RBA – Page 35 – Digital Finance Analytics (DFA) Blog

RBA Minutes – Global Risks Rising

International Economic Conditions

The RBA released their minutes from their last meeting today. What is clear now is the a weakening global economic outlook may make them cut again, not just a weaker labour market – a significant shift, which actually gives them a paper thin alibi in terms of plausible deniability for bad policy! In fact they spun the local economic outlook more positively.

Yet we know they are considering government bond purchases to drive rates lower. QE is coming.

Members commenced their discussion of the global economy by noting that global growth had remained reasonable, having eased since mid 2018. Near-term indicators relating to trade, manufacturing and investment had remained subdued, although consumption growth had been relatively resilient, supported by strong labour market conditions especially in the advanced economies. Despite wages growth having generally trended higher over the preceding few years, inflation had remained below target in a range of economies.

Growth in major trading partners was expected to slow a little in 2019 and 2020. This outlook had been revised down a little since the May Statement on Monetary Policy in light of the escalation of the US–China trade and technology disputes and the related weakness in indicators of investment. Members noted the recent announcement by the US administration of a 10 per cent tariff to be imposed on a further US$300 billion of Chinese exports to the United States. Further escalation presented a downside risk to the outlook, particularly if heightened uncertainty weighed further on business investment. Members noted that investment intentions had already eased significantly in a number of economies, including the United States and the euro area, and investment had fallen in a number of economies with a high exposure to international trade, including South Korea.

In China, a range of activity indicators suggested that domestic economic conditions had slowed further in the June quarter. Further monetary and fiscal stimulus measures had also been announced. Fiscal support had encouraged investment in infrastructure, while residential construction had continued to grow relatively strongly, which in turn had supported steel production. The outlook for the Chinese economy had been revised lower, largely because of the ongoing US–China trade and technology disputes. Uncertainty about how these disputes would play out and how effective domestic policy measures would be in supporting Chinese demand continued to be an important consideration for the global growth outlook and, from an Australian perspective, the future demand for steel and bulk commodities.

The US–China disputes and the slowing in Chinese domestic demand had affected export and investment growth in the east Asian region. However, exports to the United States had increased for some economies in the region, including Vietnam, as a result of trade diversion. By contrast, growth in consumption in the east Asian region had generally remained more resilient. Growth in output in India had slowed and the outlook was weaker than previously forecast, largely because there had been less fiscal support and trade tensions with the United States were emerging.

In the major advanced economies, risks to the outlook remained tilted to the downside, reflecting the trade disputes. The US economy had continued to grow relatively strongly into the June quarter. This was despite the effects of the trade dispute on the manufacturing sector and on business investment more generally, partly because tight labour markets had supported strong consumption growth. Members noted that the most recent round of tariff announcements would affect US imports of consumption goods from China and could boost US consumer prices to some extent. Further slowing in investment seemed likely as the effect of earlier fiscal stimulus waned and the uncertainty related to the trade and technology disputes persisted.

Weaker global trade and greater uncertainty had also affected growth in output in the euro area. Growth in Japan was expected to be boosted temporarily by spending brought forward ahead of an increase in the consumption tax in October, although weaker external demand had weighed on export growth.

Commodity prices had generally fallen since the previous meeting, partly in response to the escalation of trade tensions in early August. After more than doubling in the first half of 2019, iron ore prices had declined to be below US$100 per tonne. Coal and oil prices had also declined over the previous month. Rural commodity prices had been little changed. Members noted that the terms of trade for Australia in the June quarter had been higher than expected.

Domestic Economic Conditions

Turning to the domestic economy, members noted that GDP growth was expected to have been firmer in the June quarter after three weak quarters. This was partly because resource exports had recovered from earlier supply disruptions and mining investment was likely to be less of a drag on growth. Partial indicators suggested that consumption growth had remained subdued in the June quarter; the volume of retail sales had been subdued and sales of new cars had declined. While dwelling investment was expected to have declined further in the June quarter, public demand and non-mining business investment were expected to have continued to support growth.

Members observed that the lower near-term GDP growth forecast mostly reflected the fact that consumption growth had been weaker than expected over recent quarters. Members noted that consumption growth per capita had been particularly weak recently. The forecast for GDP growth over 2019 had been lowered to 2½ per cent. Growth was expected to pick up to 2¾ per cent over 2020 and to around 3 per cent over 2021. This was supported by a range of factors, including lower interest rates, tax measures, signs of an earlier-than-expected stabilisation in some established housing markets, the lower exchange rate, the infrastructure pipeline and a pick-up in activity in the mining sector.

Members noted that although the outlook for consumption remained uncertain, the risks around the outlook were more balanced than they had been for some time. The low- and middle-income tax offset was expected to boost income growth, with a surge in the lodgement of tax returns since the end of June. In addition, signs of a recovery in some established housing markets suggested that the dampening effect of declining housing prices on consumption could dissipate earlier than had previously been assumed.

The evidence that conditions in housing markets were showing signs of a turnaround had strengthened in July. In Sydney and Melbourne, housing prices had increased, housing turnover appeared to have reached a trough and auction clearance rates had risen further. Outside the two largest cities, housing market conditions had shown tentative signs of improvement; prices had risen in Brisbane, while the pace of decline had slowed in Perth. Rental vacancies had been low in most cities except in Sydney, where they had risen further as new apartments were added to the rental stock.

