Minutes of the Monetary Policy Meeting of the Reserve Bank Board - RBA
Reserve_Bank_of_Australia, Members

Minutes of the Monetary Policy Meeting of the Reserve Bank Board – RBA

July 22, 2020

Members Participating

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

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)

International Economic Developments

Members commenced their discussion of the global economy by noting that, after a severe contraction in activity, conditions had started to improve following the easing of restrictions imposed in response to the COVID-19 pandemic. However, the number of new COVID-19 cases was rising rapidly in some countries, notably the United States and some emerging market economies. Restrictions had been eased in some countries despite new COVID-19 cases increasing or remaining at high levels. Given these developments, risks to the outlook for the world economy had increased recently despite the economic data having been on an improving path over the preceding couple of months as restrictions had been eased. Members noted that the sustainability of the economic recovery would depend in large part on health outcomes and ongoing policy support.

GDP for the March quarter had contracted sharply in a number of countries. The severity of the contraction reflected the timing of the lockdown in each country, its intensity and the types of industries and activities that had been locked down. The decline in activity in the services sector had been particularly pronounced across countries.

Members noted that survey measures of business conditions had improved in June across several economies. Activity in the services sector had recovered more than manufacturing in June, but generally remained weak. The recovery in business conditions appeared to have been strongest in the United States and China.

A range of indicators pointed to economic conditions continuing to normalise in China. Industrial activity and most property-related activity had returned to levels prevailing prior to the COVID-19 outbreak. However, consumer spending and travel-related activity remained well below typical levels. In India, employment had recovered strongly, alongside an increase in new COVID-19 cases. In general, high-frequency indicators in India suggested that people were restricting all but essential travel.

Members observed that household consumption in the June quarter was likely to have been very weak globally. Consumers had been substituting away from services in favour of goods, and from international services to domestic retail goods, in particular. In advanced economies, retail sales values in May had recovered most or all of the decline in April; in China, retail sales had been recovering since nationwide restrictions were lifted in February.

The contraction in activity in the global economy had been accompanied by a very severe deterioration in labour market conditions. Members noted that government policies were offering substantial support to labour markets around the world. A large share of the labour force in advanced economies was supported by wage subsidy programs. Maintaining workers’ attachment to their employers was preventing a large increase in measured unemployment. Government support measures were also helping to sustain household incomes. In the United States, aggregate household income had increased in recent months, in part owing to increases in unemployment insurance, which had raised the incomes of many unemployed people. Definitional differences had contributed to wide cross-country variation in recorded unemployment rates. For instance, in the United States the unemployment rate had risen most and then declined fastest because people who were temporarily stood down (and immediately classified as unemployed) had more recently returned to work.

Domestic Economic Developments

Turning to the domestic economy, members noted that economic conditions in Australia had weakened significantly since the start of the year, but the downturn had been less severe than feared a few months earlier. Consumer spending in May and June had been stronger than expected, and had also held up better than in most other countries. Manufacturing and construction activity had also been less affected in Australia than elsewhere. Similarly, the contraction in the labour market had been less severe than expected in May. Nevertheless, the shock to the Australian economy would be the most severe since the 1930s, and the outlook remained highly uncertain as it depended in large part upon containment of the pandemic.

Household consumption had declined by around 1 per cent in the March quarter, and was expected to have contracted considerably more sharply in the June quarter. Reduced spending on international travel was likely to account for a material share of the fall in household consumption. Members noted that the restrictions imposed had also significantly dampened non-retail consumption, including of personal services, in the June quarter. While consumption of services, especially discretionary services, had been weak since March, the value of retail sales, which accounts for one-third of consumption, was higher in May than levels before the COVID-19 outbreak. This partly reflected substitution away from services where restrictions were applied in favour of goods such as food, household items and recreational items. Vehicle sales had also picked up markedly in June, after having fallen considerably in April. Across the states, growth in retail spending had been most subdued in Victoria; states where numbers of active COVID-19 cases were very low had seen larger increases in retail sales.

