Tag: RBA

Phil Lowe gave an important speech yesterday outlining their monetary policy response. “At some point, the virus will be contained and our economy and our financial markets will recover”. We are going to hear a lot more about bridges and cushions.

The Reserve Bank Board met yesterday and decided on a comprehensive package to help support jobs, incomes and businesses as the Australian economy deals with the coronavirus. I would like to use this opportunity to explain this package and to answer your questions.

We are clearly living in extraordinary and challenging times. The coronavirus is first and foremost a very major public health problem. But it has also become a major economic problem, which is having deep ramifications for financial systems around the world. The closure of borders and social distancing measures are affecting us all and they are changing the way we live. Understandably, our communities and our financial markets are both having trouble dealing with a rapidly unfolding situation that they have not seen before.

As our country manages this difficult situation, it is important that we do not lose sight of the fact that we will come through this.

At some point, the virus will be contained and our economy and our financial markets will recover.

Undeniably, what we are facing today is a very serious situation, but it is something that is temporary. As we deal with it as best we can, we also need to look to the other side when things will recover. When we do get to that other side, all those fundamentals that have made Australia such a successful and prosperous country will still be there. We need to remember that.

To help us get to the other side, though, we need a bridge. Without that bridge, there will be more damage, some of which will be permanent, to the economy and to people’s lives.

Building that bridge requires a concerted team effort, with us all pulling together in the country’s interest. On the economic front, there is very close policy coordination between the Australian Government, the Australian Treasury, the Reserve Bank and Australia’s financial regulators. We are all in close contact with one another and are working constructively together and we will continue to do so. This coordination is evident in the various policy statements today.

Governments across Australia are playing their important role in building that bridge to the recovery, with the various fiscal initiatives from the Australian and state governments providing very welcome support. Rightly, the focus is on supporting businesses and households who will suffer a major hit to their incomes. It is increasingly clear that further help will be required on this front and the Australian Government has indicated that additional policy measures will be announced shortly. Australian public finances are in good shape and the country’s history of prudent fiscal management gives us the capacity to respond now.

The banks too have an important role to play in building that bridge to the recovery by supporting their customers. Without this support, it will be harder for us all to get to the other side in reasonable shape.

Australia has a strong financial system, which is well placed to provide the needed support to businesses and households. The system has strong capital and liquidity positions and our financial institutions have invested heavily in resilience. As APRA confirmed this afternoon in a public statement, the current large buffers of capital and liquidity are able to be used to support ongoing lending to the economy.

The financial regulators have also confirmed that they are examining how the timing of various regulatory initiatives might be adjusted to allow financial institutions to concentrate on their businesses and work with their customers. APRA and ASIC both stand ready to assist institutions work through regulatory issues arising from the virus. The Council of Financial Regulators is meeting again tomorrow and will also meet with the largest lenders to discuss how they can support their customers and whether there are any regulatory impediments in the way.

The Reserve Bank itself is also playing a role in building that bridge to the recovery. I will now turn to that.

Our major focus is to support jobs, incomes and businesses, so that when the health crisis recedes the country is well placed to recover strongly. Supporting small business over coming months is a particular priority.

Prior to today’s announcement, we had already taken several steps over recent days to support the Australian economy.

Over the past week or so we have been injecting substantial extra liquidity into the financial system through our daily market operations. As part of this effort, we will be conducting one-month and three-month repo operations each day. We will also conduct repo operations of six-month maturity or longer at least weekly, as long as market conditions warrant. As a result of these liquidity operations, Exchange Settlement balances have increased from around $2.5 billion a month ago to over $20 billion today.

The Reserve Bank also stands ready to purchase Australian government bonds in the secondary market to support its smooth functioning. The government bond market is a key market for the Australian financial system, because government bonds provide the pricing benchmark for many financial assets. Our approach here is similar in concept to our longstanding approach to the foreign exchange market, where we have been prepared to support smooth market functioning when liquidity conditions are highly stressed. We now stand ready to do the same in the bond market and we are working in close cooperation on this with the Australian Office of Financial Management (AOFM).

In addition to these previously announced measures, today’s package has four elements. They are: a reduction in the cash rate to 0.25 per cent; a target of 0.25 per cent for the yield on 3-year government bonds; a term funding facility to support credit to businesses, particularly small and medium-sized businesses; and an adjustment to the interest rate on accounts that financial institutions hold at the RBA.

I will discuss each of these in turn.

1. A Further Reduction in the Cash Rate to ¼ Per Cent

This brings the cumulative decline over the past year to 1¼ percentage points. This is a substantial easing of monetary policy, which is boosting the cash flow of businesses and the household sector as a whole. It is also helping our trade-exposed industries through the exchange rate channel. At the same time, though, low interest rates do have negative consequences for some people, especially those relying on interest income. The Reserve Bank Board has discussed these consequences extensively, but the evidence is that lower interest rates do benefit the community as a whole, although I acknowledge that the effects are uneven.

