Minutes of the Monetary Policy Meeting of the Reserve Bank Board

Sydney – 3 September 2019

Members Present

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

Others Present

Luci Ellis (Assistant Governor, Economic), Christopher Kent (Assistant Governor, Financial Markets), Alexandra Heath (Head, Economic Analysis Department), David Jacobs (Deputy Head, International Markets and Relations, International Department)

Anthony Dickman (Secretary), Ellis Connolly (Deputy Secretary)

International Economic Conditions

Members commenced their discussion of the global economy by noting that business conditions in the manufacturing sectors in many economies had remained subdued. They discussed the escalation of the US–China trade and technology disputes, which had intensified the downside risks to the global outlook. By contrast, conditions in more domestically focused sectors had generally continued to be resilient, supported by ongoing strength in labour markets. Employment growth had remained robust in the major advanced economies, although it had eased a little in some economies in recent months, and unemployment rates had remained low. Although wages growth had picked up, year-ended inflation had remained below target in the major advanced economies. Members noted that inflation in the United States had increased in recent months.

The main development over the previous month had been the escalation of the US–China trade and technology disputes. The United States had announced higher tariffs on most imports from China, including consumer goods that had not previously been subject to the tariff increases, to take effect over the remainder of 2019. Members noted that recent and prospective increases in tariffs could increase consumer price inflation in the United States by between ¼ and ½ percentage point over the following few years, based on a range of published estimates. In response to the US announcements, China had suspended purchases of US agricultural products and had announced plans to increase tariffs on around one-half of the value of US imports. In value terms, US exports to China had contracted by around 20 per cent over the year to June, while US imports from China had been around 3 per cent lower. Members also noted that some other east Asian economies were benefiting from the diversion of US imports away from China.

More generally, global trade volumes had fallen over the previous year, reflecting both the escalation of trade tensions and slower growth in Chinese domestic demand. Weak external demand had been reflected in slowing growth in global industrial production and below-average conditions in the global manufacturing sector. Recent indicators suggested trade-related activity would remain weak for some time.

Members noted that weak external demand and heightened geopolitical uncertainty had contributed to lower growth in business investment in many economies, including the United States, the euro area and the United Kingdom. These economies had also recorded declines in investment intentions. By contrast, in the United States the household sector had been resilient, but overall GDP growth had slowed in the June quarter. GDP growth had also slowed in most euro area countries in the June quarter; Germany had recorded a small contraction in GDP. By contrast, GDP growth in Japan had been moderate, supported by consumption brought forward ahead of a scheduled increase in the consumption tax in October, as well as ongoing growth in investment, bolstered by the need to address labour shortages.

Recent data suggested that growth in China had eased further. Most indicators of economic activity had slowed in July, including in components being supported by recent policy measures, such as infrastructure investment. The level of steel production had declined slightly. Retail sales growth had resumed its downward trend, after having received a boost from strong growth in car sales in recent months ahead of tighter emission standards coming into effect. In India, recent indicators had also pointed to output growth slowing.

Weak global trade had continued to weigh on growth in east Asia. Trade within the region and with China had contracted further in June. Growth in industrial production and survey measures of manufacturing conditions had remained weak. Political unrest had weighed on economic conditions for businesses and households in Hong Kong, while an ongoing dispute with Japan had disrupted South Korean production of electronics. However, domestic demand elsewhere in the region had held up, supported by government policies in some cases.

Iron ore prices had declined since the previous meeting, but were around 40 per cent higher than a year earlier. Market reports had attributed these declines to a number of factors, including concerns about the outlook for steel demand in China following the escalation of the disputes between the United States and China in early August, lower steel prices and an easing in supply concerns. The prices of coal and rural commodities had been somewhat lower over the prior month, while oil and base metals prices had been little changed, except where there had been disruptions to the supply of specific metals.

Domestic Economic Conditions

The main information on the domestic economy received since the previous meeting had been on the labour market as well as partial indicators of output growth in the June quarter in the lead-up to the publication of the national accounts. Quarterly GDP growth was expected to be around ½ per cent, supported by a strong recovery in resource exports from earlier supply disruptions.

The ABS capital expenditure (Capex) survey suggested that mining investment had grown in the June quarter, driven by an increase in machinery & equipment investment. The Capex survey suggested there had also been an increase in machinery & equipment investment by the non-mining sector in the June quarter, while non-residential construction was expected to have declined. Investment intentions for 2019/20 had been positive for the mining sector, but had been modestly lower for the non-mining sector. Members noted that the outlook for the construction sector was particularly weak.