Imports and exports had both been lower in May, leaving the trade surplus broadly unchanged at a historically high level. The decline in imports had been broadly based and consistent with weakness in overall consumption. While exports of resources had declined only marginally, members observed that the value of services exports had contracted sharply in recent months, with travel exports nearly halving in value and transport service exports also declining. Around two-thirds of travel service exports are education-related, including the tuition and living expenses of international students, with tourism accounting for the remaining third. It was noted that the full effect of the closure of Australia’s international borders would be evident in the June quarter rather than the March quarter. Meanwhile, consumer and business confidence, and surveys of business conditions, had picked up as restrictions on activity were eased.

Members noted that fiscal policy was playing a key role in supporting economic activity and the labour market in Australia and elsewhere. Domestically and abroad, this policy support had included direct payments to households and businesses, increased spending on health services, wage subsidies and loan guarantees. In Australia, government assistance – particularly the JobKeeper and JobSeeker programs – was playing an important role in supporting household incomes and consumption. Mortgage payment forbearance, rental reductions and withdrawals from superannuation balances had also supported household cash flows in the June quarter and into the September quarter. Superannuation withdrawals had been significant, equivalent to around 6 per cent of quarterly household income, with more than 3 million requests filed to date.

Conditions in the labour market had been very weak, but not as severe as expected a few months earlier. Another large decline in employment in May had brought the number of people who had lost their job over two months to 835,000. The unemployment rate had risen by 0.7 percentage points to 7.1 per cent in May. As had been the case in April, an unusually large share of people who left employment in May did not actively search for work and were therefore recorded as having exited the labour force. Members noted that the employment-to-population ratio and the participation rate had both fallen significantly and were at their lowest levels in many years. Underemployment had eased in May, albeit from a very high level, as more people resumed working longer hours. As with employment, total hours worked declined again in May but by less than in April. The peak-to-trough decline in total hours worked was now expected to be closer to 10 per cent than the 20 per cent decline expected earlier. Payroll data indicated that job losses were reversing gradually in those industries most directly affected by the restrictions on activity, such as accommodation, cafes and restaurants. Jobs in other industries that had also been affected, such as business services, had yet to recover materially. Payroll data also suggested that the worst of the job losses was likely to have passed.

Members noted that conditions in the established housing market remained mixed. Housing prices in some larger cities had declined in June, though were only a little below recent peaks in the case of Sydney and Melbourne. Housing prices in a number of smaller cities were broadly unchanged. Housing turnover declined significantly when in-person auctions and open homes were banned owing to physical distancing restrictions, but as these were lifted turnover had recovered somewhat. Conditions in the rental market remained weak, partly reflecting an increase in the supply of rental housing in some areas. The reduced flow of new arrivals to Australia was also affecting some markets. Rental vacancy rates had increased sharply in Melbourne and Sydney to just above 4 per cent. Soft conditions in the rental market were expected to weigh on rent inflation for some time.

Investment activity in the residential and non-mining business sectors had been subdued and was expected to remain so for some time. Members noted that uncertainty about job losses had affected the demand for new housing, and building approvals had declined, particularly for apartments. Liaison contacts had indicated that the recently announced HomeBuilder package had provided a boost to buyer interest in the detached housing market, but less so for apartments. Non-mining business investment had been weak prior to the onset of the pandemic, and indications from liaison contacts suggested it would weaken further in the period ahead. Uncertainty about the future path of the pandemic, associated containment measures and the strength of the economy was significantly affecting investment plans. Non-essential investment spending was most at risk of a sharp pullback. While the turning point in mining investment was now evident, overall business investment was expected to remain weak in the period ahead.

International Financial Markets

Members noted that global financial conditions had remained accommodative amid substantial policy stimulus. Government bond yields had remained around historic lows in many economies, including Australia. This was partly because monetary policies were expected to remain stimulatory for some years, and occurred notwithstanding a sharp rise in sovereign debt issuance. Sovereign bond spreads in the euro area remained low.

Members of the Federal Open Market Committee had signalled that they expected the policy interest rate would remain very low until at least 2022 and that they would consider new easing measures, if required. Senior Federal Reserve officials had stated that negative interest rates were unlikely to be an appropriate policy tool in the United States. The European Central Bank, Bank of England and Swedish Riksbank had all extended their programs to purchase sovereign and/or private sector assets in June. Many central banks had also refined the various measures they had introduced to provide support for credit, particularly for the business sector. Members observed that, at the same time, central banks had continued to scale back their operations to support the functioning of financial markets because trading conditions had largely normalised.