With this decision today, the policy rates set by the Reserve Bank of Australia, the United States Federal Reserve, the Bank of England and the Reserve Bank of New Zealand are all effectively at ¼ per cent. Each of us are using all the scope we have with interest rates to support our economies through a very challenging period.

At its meeting yesterday, the Board also agreed that we would not increase the cash rate from its current level until progress was made towards full employment and that we were confident that inflation will be sustainably within the 2–3 per cent range. This means that we are likely to be at this level of interest rates for an extended period.

Before the coronavirus hit, we were expecting to make progress towards full employment and the inflation target, although that progress was expected to be only very gradual. Recent events have obviously changed the situation and we are now likely to remain short of those objectives for somewhat longer.

I am not able to provide you with an updated set of economic forecasts. The situation is just too fluid. But we are expecting a major hit to economic activity and incomes in Australia that will last for a number of months. We are also expecting significant job losses. The scale of these losses will depend on the ability of businesses to keep workers on during this difficult period. We saw during the global financial crisis how flexibility in working arrangements limited job losses and this benefited the entire community. I hope the same is true in the months ahead.

It is also important to repeat that we are expecting a recovery once the virus is contained. The timing and strength of that recovery will depend in part upon how successful we are, as a nation, in building that bridge to the other side. When that recovery does come, it will be supported by the low level of interest rates. We will maintain the current setting of interest rates until a strong recovery is in place and the achievement of our objectives is clearly in sight.

2. A Target Yield on 3-year Australian Government Bonds

Over recent decades, the Reserve Bank’s practice has been to target the cash rate, which forms the anchor point for the risk-free term structure. We are now extending and complementing this by also targeting a risk-free interest rate further out along the yield curve.

In particular, we are targeting the yield on 3-year Australian Government Securities (AGS) and we have set this target at around 0.25 per cent, the same as the cash rate. Over recent weeks, the yield on 3-year AGS has averaged 0.45 per cent, so this represents a material reduction.

We have chosen the three-year horizon as it influences funding rates across much of the Australian economy and is an important rate in financial markets. It is also consistent with the Board’s expectation that the cash rate will remain at its current level for some years, but not forever.

To achieve this yield target, we will be conducting regular auctions in the bond market. We published some technical details earlier today and we will keep the market informed of our operations. Our first auction will be tomorrow. As part of this program, our intention is to purchase bonds of different maturities given the high level of substitutability between bonds. We are also prepared to buy semi-government securities to achieve the target and to help facilitate the smooth functioning of Australia’s bond market.

I want to make it clear that our purchases will be in the secondary market and we will not be purchasing bonds directly from the Government.

I would also like to emphasise that we are not seeking to have the three-year yield identically at 25 basis points each and every day. There will be some natural variation, and it does not make sense to counter that. It may also take some time for yields to fall from their current level to 25 basis points.

I understand why many people will view this as quantitative easing – or QE. This is because there is a quantitative aspect to what we are doing – achieving this target will involve the Reserve Bank buying bonds and an expansion of our balance sheet.

But our emphasis is not on the quantities – we are not setting objectives for the quantity and timing of bonds that we will buy, as some other central banks have done. How much we need to purchase, and when we need to enter the market, will depend upon market conditions and prices.

Rather than quantities or the size of our balance sheet, our focus is very much on the price of money and credit. Our objective here is to provide support for low funding costs across the entire economy. By lowering this important benchmark interest rate, we will add to the downward pressure on borrowing costs for financial institutions, households and businesses. We are prepared to transact in whatever quantities are necessary to achieve this objective.

We expect to maintain the target for three-year yields until progress is being made towards our goals of full employment and the inflation target. Our expectation, though, is that the yield target will be removed before the cash rate is increased.

3. A Term Funding Facility for the Banking System with Support for Business Credit, Especially to Small and Medium-sized Businesses

The scheme has two broad objectives.

The first is to lower funding costs for the entire banking system so that the cost of credit to households and businesses is low. In this regard, it will complement the target for the three-year yield on AGS.

The second objective is to provide an incentive for lenders to support credit to businesses, especially small and medium-sized businesses. This is a priority area for us. Many small businesses are going to find the coming months very difficult as their sales dry up and they support their staff. Assisting small businesses through this period will help us make that bridge to the other side when the recovery takes place. If Australia has lost lots of otherwise viable businesses through this period, making that recovery will be harder and we will all pay the price for that. So it is important that we address this.

Under this new facility, authorised deposit-taking institutions (ADIs) in total will have access to at least $90 billion in funding. ADIs will be able to borrow from the Reserve Bank an amount equivalent to 3 per cent of their existing outstanding credit to Australian businesses and households. ADIs will be able to draw on these funds up until the end of September this year.

Lenders will also be able to borrow additional funds from the Reserve Bank if they increase credit to business this year. For every extra dollar lent to large business, lenders will have access to an additional dollar of funding from the Reserve Bank. For every extra dollar of loans to small and medium-sized businesses they will have access to an additional five dollars. These funds can be drawn upon up until the end of March next year. There is no extra borrowing allowance for additional housing loans.

