Minutes of the Monetary Policy Meeting of the Reserve Bank Board

Hybrid – 5 December 2023

Members participating

Michele Bullock (Governor and Chair), Ian Harper AO, Carolyn Hewson AO, Steven Kennedy PSM, Iain Ross AO, Elana Rubin AM, Carol Schwartz AO, Alison Watkins AM

Others participating

Christopher Kent (Assistant Governor, Financial Markets), Marion Kohler (Acting Assistant Governor, Economic), Carl Schwartz (Acting Head, Domestic Markets Department)

Anthony Dickman (Secretary), David Norman (Deputy Secretary)

Penelope Smith (Head, International Department), Tom Rosewall (Acting Head, Economic Analysis Department)

International economic developments

Members commenced their discussion of international economic developments by noting that the information on global inflation had been a little more encouraging over the prior month. Headline inflation rates had declined, driven by a fall in oil prices, while core inflation had continued to ease. Goods prices had declined in some countries in preceding months. However, inflation in the services sector had declined only gradually, reflecting still-tight labour markets, and housing inflation remained strong in a number of countries. Central banks generally expected inflation to return to their targets in late 2024 or 2025.

Members observed that output growth in several advanced economies had slowed noticeably in response to tighter monetary policy and cost-of-living pressures, particularly in Europe. In the United States, output growth had held up better than expected, helped by resilient consumption. Labour markets remained tight, but conditions had clearly eased in response to the slowing in economic activity. Job vacancies had fallen and unemployment rates, while still very low, had increased over preceding months, including in the United States. The pace of wages growth remained above levels considered consistent with central banks’ inflation targets for some economies, but they had generally moderated in response to the gradual easing in labour market conditions and inflation. As a result, core inflation was expected to continue to moderate.

Turning to developments in China, members observed that the latest indicators of activity had generally been positive, and growth in retail sales and industrial production in October had remained strong. Activity had been supported by the continued recovery in services consumption after the pandemic, along with a range of supportive fiscal policy measures. There had, however, been little sign of improvement in the property sector. Real estate investment had continued to decline because of weak demand and liquidity constraints facing property developers.

Nonetheless, the continued positive information about the Chinese economy outside the property sector had supported iron ore prices, which had increased a little over the prior month and remained at high levels. Coking coal prices had fallen as supply disruptions in Australia had been resolved. Oil and gas prices had declined further over the prior month, as demand had eased in line with slower global growth and amid signs that the Hamas–Israel conflict seemed not to be spreading more widely across the region. Oil prices were around 15 per cent lower than their recent peak in late September.

Domestic economic conditions

Turning to the domestic economy, members observed that inflation had continued to moderate. The monthly CPI indicator for October showed that annual inflation had eased, with declines in the prices of petrol and holiday travel. Inflation excluding volatile items had also eased, largely reflecting the flow-through of declines in global goods price inflation. Rents had declined in October, but this owed entirely to an increase in Commonwealth Rent Assistance, which offset pressure from very tight rental markets in the capital cities. Tight rental markets were likely to be an ongoing source of inflationary pressure for some time. There had been little new information on inflation in other parts of the services sector. Firms in the Bank’s liaison program expected price increases to moderate over the coming year, due to subdued demand and stronger competition among retailers, though many firms had also reported persistent cost pressures. Members noted some measures of inflation expectations had moved a little higher over preceding months but generally remained consistent with the inflation target.

Wages growth had picked up significantly over the preceding year or so. The Wage Price Index had recorded its highest quarterly growth rate since the series commenced in the late 1990s, reflecting the implementation of the Fair Work Commission’s decision to significantly increase minimum and award wages. However, on the evidence available, spillovers to non-award wages did not appear to be larger than usual. Year-ended growth in wages was a little stronger than had been expected but the most recent forecasts had wages growth peaking at around 4 per cent by the end of the year. The wages growth outcome for the September quarter was still consistent with these forecasts, but members noted that the balance of risks had shifted a little to the upside. Conversely, there was some evidence of slowing in wages growth in those parts of the labour market where conditions had eased. In liaison, firms had reported that they generally expect wages growth to ease over the year ahead.

Members observed that labour market conditions remained tight, but less so than earlier in the year, as the demand for labour had adjusted to slower economic growth and labour supply had increased. Employment growth had eased to be a little below the rate of growth in the working-age population over the preceding few months, with the unemployment rate drifting up to 3.7 per cent. Members noted that the shifting composition of employment growth towards more part-time jobs and a decline in average hours worked over preceding months were consistent with hours worked being a key margin of adjustment to slower growth in demand. Forward-looking indicators, such as hiring intentions reported in business surveys and information from the Bank’s liaison, pointed to a further easing in the demand for labour in coming months.