Members observed that it could take some time for the stabilisation of conditions in the established housing market to translate into a pick-up in construction activity. Indeed, leading indicators suggested that dwelling investment was likely to decline further in the near term. Residential building approvals had declined further over May and June and were around their lowest levels in six years. Timely information from liaison contacts suggested that increased buyer interest had yet to translate into more housing sales. However, members noted that signs of a turnaround in housing markets suggested there were some upside risks to dwelling investment later in the forecast period, particularly given the expected strength in population growth.

Forward-looking indicators for business investment had been mixed. Survey measures of business conditions had been less positive than a year earlier, especially in the retail and transport sectors, but generally had remained around average. By contrast, non-residential building approvals had trended up in recent months and the pipeline of work under way was already quite high. There was also a large pipeline of private sector projects to build transport and renewable energy infrastructure, which was expected to support non-mining business investment.

Although mining investment had declined in the March quarter as large liquefied natural gas (LNG) projects approached completion, the medium-term outlook for mining investment had remained positive. A number of projects had been committed and others were under consideration, which would add to investment in coming years if they went ahead. Members noted that the outlook for mining investment had not been affected by the recent elevated levels of iron ore prices. However, they observed that higher iron ore prices would add to government taxation revenues and boost household income and wealth through dividends and the effect on share prices. At the margin, this could provide greater impetus to spending than currently assumed.

Resource exports had picked up during the June quarter as some supply disruptions to iron ore had been resolved and LNG production had increased further. Resource exports were expected to contribute to growth over the forecast period and the recent depreciation of the Australian dollar was expected to support further growth in service and manufacturing exports.

Members noted that recent labour market data had been mixed. The unemployment rate had remained at 5.2 per cent for the third consecutive month, which was higher than had been expected in May. However, growth in employment had continued to exceed growth in the working-age population in the June quarter and had been stronger than forecast in May. As a result, the employment-to-population ratio and the participation rate had remained around record highs. Over the previous year, there had been a particularly notable increase in the participation rates of women aged between 25 and 54 years and workers aged 65 years and over. Members noted that the increase in participation by older workers had more than offset any tendency for the ageing of the population to reduce aggregate participation in the labour force. Members discussed some of the factors that could be contributing to these trends, including slow income growth, improvements in health and greater flexibility in the labour market.

Leading indicators implied a moderation in employment growth over the following six months: job vacancies had declined slightly over the three months to May (but remained high as a share of the labour force) and firms’ near-term hiring intentions had moderated, to be just above their long-run average. The unemployment rate forecast had been revised higher, with the unemployment rate expected to remain around 5¼ per cent for some time before declining to about 5 per cent as growth in output picked up.

Members noted that the outlook for the labour market was one of the key uncertainties for the forecasts, with implications for growth in wages, household income and consumption. The outlook for wages growth had been revised a little lower because the outlook for the labour market suggested that there would be more spare capacity than previously thought. Private sector wages growth was expected to pick up only modestly, while public sector wages growth would be contained by government caps on wage increases. Members observed that the outlook for household consumption spending could be weaker if households expected low income growth to persist for longer.

Members noted that the June quarter CPI had been largely as expected. Trimmed mean inflation had increased a little to 0.4 per cent in the June quarter, but had remained at 1.6 per cent over the preceding year, consistent with the forecast in May. Headline inflation had been 0.7 per cent (seasonally adjusted), partly because fuel prices had increased by around 10 per cent in the June quarter; over the year, headline inflation had also been 1.6 per cent. Overall, members noted that there had been few signs in the June quarter CPI numbers of inflationary pressures emerging.

Inflation in market-based services had remained steady, which was consistent with a lack of wage pressures in the economy. Inflation in the housing-related components of the CPI had been around historical lows. New dwelling prices had declined again in the June quarter, reflecting the use of bonus offers and purchase incentives by developers to counter the weak housing conditions. Rent inflation had been flat in the quarter in aggregate, but had fallen noticeably in Sydney, consistent with the rising vacancy rate; rent deflation had eased in Perth and had been steady in most other cities. Members noted that low inflation in new dwelling costs and rents, which represent around one-sixth of the CPI basket, was likely to persist in the near term.

There had been an increase in inflation for retail items because there had been some pass-through of the exchange rate depreciation and the drought had boosted certain food prices. These effects were expected to dissipate if there was no further exchange rate depreciation, as is usually assumed in the forecasts, and once normal seasonal conditions returned. Inflation in the prices of administered items and utilities had remained well below typical increases recorded a few years earlier.

Inflation was expected to pick up more gradually than previously forecast because of subdued wage outcomes and the evidence of spare capacity in the economy. The experience of other economies suggested that any pick-up in wages growth might take longer to translate into inflation than in the past. Underlying inflation and headline inflation were both expected to pick up to be a little above 2 per cent over 2021, as spare capacity in the labour market declined and as growth increased to run above potential. Members noted that there were downside risks to some individual CPI components. In the near term, electricity prices could grow at a below-average pace or even fall, and government cost-of-living initiatives could weigh on other items in the CPI basket. Inflation rates for both new dwelling prices and rents were also expected to remain low in the near term, but were more uncertain towards the end of the forecast period.

Financial Markets

Members commenced their discussion of financial markets by noting that central banks in the major economies had eased, or were expected to ease, policy settings in response to downside risks to growth and subdued inflation outcomes. Financial market volatility had increased recently from low levels, in response to the escalation of the trade and technology disputes between the United States and China.