The funding from the Reserve Bank will be for three years at a fixed interest rate of 0.25 per cent, which is substantially below lenders’ current funding costs. Institutions accessing this scheme will need to provide the usual collateral to the Reserve Bank, with haircuts applying. The first drawings under this facility will be possible no later than four weeks from today.

This scheme is similar to that introduced by the Bank of England. Unlike the Bank of England’s scheme, though, the interest rate is fixed for the term of the funding. This is consistent with our view that the cash rate is likely to stay at its current level for some time. Another difference with the Bank of England’s scheme is that we have not included a higher interest rate if credit contracts. While a decline in credit would be undesirable, including a penalty may act as a disincentive for institutions to take part in the scheme.

We are encouraging all ADIs to use the term funding facility to help support their customers. I welcome APRA’s confirmation this afternoon that it also supports ADIs using this scheme. I also welcome the Australian Government’s announcement that it will support the markets for asset-backed securities through the AOFM. This support is important as it will help non-bank financial institutions and small lenders to continue to provide credit to Australian households and businesses.

4. An Adjustment to the Interest Rate on Exchange Settlement Balances

Under our longstanding framework, the RBA operates a corridor system around the cash rate. Under that system, the balances that banks hold with the RBA overnight in Exchange Settlement accounts earn an interest rate 25 basis points below the cash rate. And on the other side of the corridor, in the event that a bank needed to borrow from the RBA overnight, it would be charged 25 basis points above the cash rate.

Under this arrangement and with the cash rate now at 25 basis points, the interest rate on Exchange Settlement balances would have been zero. We have decided to increase this to 10 basis points. We are not making any change to the arrangements for the top of the corridor.

This adjustment to the corridor reflects the fact that there will be a significant increase in the balances held in Exchange Settlement accounts due to the combined effect of the Bank’s enhanced liquidity operations, bond purchases and term funding program. Maintaining a zero interest rate on these balances would increase the costs to the banking system. In the current environment, this would be unhelpful.

The increase in settlement balances is also expected to change the way that the cash market operates. In other countries, where there have been large increases in balances at the central bank, the cash rate equivalent has drifted below the target and transaction volumes in the cash market have declined. It is likely that we will see the same outcome in Australia. The Reserve Bank will continue to monitor the cash market closely and is prepared to adjust arrangements if the situation requires.

So these are the four measures announced earlier this afternoon. Together, they represent a comprehensive package to lower funding costs in Australia and support the supply of credit. Complementary initiatives by APRA and the AOFM are also working towards those same objectives.

The term funding scheme and the three-year yield target are both significant policy developments that would not have been under consideration in normal times. They both carry financial and other risks for the Reserve Bank and they both represent significant interventions by the Bank in Australia’s financial markets.

The Reserve Bank Board did not take these decisions lightly. But in the context of extraordinary times and consistent with our broad mandate to promote the economic welfare of the people of Australia, we are seeking to play our full role in building that bridge to the time when the recovery takes place. By doing all that we can to lower funding costs in Australia and support the supply of credit to business, we will help our economy and financial system get through this difficult period.

RBA Deputy Governor Guy Debelle gave a keynote Address at the Australian Financial Review Business Summit. It was a summary of how the Bank is seeing developments in the economy at the moment. As normal, the story was the economy was doing quite well, until the onset of the coronavirus. And once it passes things will revert to this trend.

They admit that the global economy will be materially weaker in the first quarter of 2020 and in the period ahead. Australia will see at least a 0.5% fall in growth in the current quarter, but it is just too uncertain to assess the impact of the virus beyond the March quarter, he said. Despite the fact that spreads on Australian bank bonds have widened, yields remain at levels that are still very low historically, and banks are strongly capitalised.

Weirdly, he fails to discuss the Fed’s ongoing repo operations and growing balance sheet. John Adams and I released a show on this just today:

Here is the speech in full:

The December quarter national accounts confirmed our assessment that the Australian economy ended 2019 with a gradual pick-up in growth. Growth over the year was 2¼ per cent, up from a low of 1½ per cent. Consumption growth was a little stronger in the quarter, although still subdued. We had estimated that the bushfires will subtract around 0.2 percentage points from growth across the December and March quarters, but besides that, economic growth was set to continue to pick up supported by low interest rates, the lower exchange rate, a rise in mining investment, high levels of spending on infrastructure and an expected recovery in residential construction.

On the global side, around the turn of the year there were indications that the global economy was coming out of a soft patch of growth. The trade tensions between China and the US had abated, surveys of business conditions were picking up and industrial production was improving. Financial conditions were very stimulatory and supporting the pick-up in global growth.

Since then, there is no doubt that the outbreak of the virus has significantly disrupted this momentum, initially in China and now more broadly. We do not have a clear picture yet on the disruption to the Chinese economy caused by the virus and the measures put in place to contain the virus. But the following two graphs provide some sense of the significant disruption to the Chinese people and economy.

The coal consumption graph (Graph 1) shows the regular significant decline in production around Chinese New Year. But this year, the return to normal production has been significantly delayed. There was no ramp up in production after the holiday period, and we are now more than four weeks past the point where the Chinese economy is normally back to full-scale production. The straight arithmetic of losing a substantial amount of output over a period of several weeks implies a significant hit to economic activity. The road congestion graph (Graph 2) tells a similar story of a protracted period of low output.