Output growth in Australia had slowed over the prior year to a rate below trend. The national accounts, which were scheduled to be released the day after the meeting, were expected to show that GDP growth had remained at a below-trend rate in the September quarter. Members discussed the implications for productivity of below-trend growth in economic activity and potential explanations for this outcome. While growth in household consumption had been weak, and was negative in per capita terms, overall demand had been supported by strong business investment and public demand.

Members noted that growth in household consumption was expected to have remained subdued in the September quarter, as higher interest rates and cost-of-living pressures weighed on real household disposable incomes and household spending. Timely indicators suggested that growth in consumer spending had also remained subdued into the December quarter. The increased importance of the November ‘Black Friday’ sales had distorted usual seasonal spending patterns and would make it difficult to obtain a clear reading of the underlying momentum in retail spending. Housing prices had increased further in November and had more than fully recovered their earlier declines. If sustained, higher household wealth would support consumer spending in the period ahead.

Despite slow growth in consumption, survey measures of business conditions had remained steady over prior months and were generally around average levels. The level of capacity utilisation had trended down over the prior year but remained high. Members noted that shortages of labour and materials remained a challenge in parts of the construction sector. Firms in the liaison program reported that investment intentions remain positive, reflecting solid cashflows and a large pipeline of construction and other projects, which was broadly in line with the results of the most recent ABS Capital Expenditure Survey.

International financial markets

Most advanced economy central banks had left policy rates unchanged since September, with most judging financial conditions to be restrictive. Central banks had continued to emphasise that policy rates may still need to rise further, but most noted that the risks to the outlook had become more balanced as inflation eased and labour market conditions became less tight. Market participants’ expectations for policy rates in many advanced economies had been revised lower over the preceding months, with reductions in policy rates priced in by the middle of 2024. However, central banks had emphasised that it was too early to consider the timing of rate reductions.

Government bond yields in advanced economies had declined since the previous meeting, reversing most of the substantial increase over preceding months. The decline in bond yields had resulted from lower real yields, which reflected changing market expectations for policy rates as well as a decline in market-implied inflation expectations. Estimated term premia for sovereign bonds had also declined.

Conditions in private funding markets had loosened a little since the previous meeting. Equity prices had risen strongly as longer term interest rates fell and investors gained confidence that inflation could be returned to central banks’ targets without significant declines in corporate profits, economic activity or employment. Corporate bond yields had declined alongside the fall in government bond yields and a narrowing of credit spreads.

In China, government bond yields had increased slightly alongside better-than-expected economic data and the announcement of further government bond issuance to support investment. Equity prices in China were little changed. Prices of securities issued by property developers remained at severely distressed levels, but had been supported in November by reports that authorities had established a list of developers eligible for additional funding.

The Australian dollar had appreciated by around 2 per cent against the US dollar and around 1 per cent on a trade-weighted basis since the previous meeting. Members observed that the trade-weighted Australian dollar was trading near early-2022 levels.

Domestic financial markets

Members noted that financial conditions in Australia were restrictive. Total household debt payments as a share of disposable income had increased significantly during the tightening phase. Although scheduled mortgage payments had increased to an all-time high of 10 per cent in October, estimated payments for personal credit were low relative to history because households’ use of personal credit had declined significantly since 2008. As a result, total household debt payments remained below their estimated historical peak. Scheduled mortgage payments will continue to rise as borrowers with expiring fixed-rate loans roll off onto higher mortgage rates and lenders pass on the cash rate increase in November to lending rates.

New housing loan commitments had increased further, driven largely by investors and first home buyers. Commitments were 17 per cent above the February 2023 trough, though they were still almost 25 per cent below their peak in January 2022 and at low levels as a share of housing credit. Total extra payments into borrowers’ mortgage offset and redraw accounts were still positive but were running lower in 2023 than the pre-pandemic average. This was consistent with pressures on disposable incomes from increases in interest rates and the broader rise in the cost of living.

Market participants’ expectations for the path of the cash rate, as implied by market pricing, were a little lower than just prior to the November meeting. Markets were pricing in a 40 per cent chance of a further increase in the cash rate at future meetings. Markets were then pricing in some chance of a reduction in the cash rate by late 2024. This was broadly consistent with the views of market economists, most of whom expected no further rate increases and that the first reductions in the cash rate would be later in 2024.