The US Federal Reserve lowered its policy rate target by 25 basis points in July. Market pricing suggested that the federal funds rate was expected to decline by a further 100 basis points or so over the following year. The Federal Reserve noted that the US labour market had remained strong. However, it was perceived by members of the Federal Open Market Committee that there was room for some easing of monetary policy given the implications of global developments for the US economic outlook and subdued inflation pressures. Elsewhere, the European Central Bank (ECB) had foreshadowed additional monetary stimulus unless the outlook for inflation in the euro area improved. The ECB indicated that it could expand its bond-buying program, among other measures, and market pricing suggested that the ECB was likely to reduce its policy rate over the following months. Market participants were also expecting the Bank of Japan to ease monetary policy further in the period ahead.

In response to the shift in the outlook for monetary policy, long-term interest rates had declined to historical lows in several markets, including in Australia. Yields on government bonds were negative for a number of European sovereigns and Japan. In addition, corporate bond spreads were low globally, with a growing portion of corporate debt in the euro area trading at yields below zero. Members discussed the implications of the low level of bond yields for corporate balance sheets and investment.

Global equity markets had declined sharply prior to the meeting, in response to the recent escalation of the trade and technology disputes. Nevertheless, equity market indices were still well above their levels earlier in the year, supported by lower bond yields and expectations that earnings growth would be reasonable. During July, equity market indices in the United States and Australia had reached record high levels.

In foreign exchange markets, prior to the meeting there had been an increase in volatility, from very low levels, in response to the escalation of the trade and technology disputes. In particular, the yen had appreciated against the US dollar while the Chinese yuan had depreciated. Members took note of the market commentary that the US and Japanese authorities could intervene in an effort to lower the value of their currencies. The Australian dollar had depreciated in recent times to be at its lowest level in many years.

In Australia, the reduction in variable mortgage rates had been broadly consistent with the reduction in the cash rate in June and July. The degree of pass-through of the cash rate reductions was also comparable to that observed over the preceding decade. Housing credit growth had declined in June, for both owner-occupiers and investors. At the same time, however, loan approvals had picked up in June, which for investors was the first sizeable increase for some time. This was consistent with other indicators suggesting that the housing market had stabilised over recent months. However, loan approvals to property developers had remained subdued. Members also noted that access to finance for small businesses continued to be tight.

Banks’ debt funding costs and borrowing rates for households and businesses were at historically low levels. Rates in short-term money markets, bank bond yields and deposit rates had all declined to historically low levels. The proportion of bank deposits that attract no interest had increased marginally to be just under 10 per cent. Despite the low level of funding costs, banks’ bond issuance remained subdued. This reflected slow credit growth, along with the banks increasing their issuance of hybrid securities to fulfil new regulatory capital requirements. Members also noted that mergers and acquisitions activity had not been especially high, despite funding conditions being very accommodative for large businesses.

Market pricing implied that the cash rate was expected to remain unchanged in August. A 25 basis points reduction had been fully priced in by November 2019, with a further 25 basis points reduction expected in 2020. The low level of bond yields implied that the cash rate was expected to remain very low for several years.

Members reviewed the experience of other advanced economies with unconventional monetary policy measures over the preceding decade. These measures comprised: very low and negative policy interest rates; explicit forward guidance; lowering longer-term risk-free rates by purchasing government securities; providing longer-term funding to banks to support credit creation; purchasing private sector assets; and foreign exchange intervention. Members considered the key lessons from the international experience, noting that a full evaluation could not be undertaken as many of these measures were yet to be unwound. One key lesson was that the effectiveness of these measures depended upon the specific circumstances facing each economy and the nature of its financial system. Some measures had been successful in reducing government bond yields, which had flowed through to lower interest rates for private borrowers. Other measures had been effective in addressing dislocations in credit supply. Members noted that a package of measures tended to be more effective than measures implemented in isolation. Finally, it was important for the central bank to communicate clearly and consistently about these measures.

Considerations for Monetary Policy

Turning to the policy decision, members observed that the escalation of the trade and technology disputes had increased the downside risks to the global growth outlook, although the central forecast was still for reasonable growth. Uncertainty around trade policy had already had a negative effect on investment in many economies. Members noted that, against this backdrop, the low inflation outcomes in many economies provided central banks with scope to ease monetary policy further if required. Indeed, a number of central banks had reduced interest rates this year and further monetary easing was widely expected. In China, the authorities had taken steps to support economic growth, while continuing to address risks in the financial system.

Overall, global financial conditions remained accommodative. Long-term government bond yields had declined further and were at record lows in many economies, including Australia. Borrowing rates for both households and businesses were also at historically low levels and there was strong competition for borrowers of high credit quality. Despite this, demand for housing credit, particularly from investors, remained subdued, while access to credit for some types of borrowers, especially small businesses, remained tight. The Australian dollar had depreciated to its lowest level in recent times.

Domestically, growth had been lower than expected in the first half of 2019. Looking forward, growth was expected to strengthen gradually, to 2¾ per cent over 2020 and to around 3 per cent over 2021. This outlook was supported by a number of developments, including lower interest rates, higher growth in household income (including from the recent tax cuts), the depreciation of the Australian dollar, a positive outlook for investment in the resources sector, some stabilisation of the housing market and ongoing high levels of investment in infrastructure. Overall, the domestic risks to the forecast for output growth appeared to be tilted to the downside in the near term, but were more balanced later in the forecast period.

Employment growth had been stronger than expected and labour force participation had increased to a record high. However, the unemployment rate had increased and there appeared to have been more spare capacity in the labour market than previously appreciated, although there was uncertainty around the extent of this. The unemployment rate was expected to decline to around 5 per cent over the following couple of years, consistent with the gradual pick-up in GDP growth. Wages growth had been subdued and there were few signs of wage pressures building in the economy. Combined with the reassessment of spare capacity in the labour market, this had led to a more subdued outlook for wages growth than three months earlier.