Both show that the Chinese economy is now only gradually returning to normal. Even as this occurs, it is very uncertain how long it will take to repair the severe disruption to supply chains.

In the meantime, the virus has spread to other countries. They too are beginning to suffer significant disruptions, the extent and duration of which is unknown at this time.

The conclusion is that the global economy will be materially weaker in the first quarter of 2020 and in the period ahead.

In terms of the effect on the Australian economy, we have estimated the direct impact on the education and tourism sectors in the March quarter. Graph 3 shows the normal profile of visitor arrivals into Australia. Since January, inbound airline capacity from China has declined by 90 per cent, which gives a guide to the size of the decline in arrivals from China. Up until recently, tourist arrivals from other countries had held up reasonably well but that may no longer be true. From our liaison with the education sector, including the universities, as well as student visa numbers, we have information on the number of foreign students who have been unable to resume their studies. Graph 4 shows the country of origin of foreign students in Australia.

We have used this information to estimate the impact of the virus in these two sectors of the economy. The estimate is approximate, but at this stage we think the decline in services exports in the March quarter will amount to at least 10 per cent, roughly evenly split between lower tourism and education exports. As service exports account for 5 per cent of GDP, this translates into a subtraction from growth of ½ per cent of GDP in the March quarter from these two sources.

Through our business liaison program we are gathering information on supply chain disruptions which are affecting the construction and retail sectors in particular. Clearly we are still only in the early weeks of March, so the picture can change from here.

It is just too uncertain to assess the impact of the virus beyond the March quarter.

Our liaison with the resources sector does not indicate any material disruption to exports of iron ore and coal at this stage. Indeed, iron ore and coal prices have been resilient. Disruptions to Chinese domestic production of iron ore and coal have been a factor in this, which has resulted in more use of imported resources. Another is the expectation that the Chinese policy response will involve a significant amount of infrastructure spending which will benefit bulk commodities. The movements in these commodity prices stand in contrast to the large decline in the oil price, which will flow through to LNG prices (Graph 5).

I will now summarise recent developments in financial markets. There has been a large increase in risk aversion and uncertainty. The virus is going to have a material economic impact but it is not clear how large that will be. That makes it difficult for the market to reprice financial assets.

Policy interest rates have been reduced in some countries, including Australia, and further reductions are expected where that is possible. Currently market pricing implies a reduction of between 75 and 100 basis points in the Fed’s policy rate at their meeting next week.

Government bond yields have declined to historic lows, because of the shift downwards in actual and expected policy rates, reduced expectations for growth and a flight to safety (Graph 6). The 25 per cent fall in oil prices on Monday morning has also led to lower expectations of inflation. The 10 year US treasury yield reached a low below 35 basis points on Monday, including a 25 basis point decline at the opening of trade in Asia. It has since risen to be around 65 basis points at the time of writing.

Australian government bond yields have been driven by the global developments. They haven’t declined as much as US Treasuries, such that the spread between the 10 year yields is now slightly positive, having been negative over the past two years. At the time of writing, the Australian government can borrow for 10 years at 75 basis points.

Equity prices have fallen by as much as 20 per cent since their all-time peak of less than a month ago, although the Australian market rebounded on Tuesday (Graph 7). The falls have been particularly large for companies in the oil sector, as well as tourism.

Corporate bond spreads have widened. Through the first part of this move, the widening in large part reflected the rapid shift downwards in the risk free (government bond) curve. Investment grade bond spreads widened but investment grade yields actually fell (Graph 8). In the last few days though, we have seen yields rise along with the spreads. The high yield sector has seen a marked rise in yields and spreads, particularly in the US reflecting the prevalence of energy companies in that market. Bond issuance has been extremely low, in part because issuers do not want to appear to be in desperate need of funds in a dislocated market. It is also worth noting that just as equities prices have fallen from historic highs, so too have corporate bond prices fallen from historic highs.

Liquidity in fixed income markets has been poor at times, including in US Treasuries. The liquidity environment has changed considerably in the past decade in response to changed regulations. The banking sector is much less willing and able to warehouse risk and provide liquidity than in the past.^[2]

The Australian banking system is well capitalised and is in a strong liquidity position. The Australian banks had raised a significant amount of wholesale funding before the disruption to markets and deposit inflows are robust. They are resilient to a period of market disruption. Spreads on Australian bank bonds have widened, although yields remain at levels that are still very low historically. We have not seen any particular sign of pressure in our daily market operations to date. The spread between the bank bill swap rate and the expected policy rate (OIS) has risen in recent days but remains low, nothing at all like what occurred in GFC.

