of 2023.

Members observed that, after rising sharply in October, yields had declined earlier in November after the Board's decision to discontinue the yield target and communication by the Bank that an increase in the cash rate in 2022 was not warranted on the basis of the Bank's central scenario for the inflation outlook. In the second half of the month, yields on Australian Government bonds had declined further alongside those internationally. The spread to US treasuries had declined over the preceding month from around 50 basis points at the end of October to around 20 basis points.

Members noted that overall funding costs for banks remained historically low, despite yields on bank bonds having risen in recent months. Much of banks' funding costs are ultimately linked to the three-month bank bill swap rate, which remained very low and close to the cash rate. The rise in longer-term swap rates in recent months had flowed through to higher fixed rates for new housing loans, but at the same time banks had offered increased discounts on some variable rate housing loans.

Overall, the monthly pace of credit growth had eased a little in prior months. Commitments for new business and housing loans remained at high levels, although they had declined for owner-occupiers, including first home buyers. The higher serviceability assessment rate for new housing loans, which was announced by the Australian Prudential Regulation Authority in early October, had been scheduled to be used by banks since early November.

Considerations for monetary policy

In considering the policy decision, members observed that the Australian economy was rapidly recovering after the interruption to growth caused by the outbreak of the Delta variant of COVID-19. High rates of vaccination and substantial policy support continued to underpin the recovery. The emergence of the Omicron variant was a new source of uncertainty, but it was not expected to derail the recovery.

In the domestic economy, hours worked had stabilised and forward-looking indicators of labour demand were consistent with strong employment growth over coming months. The unemployment rate was expected to trend lower to be around 4 per cent by the end of 2023. Wages growth had picked up, but only to the low rates prevailing prior to the onset of the pandemic. A further gradual pick-up in wages growth was expected as the labour market tightens. Members noted the uncertainty about the behaviour of wages as the unemployment rate declines to historically low levels.

Members observed that inflation had increased, but remained low in underlying terms. Underlying inflation had picked up to a little above 2 per cent for the first time in six years. Members noted that inflation pressures in Australia were lower than in many other countries, owing to a range of factors, including differences in energy markets and modest wages growth in Australia. A further, but only gradual, pick-up in underlying inflation was expected. The central forecast was for underlying inflation to reach 2½ per cent over 2023.

Members noted that financial conditions in Australia were still highly accommodative, with most lending rates at record lows. Globally, bond yields had declined over the preceding month because of concerns about the Omicron variant of COVID-19. The Australian dollar exchange rate had depreciated and was around its lows of the preceding year.

Housing prices had risen strongly over the prior year, although the rate of increase had eased. Housing credit growth had stopped increasing, and the value of housing loan commitments had recently declined, but it remained at a high level. Members continued to emphasise the importance of maintaining lending standards at a time of historically low interest rates.

The Board had previously announced that it would make a decision about the bond purchase program in February 2022. Members discussed the bond purchase program ahead of that decision. They noted that the program was providing ongoing support to the economy, by lowering funding costs, supporting asset values and leading to a lower exchange rate than would otherwise have been the case. At the time of the meeting, the Bank held 34 per cent of outstanding Australian Government Securities and 17 per cent of outstanding securities issued by the states and territories. Members noted that the stimulus associated with the stock of bonds already purchased would provide significant support to the economy for some time.

Members reaffirmed that the decision in February 2022 would depend on the criteria the Board had previously agreed to – namely, progress towards the Board's goals for employment and inflation, the actions of other central banks and the functioning of the Australian bond market. Members noted that more information on these criteria would be available by the time of the February meeting. This included information on the December quarter CPI and how the labour market had performed over December and January. The risk to the recovery posed by the Omicron variant would also be more apparent by that time.

Three possible options for the bond purchase program were discussed. The first option was to reduce the pace of purchases from mid February with an expectation of a likely end point in May 2022. The second option was to reduce the pace of purchases and review it again in May 2022. The third option was to cease purchases altogether in mid February. These options reflected the expectation that the economy would continue to bounce back from the disruption of the outbreak of the Delta variant.

The first option (i.e. to reduce the pace of purchases from mid February with an expectation of a likely end point in May 2022) was consistent with the Bank's November forecasts for employment and inflation. If better-than-expected progress towards the Board's goals was made, then the third option (i.e. to cease bond purchases in mid February) would become more appropriate. Alternatively, if progress was slower than expected, or if the outlook became more uncertain, the case for the second option (i.e. to reduce the pace of purchases and then review it again in May 2022) would be stronger. Members agreed these options constituted the most plausible alternatives. If there were another serious economic setback, a different set of options would need to be considered.

Turning to the decision for the cash rate, the Board remained committed to maintaining highly supportive monetary conditions to achieve its objectives of a return to full employment and inflation consistent with the target. As previously determined, the Board will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range. This will require the labour market to be tight enough to generate wages growth that is materially higher than it is currently. This is likely to take some time and the Board is prepared to be patient.

The decision

The Board decided upon the following policy settings:

• maintain the cash rate target at 10 basis points and the interest rate on Exchange Settlement balances at zero per cent
• continue to purchase government securities at the rate of $4 billion a week until at least mid February 2022.