Funding conditions for corporations had remained favourable for most borrowers, particularly those that were highly rated. Corporate bond spreads had narrowed a little further, notwithstanding record issuance in the United States and the euro area in the June quarter. Members noted that equity prices in major markets had recovered much of their decline earlier in the year, suggesting that market participants were generally expecting a short-lived decline in earnings. However, volatility in equity markets had picked up more recently, partly reflecting uncertainty associated with the increasing spread of the virus in much of the United States and a number of large emerging market economies. In Australia, equity prices had retraced around half of their earlier decline.

Improved risk sentiment and the extent of policy easing by the Federal Reserve had seen the US dollar depreciate against the currencies of most economies over recent months. Members observed that a wide range of advanced economy currencies had returned to levels previously seen prior to the onset of the pandemic. This was also the case for the Australian dollar, consistent with commodity prices and interest differentials having been little changed over that period.

In China, authorities had remained cautious about injecting further monetary stimulus amid concerns about risk-taking in some parts of the financial system. Nonetheless, the authorities had continued to encourage banks to lend to businesses, particularly small enterprises, and the growth rate of overall financing had risen over recent months.

Domestic Financial Markets

Members discussed the Bank’s package of policy measures, which had been working broadly as expected. The cash rate had continued to trade at around 13–14 basis points amid ample Exchange Settlement balances, and investors expected it to remain around this level for some time. Three-year Australian Government bond yields had been stable at the target of around 25 basis points and government bond markets had continued to function smoothly. As a result, the Bank had not needed to purchase government securities for some time. Ten-year Australian Government bond yields were low, albeit a little higher than those prevailing in a number of the major advanced economies. There had been further gradual take-up of the Term Funding Facility (TFF).

Funding costs for Australian banks had been at historic lows and the banks had ample access to funding. The larger banks had continued to indicate that they would draw on the TFF in time as other funding matured. Given ample funding from other sources, these banks had not needed to issue senior unsecured bonds this year. These bonds were also more expensive than the option of obtaining funding through the TFF. Money market rates and rates on deposits had declined to low levels.

Members noted that interest rates on business loans had declined to historically low levels. Large businesses had drawn on revolving credit facilities earlier in the year to bolster their liquidity positions, but had since repaid some of those funds. Lending to small and medium-sized enterprises (SMEs) had remained little changed over the preceding year or more. While the supply of business credit appeared to have tightened, demand for new loans from SMEs had been low given the uncertain outlook and that other policy initiatives had provided businesses with a source of funds.

Large businesses had continued to tap capital markets, particularly by raising new equity. Members observed that listed companies in Australia had raised more equity as a proportion of the overall size of the market than had been seen in markets such as the United Kingdom and United States. Equity raisings in Australia had been more common than debt raisings, while the opposite had been true elsewhere, in particular the United States and the euro area. An important factor explaining this difference was that the market for Australian corporate debt is smaller and less liquid than for companies in other jurisdictions.

Interest rates on Australian housing loans had declined to historically low levels. Around half of the decline in the cash rate since February had been passed through to variable mortgage rates. Members noted that refinancing activity had risen sharply as borrowers had taken advantage of lower rates and the strong competition for lower-risk borrowers. Interest rates on new fixed-rate mortgages were noticeably lower than on new variable rate mortgages, which had led to an increasing share of new or refinanced loans on fixed rates. While some existing borrowers had deferred their loan payments, payments into offset accounts had remained high. This was consistent with many home loan borrowers saving for precautionary reasons and having reduced opportunities for spending.

Housing credit extended to owner-occupiers had continued to grow steadily at around the pace of preceding months, while housing credit to investors had continued to contract. Housing credit growth overall was likely to slow in the months ahead, with commitments for new housing loans having fallen sharply in May. Members noted that this was consistent with weak economic conditions and the soft outlook for the housing market.

Considerations for Monetary Policy

Members began their discussion by reviewing the monetary policy measures that have been used in other advanced economies and their applicability to Australia.