In the June quarter, inflation had been broadly as expected at 1.6 per cent. Members noted that inflation had averaged a little below 2 per cent for a number of years. In the near term, there were few signs of inflationary pressures building, but, over time, inflation was expected to increase gradually to be a little under 2 per cent over 2020 and a little above 2 per cent over 2021.

Based on the information available and the central scenario that was presented, members judged it 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. Having eased monetary policy at the previous two meetings, the Board judged it appropriate to assess developments in the global and domestic economies before considering further change to the setting of monetary policy. Members would consider a further easing of monetary policy if the accumulation of additional evidence suggested this was 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.

RBA Still Up The Creek Without A Paddle

The latest Statement On Monetary Policy to me seem too optimistic, partly because of the accelerated risks internationally, and partly because their rose tinted spectacles appear to have been turned up to 11! Remember the current rate of growth is weakening, and the trade balance is flattered by ultra-high iron ore prices, which are now coming back. And frankly the statement appears to be an attempt to post rationalise their past poor decisions. We do agree the Government needs to do more, even if the “surplus” is sacrificed as a result.

Lowe’s opening address this morning, where he outlines the main points.

Our central forecast is for the Australian economy to expand by 2½ per cent this year and 2¾ per cent over 2020.

The growth forecast for this year has been revised down since we met six months ago, but the forecast for next year is unchanged. The downward revision this year mainly reflects weak consumption growth. It has become increasingly clear that the extended period of unusually slow growth in household incomes has been weighing on household spending, as has the adjustment in the housing market. Given this experience, the outlook for consumption continues to be the main domestic source of forecast uncertainty.

Even so, looking ahead, there are signs the economy may have reached a gentle turning point. Consistent with this, we are expecting the quarterly GDP growth outcomes to strengthen gradually after a run of disappointing numbers. This outlook is supported by a number of developments including: lower interest rates, the recent tax cuts, a depreciation of the Australian dollar, a brighter outlook for investment in the resources sector, some stabilisation of the housing market and ongoing high levels of investment in infrastructure. It is reasonable to expect that, together, these factors will see growth in the Australian economy return to around its trend rate next year.

The major uncertainty continues to be the trade and technology disputes between the United States and China. These disputes pose a significant risk to the global economy. Not only are they disrupting trade flows, but they are also generating considerable uncertainty for many businesses around the world. Worryingly, this uncertainty is leading to investment plans being postponed or reconsidered. It is also now generating volatility in financial markets and has increased the prospects of monetary easing in many countries. This means that we have a lot riding on these disputes being resolved.

Turning now to the Australian labour market, the unemployment rate, at 5.2 per cent, is a little higher than when we met six months ago. This is despite employment growth having been stronger than we had expected. What has happened is that increased demand for labour has been met with more labour supply, especially by women and older Australians. Reflecting this, a higher share of the Australian adult population is participating in the labour market than ever before. This is good news. But one side-effect of this flexibility of labour supply is that it is harder to generate a tight labour market and so, in turn, it is harder to generate a material lift in aggregate wages growth.

Looking forward, while some slowing in employment growth is expected, the central scenario is for the unemployment rate to move lower to reach 5 per cent again in 2021.

If things evolve in line with this central scenario, it is probable that we will still have spare capacity in the labour market for a while yet, especially taking into account underemployment. This means that the upward pressure on wages growth over the next couple of years is likely to be only quite modest, and less than we were earlier expecting. Caps on wages growth in public sectors right across the country are another factor contributing to the subdued wage outcomes. At the aggregate level, my view is that a further pick-up in wages growth is both affordable and desirable.

Turning now to inflation, the June quarter outcome was broadly in line with expectations, after a run of lower-than-expected numbers in earlier quarters. Over the year to June, inflation was 1.6 per cent, in both headline and underlying terms, extending the period over which inflation has been below the 2–3 per cent medium-term target range. The Reserve Bank Board remains committed to having inflation return to this range, but it is taking longer than earlier expected.

There are a few factors that I would highlight as contributing to the low inflation outcome over the past year. These are: the slow growth in wages; the ongoing spare capacity in the economy; various government initiatives to address cost-of-living pressures on households; and the adjustment in the housing market, which has contributed to unusually low increases in rents and declines in the price of building a new home in some cities. Working in the other direction, the drought and the depreciation of the exchange rate have been pushing some prices up.

Looking ahead, inflation is still expected to pick up, but the date at which it is expected to be back at 2 per cent has been pushed out again. Over 2020, inflation is forecast to be a little under 2 per cent and over 2021 it is expected to be a little above 2 per cent.

At this point, I would like to turn to monetary policy.

When we met with the Committee in February, I indicated that I thought the probabilities of a cash rate increase and a cash rate decrease were broadly balanced. Following that hearing, the situation continued to evolve and the Board reduced the cash rate twice – at its June and July meetings – to a new low of 1 per cent.

A reasonable question to ask is: what changed?

The answer is the accumulation of evidence that the economy could be on a better path than the one we looked to be on. The incoming data on wages, prices, GDP and unemployment all suggested that the Australian economy was some distance from running up against capacity constraints. It also suggested that the day at which inflation was comfortably back within the 2–3 per cent medium-term target range was not getting any closer.

Faced with this evidence, the Board decided that it was appropriate to lower the cash rate, after having kept it unchanged for more than 2½ years. It judged that a lower cash rate would boost jobs and help make more assured progress towards the inflation target.