Exchange rate volatility has been very low for a considerable period of time, but has picked up in the past few days. However it still remains considerably lower than volatility in other financial markets. The yen has appreciated by as much as 10 per cent against the US dollar, as Japanese investors repatriate funds, as normally occurs in these type of situations (Graph 9). More surprisingly, the euro has also appreciated against the US dollar. Market intelligence indicates that part of the reason for this is the liquidation of trades that were funded in euros and invested in higher yielding assets such as emerging market bonds. The sharp narrowing in the interest differential with the US has also contributed.

The Australian dollar has depreciated by 6 per cent since the beginning of the year to decade lows against the US dollar and on a trade-weighted basis (Graph 10). This will provide a helpful boost to the Australian economy and has occurred despite the prices of the bulk commodities, iron ore and coal, remaining resilient.

Turning to monetary policy, the Board met last week and decided to lower the cash rate by 25 basis points to 0.5 per cent. This decision was taken to support the economy by boosting demand and to offset the tightening in financial conditions that otherwise was occurring.

The reduction in the cash rate at the March meeting was passed in full through to mortgage rates. The cash rate has been reduced by 100 basis points since June. This has translated into a reduction in mortgage rates of 95 basis points. This has occurred through the combination of a reduction in the standard variable rate of 85 basis points, larger discounts to new borrowers and existing borrowers refinancing to take advantage of larger discounts. While a lower and flatter interest rate structure puts pressure on bank margins, it is important to remember that the easing in monetary policy will help support the Australian economy which in turn supports the credit quality of the banks’ portfolios of loans.

The virus is a shock to both demand and supply. Monetary policy does not have an effect on the supply side, but can work to ensure demand is stronger than it otherwise would be. Lower interest rates will provide more disposable income to the household sector and those businesses with debt. They may not spend it straight away, but it brings forward the day when they will be comfortable with their balance sheets and resume a normal pattern of spending. Monetary policy also works through the exchange rate which will help mitigate the effect of the virus’ impact on external demand.

The effect of the virus will come to an end at some point. Once we get beyond the effect of the virus, the Australian economy will be supported by the low level of interest rates, the lower exchange rate, a pick-up in mining investment, sustained spending on infrastructure and an expected recovery in residential construction.

The Government has announced its intention to support jobs, incomes, small business and investment which will provide welcome support to the economy. The combined effect of fiscal and monetary policy will help us navigate a difficult period for the Australian economy. They will also help ensure the Australian economy is well placed to bounce back quickly once the virus is contained.

At its meeting today, the Board decided to lower the cash rate by 25 basis points to 0.50 per cent. The Board took this decision to support the economy as it responds to the global coronavirus outbreak.

We suspect some banks will have difficulty in passing that cut through to mortgage holders, given the lower bounds problem. Westpac has however as first mover.

And the RBA only has one shot in the locker before QE starts.

The coronavirus has clouded the near-term outlook for the global economy and means that global growth in the first half of 2020 will be lower than earlier expected. Prior to the outbreak, there were signs that the slowdown in the global economy that started in 2018 was coming to an end. It is too early to tell how persistent the effects of the coronavirus will be and at what point the global economy will return to an improving path. Policy measures have been announced in several countries, including China, which will help support growth. Inflation remains low almost everywhere and unemployment rates are at multi-decade lows in many countries.

Long-term government bond yields have fallen to record lows in many countries, including Australia. The Australian dollar has also depreciated further recently and is at its lowest level for many years. In most economies, including the United States, there is an expectation of further monetary stimulus over coming months. Financial markets have been volatile as market participants assess the risks associated with the coronavirus. Australia’s financial markets are operating effectively and the Bank will ensure that the Australian financial system has sufficient liquidity.

The coronavirus outbreak overseas is having a significant effect on the Australian economy at present, particularly in the education and travel sectors. The uncertainty that it is creating is also likely to affect domestic spending. As a result, GDP growth in the March quarter is likely to be noticeably weaker than earlier expected. Given the evolving situation, it is difficult to predict how large and long-lasting the effect will be. Once the coronavirus is contained, the Australian economy is expected to return to an improving trend. This outlook is supported by the low level of interest rates, high levels of spending on infrastructure, the lower exchange rate, a positive outlook for the resources sector and expected recoveries in residential construction and household consumption. The Australian Government has also indicated that it will assist areas of the economy most affected by the coronavirus.

The unemployment rate increased in January to 5.3 per cent and has been around 5¼ per cent since April last year. Wages growth remains subdued and is not expected to pick up for some time. A gradual lift in wages growth would be a welcome development and is needed for inflation to be sustainably within the 2–3 per cent target range.

There are further signs of a pick-up in established housing markets, with prices rising in most markets, in some cases quite strongly. Mortgage loan commitments have also picked up, although demand for credit by investors remains subdued. Mortgage rates are at record lows and there is strong competition for borrowers of high credit quality. Credit conditions for small and medium-sized businesses remain tight.

The global outbreak of the coronavirus is expected to delay progress in Australia towards full employment and the inflation target. The Board therefore judged that it was appropriate to ease monetary policy further to provide additional support to employment and economic activity. It will continue to monitor developments closely and to assess the implications of the coronavirus for the economy. The Board is prepared to ease monetary policy further to support the Australian

The RBA released their minutes today, and its all upside. Just seems disconnected from reality! Rates will remain low, for years!!!