Members recognised that, overall, Australian businesses had not appeared to have been affected by the weak trade environment to the same extent as businesses in other advanced economies. This was partly because Australia's exports are more exposed to Chinese domestic demand and less integrated in global supply chains.

Consumption growth was expected to have remained low in the June quarter. Retail sales volumes had been weak in the June quarter and the value of retail sales had fallen in July. The low- and middle-income tax offset (LMITO) was expected to boost household income, and thus support consumption growth, in coming quarters. However, the Bank's liaison with retailers suggested that this had yet to lift spending noticeably. Members noted that even if the LMITO was used to pay off debts, this would still bring forward the point at which households could increase their spending.

Established housing market conditions had steadied in recent months. Reported housing prices in Sydney and Melbourne had risen noticeably in August and auction clearance rates had increased further, although volumes had remained low. Housing market conditions had been subdued elsewhere, although there were signs of housing prices stabilising in Brisbane. Housing turnover had remained low. Consequently, spending on home furnishings and other housing-related items was not expected to contribute to consumption growth in the near term. Indicators suggested that dwelling investment had declined further in the June quarter and indicators of earlier stages of residential building activity had remained weak; building approvals had declined further in June and other measures of early-stage activity and buyer interest had remained at low levels.

Employment growth had remained strong in July, but the unemployment rate had remained at 5.2 per cent. Employment growth over preceding months had been broadly based across states and had predominantly been in full-time work. Strong employment growth had been accompanied by a further increase in the participation rate, which had recorded another all-time high. Members noted that the increase in participation had been particularly notable for New South Wales. Forward-looking indicators had continued to suggest that employment growth would moderate over the following six months. Information from liaison suggested employment intentions had remained weak in the residential construction sector but positive among services firms.

Wages growth had remained low and the upward trend in wages growth appeared to have stalled. The wage price index had increased by 2.3 per cent over the year to the June quarter. Private sector wages growth had been unchanged in the quarter, while public sector wages growth had been a little higher. Most of this increase had been the result of a one-off adjustment to equalise the wages of nurses and midwives in Victoria with those in New South Wales.

Financial Markets

Members commenced their discussion of financial markets by noting that government bond yields had declined and were at record lows in many countries, including Australia. Volatility and risk premiums in global financial markets had increased in August, following the escalation of the disputes between the United States and China and disappointing economic data releases in Germany and China. The persistent downside risks to the global economy, combined with subdued inflation, had led a number of central banks to reduce interest rates in recent months and further monetary easing was widely expected.

In the United States, market pricing implied that the federal funds rate was expected to decline by around 100 basis points over the following year. Market participants also expected the European Central Bank to provide additional monetary stimulus in the near term, including renewed asset purchases and a reduction in its policy rate further into negative territory. Central banks in a number of other advanced economies had also eased policy, or signalled that they were prepared to do so, in response to subdued inflation, moderating activity and downside risks to growth. For similar reasons, central banks in emerging markets had also been easing policy over recent months and had signalled the possibility of further easing.

Financial conditions for corporations remained accommodative globally. This reflected market participants' ongoing expectations that central banks were likely to deliver further monetary easing to sustain the global economic expansion. Corporate bond spreads had increased a little in August, but remained low. Equity prices had declined somewhat, reflecting concerns about the outlook for growth, but remained substantially higher over the year to date. In Australia, equity prices were 5 per cent below the record high reached in late July. Australian listed companies' profits had risen, driven by the resources sector. At the aggregate level, companies had increased their dividends over the preceding year, although this reflected higher dividends in the resources sector in particular.

In China, the authorities had intervened to support three small banks in preceding months, and the People's Bank of China had continued to maintain a high level of liquidity in the banking system. While funding conditions for smaller banks had tightened this year, money market rates and corporate and government bond yields in China had generally remained low and market participants were expecting further easing in monetary policy in the period ahead.

In foreign exchange markets, the Chinese renminbi had depreciated against the US dollar in August following the escalation of the US–China disputes, while the Japanese yen had appreciated over the month. The Australian dollar had been little changed at around its lowest level in some years.