In the current environment, easier monetary policy mainly works through two channels. The first is that it affects the exchange rate, which is now at the lowest level it has been for some time. The second is that it boosts aggregate household disposable income. I acknowledge that lower interest rates hurt the finances of the many Australians who rely on interest payments and the Board has paid close attention to this issue. At the aggregate level though, for every dollar the household sector receives in interest income, it pays well over two dollars in interest to the banks and other lenders. This means that lower interest rates put more money into the hands of the household sector and, at some point, this extra money gets spent and this helps the overall economy.

At its meeting earlier this week, the Board decided to leave the cash rate unchanged at 1 per cent.

It judged that after having moved twice in quick succession it was appropriate to wait and assess developments both internationally and domestically.

As I mentioned earlier, there have been a number of developments that could be expected to support the Australian economy over the next couple of years. Determining with precision the combined effect of these developments is difficult. It is certainly possible that their combined effect will be greater than the sum of the individual parts. If so, growth would surprise on the upside. Of course, it is also possible that the concerning international developments and the ongoing weak growth in household incomes could see the economy underperform our central scenario. The labour market will continue to provide an important guide as to which path we are on.

It is, nevertheless, reasonable to expect an extended period of low interest rates in Australia. This reflects what is happening both overseas and here at home.

While we might wish it were otherwise, it is difficult to escape the fact that if global interest rates are low, they are going to be low here in Australia too. When the global appetite to save is elevated relative to the appetite to invest – as it is now – interest rates in all countries are affected. Our floating exchange rate gives us the ability to set our own interest rates from a cyclical perspective, but it does not insulate us from long-lasting shifts in global interest rates driven by saving/investment decisions around the world.

In the central scenario that I have sketched today, inflation will be below the target band for some time to come and the unemployment rate will remain above the level we estimate to be consistent with full employment. While this remains the case, the possibility of lower interest rates will remain on the table. The Board is prepared to ease monetary policy further if there is additional accumulation of evidence that this is needed to achieve our goals of full employment and inflation consistent with the target. Time will tell.

As I have discussed on other occasions, if further stimulus to demand growth is required to get us to full employment and closer to the economy’s capacity, monetary policy is not the country’s only option. Monetary policy certainly can help, and it is helping, but there are certain downsides from relying too much on monetary policy.

One option is for fiscal support, including through spending on infrastructure. Spending on infrastructure not only adds to demand in the economy but, done properly, it can boost the economy’s productivity. It can also directly improve the quality of people’s lives through reducing congestion and improving services. At the moment, there are some capacity constraints in parts of the infrastructure sector, but these should not prevent us from looking for further opportunities to boost the economy’s productive capacity and support domestic demand. There is no shortage of finance to do this, with interest rates the lowest they have ever been. This week, all governments in Australia can borrow for 10 years at less than 2 per cent.

Another option is structural policies that support firms expanding, investing, innovating and employing people. A strong, dynamic business sector is the best way of creating jobs and growing the overall economy. We will all do better if Australia is viewed as a great place to expand, invest, innovate and employ people. A program of structural reform would help move us in this direction. It would also help boost productivity growth, which over recent times has slowed noticeably. If this slowing is maintained, it will become a serious issue and as a society we will have to make some difficult adjustments. So it is important that we think about the possibilities here, not just from a short-term perspective but from a long-term perspective as well.

RBA Holds This Month

Latest from the RBA… The Statement On Monetary Policy to come Friday, will be.. well… interesting!

At its meeting today, the Board decided to leave the cash rate unchanged at 1.00 per cent.

The outlook for the global economy remains reasonable. However, the increased uncertainty generated by the trade and technology disputes is affecting investment and means that the risks to the global economy remain tilted to the downside. In most advanced economies, unemployment rates are low and wages growth has picked up, although inflation remains low. The slowdown in global trade has contributed to slower growth in Asia. In China, the authorities have taken steps to support the economy, while continuing to address risks in the financial system.

Global financial conditions remain accommodative. The persistent downside risks to the global economy combined with subdued inflation have led a number of central banks to reduce interest rates this year and further monetary easing is widely expected. Long-term government bond yields have declined further and are at record lows in many countries, including Australia. Borrowing rates for both businesses and households are also at historically low levels. The Australian dollar is at its lowest level of recent times.

Economic growth in Australia over the first half of this year has been lower than earlier expected, with household consumption weighed down by a protracted period of low income growth and declining housing prices. Looking forward, growth in Australia is expected to strengthen gradually from here. The central scenario is for the Australian economy to grow by around 2½ per cent over 2019 and 2¾ per cent over 2020. The outlook is being supported by the low level of interest rates, recent tax cuts, ongoing spending on infrastructure, signs of stabilisation in some housing markets and a brighter outlook for the resources sector. The main domestic uncertainty continues to be the outlook for consumption, although a pick-up in growth in household disposable income and a stabilisation of the housing market are expected to support spending.

Employment has grown strongly over recent years and labour force participation is at a record high. There has, however, been little inroad into the spare capacity in the labour market recently, with the unemployment rate having risen slightly to 5.2 per cent. The unemployment rate is expected to decline over the next couple of years to around 5 per cent. Wages growth remains subdued and there is little upward pressure at present, with strong labour demand being met by more supply. Caps on wages growth are also affecting public-sector pay outcomes across the country. A further gradual lift in wages growth would be a welcome development. Taken together, recent labour market outcomes suggest that the Australian economy can sustain lower rates of unemployment and underemployment.