International Economic Conditions

Members commenced their discussion of the global economy by noting the International Monetary Fund’s forecast for global growth to pick up in 2020 and 2021. The easing in trade tensions between the United States and China, and ongoing stimulus delivered by central banks, had supported a modest improvement in the growth outlook for a number of economies. Global manufacturing and trade indicators, notably export orders, had continued to show signs of stabilising in late 2019. Inflation had remained low and below most central banks’ targets. Members also discussed the coronavirus outbreak, which was a new source of uncertainty regarding the global outlook.

In China, a range of activity indicators had picked up in the December quarter, which suggested that targeted fiscal and monetary easing had been working to stabilise economic conditions. In east Asia, the growth outlook had been supported by signs of a turnaround in the global electronics cycle and more stimulatory fiscal and monetary policies in some economies in the region. On the other hand, the outlook for output growth in India had been revised lower given the broad-based slowing in economic activity there.

In major advanced economies, indicators for manufacturing and services activity had ticked up slightly and tight labour markets had supported growth in consumption. In the United States, lower interest rates had supported a pick-up in residential investment. Business investment intentions had stabilised. Japanese economic activity had slowed as expected following the increase in the consumption tax in October 2019, but the fiscal stimulus that had been announced was expected to support growth. In the euro area, survey indicators of conditions in the manufacturing sector appeared to have bottomed out, but investment had remained weak.

The progress in addressing the US–China trade and technology disputes had alleviated an important downside risk to global growth. However, given the nature of the ‘phase one’ deal and the potential for tensions to re-escalate, this risk had not been eliminated.

Members discussed the coronavirus outbreak, noting that it was a new source of uncertainty for the global economy. With the situation still evolving, members observed that it was too early to determine the extent to which growth in China would be affected or the nature of the international spillovers. It was noted that previous outbreaks of new viruses had had significant but short-lived negative effects on economic growth in the economies at the centre of the outbreak. Members observed that it was difficult to know how representative these earlier episodes could be. China now accounted for a much larger share of the global economy and was more closely integrated, including with Australia, than in 2003 at the time of the SARS outbreak. The economic effects would depend crucially on the persistence of the outbreak and measures taken to contain its spread.

Some commodity prices, notably for industrial metals, iron ore and oil, had fallen on concerns that the coronavirus outbreak would disrupt production in China and reduce Chinese commodity demand in the near term. By contrast, rural prices had been little changed.

Domestic Economic Conditions

The Australian economy had grown modestly in the September quarter. While growth in public demand and exports had been relatively strong, growth in household spending and investment had remained weak. The output of the farm sector had also subtracted from growth over the preceding year, reflecting the effects of ongoing drought conditions. Members noted that the recent bushfires had devastated some regional communities and that this was expected to have reduced GDP growth over the December and March quarters. The effects of the coronavirus outbreak were also expected to subtract from growth in exports over the first half of 2020.

Overall, economic growth was expected to be weaker in the near term than had been forecast three months earlier, partly because of the effects of the bushfires and the coronavirus outbreak. However, GDP growth was still expected to pick up over the forecast period, supported by accommodative monetary policy, a pick-up in mining investment, and recoveries in dwelling investment and consumption. The recovery from the bushfires was expected to add to growth in the second half of 2020. The central forecast for growth remained unchanged since November, at 2¾ per cent over 2020 and around 3 per cent over 2021.

An increase in mining investment was expected in the near term and a turnaround in dwelling investment was likely to have occurred by the end of 2019. However, the recovery in consumption was less certain and more consequential for overall demand. There was also uncertainty around estimates of the effects of the bushfires and the coronavirus outbreak: it was difficult to assess potential indirect effects on activity from these events and relevant data were yet to be published.

Household consumption had been lower than expected in the September quarter despite strong growth in household disposable income, supported by the receipt of tax offset payments and lower interest payments following the recent reductions in the cash rate. Information from the ABS retail sales release and the Bank’s liaison program had suggested that retail sales volumes were likely to have grown only modestly in the December quarter; although nominal retail sales had increased strongly in the month of November, much of this increase was likely to have been purchases brought forward to take advantage of ‘Black Friday’ sales. Measures of consumer sentiment had declined over recent months, but consumers’ views on their personal financial situation, which historically have had a stronger link to consumption, had been little changed.

Members noted that a number of factors had contributed to the slowdown in consumption growth since mid 2018. The downturn in the housing market had reduced households’ wealth, and the extended period of weak growth in household income had probably lowered expectations of future income growth. Members observed that the prolonged period of slow growth in income was expected to continue to weigh on consumption over coming quarters. Furthermore, recent data had suggested that households were directing more income to saving and reducing their debt.

Looking ahead, the Bank’s forecast was for growth in consumption to increase gradually, sustained by moderate growth in household disposable income and the recovery in the housing market. Growth in housing prices had picked up in most capital cities and parts of regional Australia over recent months. Prices had increased very strongly in Sydney and Melbourne in recent months. Higher housing prices and the associated increase in housing turnover were expected to support consumption and dwelling investment.