In Australia, borrowing rates for both businesses and households were at historically low levels, as were banks' funding costs. Variable mortgage rates had declined broadly in line with the reductions in the cash rate in June and July. Fixed mortgage rates had also declined substantially over the preceding six months. Financial market pricing continued to imply that the cash rate was expected to be lowered by another 25 basis points by November 2019, with a further cut expected in the early part of 2020.

Growth in housing credit had been little changed over the year to July, having declined steadily through 2018. Credit to investors had declined slightly over previous months. Meanwhile, housing loan approvals to both owner-occupiers and investors had increased for the second consecutive month in July. This pick-up in loan approvals had followed a significant decline over the preceding two years and was consistent with the signs of stabilisation in the established housing market. Borrowing by large businesses had continued to grow at a relatively strong pace. In contrast, small businesses' access to finance remained difficult, and had become more difficult over the preceding year as banks had tightened their lending practices. While new sources of non-traditional finance had been growing, including equity funding from family offices and private equity funds, they remained a small share of business funding.

Members had a detailed discussion of the ways in which financial conditions abroad affect Australia. They discussed how shifts in world interest rates and global risk premiums flow through to domestic financial conditions. While Australia's floating exchange rate means that monetary policy can be set largely according to domestic considerations, members discussed the large shifts in savings/investment decisions globally, which were affecting the level of interest rates everywhere, including in Australia. Members also noted the critical role that the exchange rate had played over many years as a shock absorber for the Australian economy. One important factor here has been that Australian entities raising offshore funding are able to do so in Australian dollars, either directly or via hedging markets.

Considerations for Monetary Policy

Turning to the policy decision, members observed that the news on the international economy had confirmed that the risks to the global growth outlook were to the downside. The trade disputes between the United States and China had escalated and growth in China had continued to slow. There had been further indications that these developments were affecting trade and investment decisions in overseas economies, although businesses had continued hiring and labour market conditions had remained tight.

Against this backdrop and with ongoing low inflation, a number of central banks had reduced interest rates over recent months and further monetary easing was widely expected. Long-term government bond yields had declined and were at record lows in many countries, including Australia. Borrowing rates for both businesses and households were also at historically low levels, and the Australian dollar exchange rate was at the lowest level that it had been in recent times.

Domestically, members considered a number of developments over preceding months that had a bearing on the monetary policy decision. First, employment had continued to grow strongly and the participation rate was at a record high. However, the unemployment rate had remained steady at around 5.2 per cent over recent months. At the same time, wages growth had remained low and there were few indications that wage pressures were building. Members noted that a further gradual lift in wages growth would be a welcome development. Taken together, recent outcomes suggested that spare capacity remained in the labour market and that the Australian economy could sustain lower rates of unemployment and underemployment.

Second, there had been further signs of a turnaround in established housing markets, especially in Sydney and Melbourne, although housing turnover had remained low. Housing credit growth had remained subdued, although mortgage rates were at record low levels and there was strong competition for borrowers of high credit quality. Data on residential building approvals and information from the Bank's liaison program suggested that there was likely to be further weakness in dwelling investment in the near term; members recognised that this could sow the seeds of an upswing in the housing price cycle at some point, particularly given the lengthy stages in the construction of higher-density residential housing. Demand for credit by investors continued to be subdued and credit conditions, especially for small and medium-sized businesses, remained tight.

Finally, based on partial indicators, GDP growth in the June quarter was expected to have been around ½ per cent. The largest contributions to growth were expected to have been from exports and public demand. Private final demand, which includes consumption, business investment and dwelling investment, was expected to have been weak.

Looking forward, the outlook for output growth was being supported by the low level of interest rates, recent tax cuts, signs of stabilisation in some established housing markets and a brighter outlook for the resources sector. A key uncertainty continued to be the outlook for consumption growth, which was expected to increase over time, supported by a gradual pick-up in growth in household disposable income and improvements in conditions in the housing market. Inflation pressures remained subdued, but inflation was expected to increase gradually to be a little above 2 per cent over 2021 as output growth picked up and the labour market tightened.

Based on the information available, members judged that it was reasonable to expect that an extended period of low interest rates would be required in Australia to make sustained progress towards full employment and achieve more assured progress towards the inflation target. Members would assess developments in both the international and domestic economies, including labour market conditions, and would ease monetary policy further if needed to support sustainable growth in the economy and the achievement of the inflation target over time.

The Decision

The Board decided to leave the cash rate unchanged at 1.00 per cent.