The recent inflation data were broadly as expected and confirmed that inflation pressures remain subdued across much of the economy. Over the year to the June quarter, inflation was 1.6 per cent in both headline and underlying terms. The central scenario remains for inflation to increase gradually, but it is likely to take longer than earlier expected for inflation to return to 2 per cent. In both headline and underlying terms, inflation is expected to be a little under 2 per cent over 2020 and a little above 2 per cent over 2021.

Conditions in most housing markets remain soft, although there are some signs of a turnaround, especially in Sydney and Melbourne. Growth in housing credit remains low. Demand for credit by investors continues to be subdued and credit conditions, especially for small and medium-sized businesses, remain tight. Mortgage rates are at record lows and there is strong competition for borrowers of high credit quality.

It is reasonable to expect that an extended period of low interest rates will be required in Australia to make progress in reducing unemployment and achieve more assured progress towards the inflation target. The Board will continue to monitor developments in the labour market closely and ease monetary policy further if needed to support sustainable growth in the economy and the achievement of the inflation target over time.

BBSW Dives Some More, And What To Expect This Week.

Following the rates cuts, the Bank Bill Swap Rate has continued to fall.

It is now more than 1.10% lower than its recent peak. This should help to support bank margins, so it will be interesting to see what is reported in the next few days as the bank reporting season fires up.

On Wednesday we will get CBA and Suncorp, and on Thursday AMP, among others.

On Friday we will get the latest Statement on Monetary Policy – watch out for their latest estimates of GDP and inflation, and Philip Lowe will also be testifying before Parliament, after the latest RBA meeting on Tuesday, where most expect no further rate change.

Finally, watch for the job ads data on Tuesday – to see if the rate cuts have lifted job opportunities as the RBA is hoping!

And by the way, it is a “bank holiday” in NSW today!

The Latest On Credit Growth, CPI And Other Things (A Shocker)

We review the latest data from the RBA, APRA and ABS, plus higher mortgage delinquencies and the new bill to clamp down on cash transactions. A lot to talk about!

Full show on the war on cash: https://youtu.be/770M2s6ZD8Y

The RBA On Inflation Targeting [Podcast]

We review the latest from the RBA – is their stance appropriate?

Digital Finance Analytics (DFA) Blog

The RBA On Inflation Targeting [Podcast]

00:00 / 00:12:18

RBA On Inflation Targeting and Economic Welfare

RBA Governor Philip Lowe spoke today, and there were some important points.

First, expect rates to be lower for longer. ” It is highly unlikely that we will be contemplating higher interest rates until we are confident that inflation will return to around the midpoint of the target range”.

Second, the RBA has more capacity to cut if required (we think they will).

Third, moving the 2-3% inflation target band is not something they would want (the Treasurer is currently reviewing the RBA’s mandate and target!). They do not want to “shift the goalposts”!

Here is the speech:

I would like to start by winding the clock back, not by three years, but instead by 40 years. It was 40 years ago that I started studying economics in high school in Wagga Wagga. I sat the 3 unit economics exam for the Higher School Certificate (HSC) in 1979. At that time, the standard exam question was in two parts: why did Australia have both high inflation and high unemployment and what should policy do about it? I recall writing numerous essays on this troubling topic.

I also recall learning about the Misery Index. For those of you whose memories don’t go back that far, this index is the sum of the unemployment rate and the inflation rate. Few people talk about this index these days, but I thought it would be useful to show it to you as background (Graph 1). As you can see, things were pretty miserable in the 1970s and 1980s. Today, though, at least according to this metric, they are not too bad. The Misery Index is now as low as it has been since the late 1960s. Today, we are living in a world of low and stable inflation and low unemployment. It is useful to remind ourselves of this sometimes.

So this means that today’s HSC students are likely to be writing about why inflation is so low at the same time that unemployment is also low. I hope that they are also being asked to write about how public policy should respond to low inflation and its close cousins of slow growth in nominal wages and household incomes.

These are important issues to be thinking about. Given this, I would like to use this opportunity to address two related questions that I am asked frequently.

The first of these is why is inflation so low globally and in Australia?

And the second is, is inflation targeting still appropriate in this low inflation world?

I will then draw on my answers to make some remarks about monetary policy here in Australia.

1. Why is Inflation so Low?

It is useful to start off with a couple of graphs.

The first is the average rate of inflation globally (Graph 2). The picture is pretty clear. Global inflation declined over the three decades to the early 2000s and has been low and stable for some time.

Low inflation has become the norm in most economies. This is evident in this next graph, which shows the share of advanced economies with a core inflation rate below 2 per cent and below 1 per cent (Graph 3). Currently, three-quarters of advanced economies have an inflation rate below 2 per cent, and one-third have an inflation rate below 1 per cent.

Graph 3: Distribution of Inflation — Graph 3

The obvious question is why this has happened?

There is no single answer. But there are three factors that, together, help explain what has happened. These are: the credibility of the current monetary frameworks; the continuing existence of spare capacity in parts of the global economy; and structural factors related to technology and globalisation.

I will say a few words about each of these.

First, the credibility of the monetary frameworks. One of the responses to the high inflation rates of the 1970s and 1980s was to put in place monetary frameworks with a strong focus on inflation control. In some countries, this took the form of rewriting the law to require the central bank to focus on just one thing: inflation. Many countries also adopted an inflation target, with monetary policy decisions being explained primarily in terms of inflation.

This increased focus on inflation has helped cement low inflation norms in our economies. Many people understand that if inflation were to pick up too much, the central bank would respond to make sure the pick-up was only temporary. This means that workers and firms can make their decisions on the basis that the rate of overall inflation will not be too different from the target rate. This has made the system less inflation prone than it once was.