Members discussed how the elements of the Bank’s March policy package could have been configured differently, noting that there has been variation across countries in the design of these measures. It would have been possible, for example, to set lower, but still positive, interest rate targets and to have purchased a quantity of government bonds above that necessary to achieve the bond yield target. Members also recognised that there was variation across countries in the design of term funding facilities and the range of collateral accepted in open market operations.

After reviewing experience both overseas and in Australia, members agreed that there was no need to adjust the package of measures in Australia in the current environment. Members agreed, however, to continue to assess the evolving situation in Australia and did not rule out adjusting the current package if circumstances warranted.

Members also reviewed the international experience with other monetary policies and their relevance in the Australian context, as they had done the previous year. These policies included negative interest rates, foreign exchange intervention, the purchase of private sector assets and also direct government financing.

Members agreed that the considerations around these options, which had been covered in a speech by the Governor in November 2019, remained relevant in current circumstances. All such options entail significant costs and involve very difficult trade-offs and, for some policies, there are legitimate questions about their effectiveness. Members agreed that negative interest rates in Australia remain extraordinarily unlikely. They also agreed there is no case for intervention in the foreign exchange market, given its limited effectiveness when the exchange rate is broadly aligned with its fundamental determinants, as at present. Members reaffirmed the importance of the longstanding principle of separating monetary policy from the financing of government, a principle that has served Australia well in practice. Members saw merit in these policy matters being addressed in an upcoming speech by the Governor on 21 July.

In considering this month’s decision, members recognised that the global economy was experiencing a severe downturn as countries sought to contain the COVID-19 outbreak. Labour markets had deteriorated and there had been a sharp rise in unemployment in many economies. Nevertheless, timely indicators of economic activity had generally picked up, suggesting that the worst of the global economic contraction had passed. However, the outlook remained uncertain and would depend upon containment of the virus. Over the preceding month, infection rates had declined in some countries, but they were still very high and rising in other countries.

Members recognised that the Australian economy was experiencing the biggest economic contraction since the 1930s. A very large number of people had lost their jobs, with many others retaining their jobs over this period only because of government support programs. Nevertheless, economic conditions had stabilised and the downturn had been less severe than earlier expected. There had been a pick-up in consumer spending in response to the decline in infections and the easing of restrictions across most of the country. However, the nature and speed of the economic recovery remained highly uncertain and, as in other countries, would depend in large part upon the containment of the virus. Uncertainty about the future path of the economy as well as the health situation was continuing to affect the consumption and investment plans of many households and businesses.

Members agreed that the Bank’s policy package was continuing to work broadly as expected. The package had helped to lower funding costs and stabilise financial conditions, and was supporting the economy. Government bond markets were operating effectively and the yield on 3-year Australian Government bonds remained at the target of around 25 basis points. Given these developments, the Bank had not purchased government bonds for some time, although it was prepared to scale up these purchases again, if necessary, to achieve the yield target and ensure bond markets remain functional.

The Board recognised that the substantial, coordinated and unprecedented easing of fiscal and monetary policy in Australia was helping the economy through this difficult period. It was likely that fiscal and monetary support would be required for some time. The Board remained committed to supporting jobs, incomes and businesses and to making sure that Australia is well placed for recovery. Its actions were keeping funding costs low and supporting the supply of credit to households and businesses. This accommodative approach would be maintained for as long as necessary.

The Decision

The Board reaffirmed the elements of the policy package announced on 19 March 2020, namely:

  • a target for the cash rate of 0.25 per cent
  • a target of 0.25 per cent for the yield on 3-year Australian Government bonds
  • the Term Funding Facility to support credit to businesses, particularly small and medium-sized businesses
  • an interest rate of 10 basis points on Exchange Settlement balances held by financial institutions at the Bank.

The Board affirmed that the target for three-year yields would be maintained until progress is made towards the Bank’s goals of full employment and the inflation target, and that it would be appropriate to remove the yield target before the cash rate itself is raised. The Board determined that it would not increase the cash rate target until progress is made towards full employment and it is confident that inflation will be sustainably within the 2–3 per cent target band.

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