Members discussed a paper that reviewed the Bank’s approach to reducing its holdings of government bonds that had been purchased during the pandemic to support markets and provide economic stimulus. The current approach – endorsed by the Board in May – was to hold these bonds until maturity rather than selling them prior to maturity. This approach recognised, among other considerations, that the Bank’s balance sheet was already set to decline rapidly as loans under the Term Funding Facility matured.

Members decided that the approach of holding the bonds to maturity remained appropriate but agreed to keep this under active consideration, including because of the Bank’s exposure to interest rate risk and given the relatively gradual decline in the Bank’s portfolio of bonds compared with some other advanced economy central banks. The initial tranche of Term Funding Facility maturities in September had passed smoothly, with the larger remaining tranche of maturities to occur through to mid-2024. These flows would continue to provide information on how financial markets respond as the Bank’s balance sheet declines. Members discussed the importance of considering the decline in the Bank’s balance sheet in the context of the broader operational framework for implementing monetary policy, given that it will affect the size and composition of the balance sheet over the longer term.

Members discussed whether any decision to sell some of the Bank’s holdings of Australian Government securities would best be implemented by selling to the market or, in the case of mutual agreement, to the Australian Office of Financial Management (AOFM). While selling directly to the AOFM would have several practical benefits, either approach would involve working closely with the AOFM to avoid market disruption.

Considerations for monetary policy

Turning to the policy decision, members noted that the limited economic data received over the prior month had been broadly in line with expectations. Inflation had continued to decline but remained high. Wages growth had reached 4 per cent a little sooner than had been expected but the staff judged that wages growth was unlikely to rise much further. Output growth had continued below trend and the labour market was tight but easing gradually. Members agreed that financial stability considerations were not a constraint on monetary policy at the current meeting.

Members noted that market expectations for policy rates in other countries had eased significantly over the prior month, while being little changed for Australia. Longer term bond yields had declined notably, perhaps signalling that markets were more confident that central banks would be able to reduce inflation back to their targets in a reasonable timeframe with current policy settings. Members also noted that, in Australia, households’ required interest payments as a share of disposable income were much higher than in recent years but still below the level recorded in 2008.

In light of these observations, members considered whether to raise the cash rate target by a further 25 basis points or to hold the cash rate target steady.

The case to raise the cash rate target by a further 25 basis points was centred on the observations that inflation was expected to remain above target for a prolonged period and that there were risks this period could be extended. Members noted that inflation was increasingly being driven by domestic demand. They also observed that underlying inflation was higher in Australia than in several other countries. Furthermore, domestic demand was judged still to be running above the level consistent with the inflation target and growth could be supported in the year ahead by a recovery in real household disposable income as inflation declined. Members noted that the staff’s most recent forecasts, which were predicated on a lift in productivity growth, would see inflation return to the top of the target band by the end of 2025, rather than the midpoint of the band.

The case to hold the cash rate target constant reflected the view that the data over the prior month did not warrant a material revision to the outlook and that there is the possibility of a larger rise in the unemployment rate than anticipated. Members observed that monetary policy was working to bring aggregate demand and supply into closer alignment. They noted that the risk that it takes longer than expected to return inflation to target was balanced by the risk that aggregate demand slows more quickly than anticipated. Members acknowledged that consumption growth had been quite weak, as many households are experiencing a painful squeeze on their finances, with inflation and higher interest rates weighing on real disposable incomes. Members also noted that the pace of disinflation in some other countries over recent months had accelerated. If emulated in Australia, this would be helpful in bringing inflation back to target.

After weighing up these two options, members agreed that the case to leave the cash rate target unchanged at this meeting was the stronger one. Members agreed there was sufficient value in waiting for further data to assess how the balance of risks was evolving and how best to balance these risks when setting policy. They noted that there had been encouraging signs of progress towards the Board’s objectives and that this needed to continue. Members also discussed the importance of preventing inflation expectations from drifting away from the inflation target and committed to monitoring this closely. At the time of the meeting, they agreed that inflation expectations remained consistent with the inflation target.

Members agreed that whether further tightening of monetary policy is required to ensure that inflation returns to target in a reasonable timeframe will depend on how the incoming data alter the economic outlook and the evolving assessment of risks. In making its decisions, the Board will continue to pay close attention to developments in the global economy, trends in domestic demand, and the outlook for inflation and the labour market. The Board remains resolute in its determination to return inflation to target and will do what is necessary to achieve that outcome.

The decision

The Board decided to leave the cash rate target unchanged at 4.35 per cent, and the interest rate on Exchange Settlement balances at 4.25 per cent.