The second explanation for low inflation is the continuing existence of spare capacity in parts of the global economy.

The existence of spare capacity was an important factor explaining low inflation in the aftermath of the global financial crisis. And today, it remains a factor in some countries, including here in Australia. But, on the surface, it is a less convincing explanation for low inflation in countries where unemployment rates are now at multi-decade lows. Based on conventional measures of capacity utilisation, these economies are operating close to their sustainable limits. One explanation for continuing low inflation in this environment is that the current rate of aggregate demand growth is simply not fast enough to put meaningful pressure on capacity. If so, stronger demand growth would be expected to see inflation pick up. Another possibility is that the unemployment rate, by itself, no longer provides a good guide to spare capacity, partly due to the flexibility of labour supply. I will come back to this idea in the discussion of inflation outcomes in Australia.

The third explanation is that globalisation and advances in technology have changed pricing dynamics. There are two main channels through which this appears to be happening. The first is by lowering the cost of production of many goods. And the second is by making markets more contestable and increasing competition. The main effect of these changes should be on the level of prices, rather than on the ongoing rate of inflation. But this level effect is playing out over many years, so it appears as persistently low inflation.

It is widely accepted that the entry into the global trading system of hundreds of millions of people with access to modern technology put downward pressure on the prices of manufactured goods. Reflecting this, goods prices in the advanced economies have barely increased over the past couple of decades (Graph 4). But the effects of globalisation and technology extend beyond this and into almost every corner of the economy, including the services sector.

Graph 4: Advanced Economies - Core Inflation — Graph 4

In today’s globalised world, there are fewer and fewer services that can be thought of as truly non-traded. Many services can now be delivered by somebody in another country. Examples include: the preparation of architectural drawings, document design and publishing, customer service roles and these days many people in professional services work with team members located in other countries. In addition, many tasks, such as accounting and payroll, are being automated. All this has been made possible by technology and by globalisation.

The new global technology platforms have also revolutionised services such as retail, media and entertainment, and transformed how we communicate and search for information and compare prices.

These changes are having a material effect on pricing, with services price inflation lower than it once was. Many firms know that if they don’t keep their prices down, another firm somewhere in the world might undercut them. And many workers are concerned that if the cost of employing them is too high, relative to their productivity, their employer might look overseas or consider automation. And, more broadly, better price discovery keeps the competitive pressure on firms. The end result is a pervasive feeling of more competition. And more competition normally means lower prices.^[1]

So these are the three important factors that are contributing to low inflation. None of them by themselves is sufficient to explain what is happening, but together they are having a powerful effect. The current high inflation rates in Argentina and Turkey remind us that globalisation and technology, by themselves, do not drive low inflation. The monetary framework clearly matters too. Weaknesses in that framework still result in high inflation.

2. Is Inflation Targeting Still Appropriate?

This brings me to my second question: is inflation targeting still the appropriate monetary framework for most countries?

It is understandable that people are asking this question. Given the factors that I have just discussed, some commentators have argued that central banks will find it increasingly difficult to achieve their inflation targets. Some then go on to argue that central banks should just accept this, not fight it; perhaps they should shift the goal posts, or even adopt another monetary framework. A related argument is that the very low interest rates that have accompanied the pursuit of inflation targets are pushing up asset prices in an unsustainable way and sowing the seeds for damaging problems in the future.

You might, or might not, agree with these perspectives. Either way, it is reasonable to ask if we are on the right track: is inflation targeting still appropriate?

Before I address this question, I would like to push back against the idea that central banks simply can’t achieve their inflation targets. As we all know, some central banks have struggled to achieve their targets over a long period of time; Japan and the euro area are the obvious examples. But this is not a universal experience. Over recent times, inflation has been around target in Canada, Norway, Sweden and the United Kingdom. So the experience is mixed (Graph 5).

Graph 5: Core Inflation in Advanced Economies — Graph 5

There is no single factor that explains this mixed experience. But countries that are operating nearer to full capacity are more likely to have inflation close to target. It also appears that if you have an extended period of very low inflation – as did Japan and the euro area – it is harder to get back to target as a deflationary mindset takes hold. It is also possible that demographics may be playing a role, although the evidence here is mixed.

Overall, these varying experiences do not support the idea that it has become impossible for central banks to achieve their targets.

Here in Australia, some have argued that a lower inflation target would be a good idea given the ongoing low rates of inflation; that we should adjust our formulation of 2–3 per cent, on average, over time. Lowering the target might have the short-run advantage of allowing us to say we have achieved our goal, but shifting the goalposts hardly seems a good way to build long-term credibility. Shifting the goal posts could also entrench a low inflation mindset.

More broadly, over recent years the international debate has gone in the other direction: that is, to argue for a higher, not lower, inflation target. The argument is that a higher rate of inflation – and thus a higher average level of interest rates – would promote economic welfare by providing more room to lower interest rates, without running up against the lower bound. This greater flexibility for monetary policy could stabilise the economy when it was hit with a negative shock. To be clear, I am not arguing for a higher inflation target, but rather acknowledging there are arguments in both directions.

This brings me back to the question: is inflation targeting still appropriate?

The short answer is yes, but it is important to be clear what this means in practice.

Inflation targeting can mean different things to different people. It comes in different shapes and sizes. Some versions require a central bank to focus on inflation alone and set monetary policy so that the forecast rate of inflation is equal to the target. But inflation targeting does not need to be rigid like this.

In my view, an inflation targeting regime should consist of the following four elements.