Dwelling investment had continued to decline in the September quarter, however, and was expected to decline further in the near term. Nonetheless, leading indicators were consistent with the forecast of a trough in dwelling investment towards the end of 2020, followed by a recovery through 2021. Private residential building approvals had increased in the December quarter. Contacts in the Bank’s business liaison program had reported an increase in sales of new homes and greenfield land in recent months.

Business investment declined in the September quarter, with both mining and non-mining investment weaker than expected as at November. Mining investment had been considerably lower because work on new liquefied natural gas plants had continued to wind down. Information from business liaison contacts and the recent ABS capital expenditure survey continued to support the view that mining investment was passing through a trough. Non-mining investment was expected to be subdued in the near term, but then to increase modestly, consistent with the expected pick-up in domestic activity. Public investment had been stronger than expected in the September quarter and information from government budgets had suggested public spending would continue to support growth in the near term, including through funding of initiatives for bushfire recovery and drought relief.

The unemployment rate had declined slightly to 5.1 per cent in December. Employment growth had moderated in the December quarter, but had remained at 2.1 per cent over the year. All the growth in the quarter had been in part-time employment. The Bank’s forecast of employment growth had been revised downwards for the first half of 2020, reflecting the overall signal from leading indicators and the downward revision to forecast GDP growth in the near term. The unemployment rate was expected to remain in the 5–5¼ per cent range for some time before declining to around 4¾ per cent in 2021, as GDP and employment growth picked up.

Members noted that the inflation data for the December quarter had been in line with expectations. Headline CPI inflation had been 0.6 per cent in the quarter and 1.8 per cent over 2019. Trimmed mean inflation had been 0.4 per cent in the quarter and 1.6 per cent over 2019. Housing inflation had continued to be a significant drag on overall inflation, with little change in rents both in the quarter and over the year. New dwelling prices had risen in the December quarter following earlier declines because smaller discounts had been offered by developers.

Inflationary pressures were expected to remain subdued. Underlying and headline inflation were expected to increase a little to around 2 per cent over the following couple of years as spare capacity in the economy declined. Wages growth was expected to be largely unchanged over the following couple of years because mild upward pressure on growth in the wage price index would likely be offset by downward pressure from the increase in the superannuation guarantee from mid 2021.

Members noted that the risks around the wage and price inflation forecasts were evenly balanced. Wages growth could pick up faster than expected if labour market conditions tightened by more than expected. The increase in the superannuation guarantee in 2021 was forecast to constrain wages growth for some wage earners, although the timing and extent of this was uncertain and broader measures of earnings growth could be expected to be boosted a little. Domestic inflationary pressures would depend on a range of factors, including how fast the economy recovered from the soft patch over the preceding year, the persistence of the effect of the drought on food prices, and developments in the housing market.

Financial Markets

Members noted that developments in global financial markets had reflected evolving perceptions of key risks.

Up until mid January, concerns over global downside risks had eased following stabilisation in a range of forward-looking indicators of growth, the passage of the ‘phase one’ US–China trade deal and improved prospects for an orderly Brexit. In response, long-term government bond yields and equity prices had risen. The US dollar and Japanese yen had depreciated a little, while the Chinese renminbi had appreciated. There had also been renewed capital flows into emerging markets.

However, since then these moves in financial markets had been partly reversed as market participants became concerned about the potential effect of the coronavirus on the prospects for global economic growth. In particular, government bond yields had declined noticeably to be back at very low levels. In Australia, the 10-year government bond yield had declined in line with movements abroad, to below 1 per cent. Also, the US dollar and Japanese yen had appreciated, while the Chinese renminbi had depreciated. The Australian dollar had also depreciated to be around its lowest level since 2009.

Overall, global financial conditions remained accommodative, in part because of ongoing stimulus delivered by central banks. After some easing of monetary policies in 2019, central banks in the major advanced economies had indicated that their current policy settings were likely to remain appropriate for some time. Central banks in the United States, Europe and Japan had recently left policy settings unchanged, noting that some downside risks had receded for the time being. However, they had also signalled that they were prepared to ease policy further if necessary, and markets were expecting some further easing in the United States, the United Kingdom and Canada in the year ahead. In China, the central bank had recently implemented targeted measures to support economic growth, including by providing additional liquidity to the financial system.

Corporate financing conditions had generally remained favourable, including in Australia. Credit spreads were at low levels and global equity prices had been higher over recent months, notwithstanding the volatility associated with the coronavirus outbreak. Members noted that equity market valuations were high relative to earnings in a number of economies, which could be explained partly by low long-term bond yields keeping overall discount rates low relative to history.

Domestically, the reductions in the cash rate in 2019 had seen bank funding costs and lending rates reach historic lows. The major banks were estimated to be paying interest of 25 basis points or less on a little over one-quarter of their deposit funding. Around 60 basis points of the 75 basis point reduction in the cash rate since mid 2019 had been passed through to standard variable mortgage rates. However, the actual rates that households were paying on their outstanding variable-rate loans had declined by more than this, with the average rate declining by almost 70 basis points over the same period. This additional decline reflected strong competition among lenders for high-quality borrowers and households continuing to switch from (more expensive) interest-only loans. If this were to continue, by around mid 2020 the average rate paid on outstanding variable-rate mortgages would have declined by around 75 basis points since May 2019.

Households’ total mortgage payments increased in the December quarter, with a rise in principal and excess payments more than offsetting the decline in interest payments. Members discussed whether this increase reflected a change in behaviour by households and the potential for it to persist. They noted that some households were likely to be repaying their debts faster in response to low growth of their incomes and the earlier fall in housing prices. The process of balance sheet adjustment had been facilitated in part by the reductions in the cash rate as well as by the higher tax refunds for low- and middle-income earners, both of which had boosted disposable incomes.

Consistent with stronger conditions in some established housing markets, housing loan commitments had continued to rise. That had been driven largely by owner-occupiers, and growth in credit extended to owner-occupiers had increased to 5½ per cent on a six-months-ended annualised basis in December. Despite accommodative funding conditions for large businesses, growth in business debt had slowed over the six months to December.

Financial market pricing at the time of the meeting suggested that market participants expected a further 25 basis point cut in the cash rate by mid 2020.

Before turning to the policy decision, members reviewed the policy and academic discussions taking place around the world regarding the operation of macroeconomic policy and monetary policy frameworks in an environment where interest rates are low because of structural factors. These discussions focused on a range of issues, including: the appropriate level and specification of inflation targets; the cases for and against more aggressive monetary policy easing when policy interest rates are near the effective lower bound; the role of forward guidance and strategies for lowering long-term interest rates and their potential side-effects; and the role of fiscal policy. Members also reviewed the international discussions regarding possible changes in the monetary transmission mechanism at low interest rates.

Considerations for Monetary Policy

In considering the policy decision, members observed that the outlook for the global economy remained reasonable, with signs that the slowdown in global growth was coming to an end. The progress in addressing the US–China trade and technology disputes had reduced but not eliminated an important downside risk to global growth. The coronavirus outbreak was a new source of uncertainty. While it was too early to tell what the overall effect would be, the outbreak presented a material near-term risk to the economic outlook for China and for international trade flows, and thereby the Australian economy.

Global financial conditions remained positive. This partly owed to ongoing stimulus delivered by central banks, and financial market participants expected some further monetary easing in some economies. Long-term government bond yields were back at very low levels, including in Australia. Borrowing rates for households and businesses were at historically low levels, and there was strong competition among lenders for borrowers of high credit quality. Conditions in some established housing markets had strengthened, and mortgage loan commitments had also picked up. The Australian dollar had depreciated to be around its lowest level since 2009.

The outlook for the Australian economy was for growth to improve, supported by a turnaround in mining investment and, further out, dwelling investment and consumption. In the short term, the effects of the bushfires were temporarily weighing on domestic growth, but the recovery was likely to reverse the negative effects on GDP by the end of the year. The forecast recovery in consumption growth remained a key uncertainty for the outlook. Consumption had been weak, as households had been gradually adjusting their spending to the protracted period of slow growth in incomes and to the fall in housing prices. Although housing prices had been rebounding nationally, it was too soon to see the response to this in household spending, and it was unclear for how long the period of balance sheet adjustment would continue.

The unemployment rate had declined a little to 5.1 per cent and was expected to remain around this level for some time before declining further to a little below 5 per cent as economic growth picked up. Wages growth was expected to be largely unchanged over the following couple of years. Members agreed that a further gradual lift in wages growth would be a welcome development and was needed for inflation to be sustainably within the 2–3 per cent target range.

In the December quarter, CPI inflation had been broadly as expected at 1.8 per cent over the year. Inflationary pressures had remained subdued, held down by flat housing-related costs. Inflation was expected to increase gradually to 2 per cent over the following couple of years, in response to some tightening in labour market conditions.

Given this outlook, members considered how best to respond.

Members reviewed the case for a further reduction in the cash rate at the present meeting. This case rested largely on the only gradual progress towards the Bank’s inflation and unemployment goals. Lower interest rates could speed progress towards the Bank’s goals and make it more assured in the face of the current uncertainties. In considering this case, the Board took into account that interest rates had already been reduced to a low level and that there are long and variable lags in the transmission of monetary policy. The Board also recognised that the incremental benefits of further interest rate reductions needed to be weighed against the risks associated with very low interest rates. Internationally, concerns had been raised about the effect of very low interest rates on resource allocation in the economy and their effect on the confidence of some people in the community, notably those reliant on savings to finance their consumption. A further reduction in interest rates could also encourage additional borrowing at a time when there was already a strong upswing in the housing market.

The Board concluded that the cash rate should be held steady at this meeting. Members agreed that it was reasonable to expect that an extended period of low interest rates would be required in Australia to reach full employment and achieve the inflation target. The Board would continue to monitor developments carefully, including in the labour market, and remained prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time.

The Decision

The Board decided to leave the cash rate unchanged at 0.75 per cent.