The inflation target should establish a clear and credible medium-term nominal anchor for the economy. A high degree of uncertainty about future inflation hurts both investment and jobs. The economy works best if there is a degree of predictability. Most people can cope with some variation in the inflation rate from year to year. But dealing with uncertainty about what inflation is likely to average over the medium term is more difficult. Inflation targeting plays an important role in reducing that uncertainty by providing a strong nominal anchor.
The inflation target should be nested within the broader objective of welfare maximisation. It is worth remembering that inflation control is not the ultimate objective. Rather, it is a means to an end. And that end is the welfare of the society that we serve. I sometimes feel that as some central banks sought to establish their credentials as inflation fighters they over-emphasised the importance of short-run inflation outcomes. And this has been difficult to walk back from. Some central banks have been concerned that if they gave weight to other considerations, the community might doubt their commitment to inflation control. So, it became all about inflation. But central banks have a broader task than just controlling inflation in a narrow range. They play an important role in preserving macroeconomic stability and thus the steady creation of jobs. Also, their decisions affect borrowing and asset prices and thus financial stability too. Central banks have to determine how to balance these considerations when making monetary policy decisions. This means it makes sense for inflation targeting to be embedded within the broader objective of maximising the welfare of society.
The inflation target should have a degree of flexibility. This is not to say that the target itself should be flexible; this would diminish its usefulness in providing a medium-term anchor. Rather, some variation in inflation from year to year is acceptable and indeed unavoidable. How much variation is too much is difficult to know, but the variation should not be so large that it generates doubt about the commitment of the central bank to achieving the target over time.
The inflation target needs to be accompanied by a high level of accountability and transparency. If the inflation target is operated flexibly and is nested within the broader objective of welfare maximisation, the central bank has a degree of discretion. It is important that when exercising this discretion, the central bank is transparent. Problems can arise if the community doesn’t understand the central bank’s actions, or if they see it as acting unpredictably or inconsistently with its mandate. This means you should expect us to explain what we are doing, why we are doing it and how we are balancing the various trade-offs.

So these are the four elements that I see as important to an effective inflation-targeting regime.

We have all four elements in Australia. Our commitment to deliver an average inflation rate over time of 2 point something provides a strong nominal anchor. We have always viewed the inflation target in the wider context, reflecting the broad mandate for the RBA set out in the Reserve Bank Act 1959. That Act was passed 60 years ago and has stood the test of time. The RBA was also one of the earliest advocates of flexible inflation targeting – this is evident in our use of the words, ‘on average, over time’ when describing our target. We also place a heavy emphasis on explaining our decisions and their rationale to the community.

Our overall assessment is that Australia’s monetary policy framework has served the country well over the past three decades. The flexibility that has always been part of our regime has helped underpin a strong and stable economy and has helped Australia deal with some very large economic shocks. We are not inflation nutters. Rather, we are seeking to deliver low and stable inflation in a way that maximises the welfare of our society.

Over the nearly 30 years we have had the inflation target, inflation has averaged 2.4 per cent, very close to the midpoint. It has, however, been below this average over recent years and I will talk about this in a few moments.

Before I do so, it is important to note that we periodically review the formulation of the current target and examine alternative monetary frameworks, including at our annual conference last year.^[2] We are also monitoring closely the discussions that are taking place in the academic community and in other central banks. In my view, the evidence does not support the idea that a change to our inflation target would deliver better economic outcomes than achieved by our current flexible inflation target. Some alternative frameworks would also be more difficult to implement and/or be harder to explain to the community. But it is important that we regularly examine the arguments.

Australian Monetary Policy

I would now like to discuss recent inflation outcomes and monetary policy in Australia.

Like other countries, Australia has had low inflation over recent years. Over the past four years, headline inflation has mostly been below 2 per cent, although it has been slightly above that mark on a couple of occasions (Graph 6). In underlying terms, inflation has been below the band for three years.

Given this history, it is reasonable to ask why this happened and how the Reserve Bank Board has thought about it.

I will first focus on the period from late 2016 to late 2018. Through most of this period, gradual progress was being made in returning inflation to target and the unemployment rate was moving lower. Inflation was on a gentle upswing and the unemployment rate was coming down more quickly that we had expected. Reflecting this, in August 2017 the two-year ahead inflation forecast was 2½ per cent. Since then it has been lower than this, at 2–2¼ per cent.

Throughout this period, the Board discussed the case for seeking a faster and more assured return of inflation to around the midpoint of the target range. It was natural to be discussing this because having inflation around the midpoint of the target range allows more scope for surprises in either direction.

As you know, in the end the Board did not adjust interest rates through this period. It judged that seeking to achieve a faster return of inflation to the midpoint of the target range would have been accompanied by more rapid growth in debt, at a time when household balance sheets were already very extended. Our judgement was that, given the progress that was being made towards our goals, it was appropriate to use the flexibility in our inflation target to pursue a course that was more likely to be in the country’s long-term interest. We could have generated a bit more inflation, but we would have had faster growth in household debt as well.

I acknowledge that others might see this trade-off differently. But given the unemployment rate was coming down and inflation had lifted from its trough, we did not see a strong case for monetary easing.

Towards the end of last year, that assessment began to shift. Inflation was turning out to be lower than we had earlier expected and our forecasts for inflation were being marked down. There are a few reasons for this, but the one I want to highlight today is the flexibility of labour supply, as this links back to my earlier discussion of the reasons for low inflation globally.

When we prepared our forecasts in mid 2017, we did so on the basis that the share of the adult population participating in the labour market (the participation rate) would remain steady over the next couple of years (Graph 7). At the time, this was considered a reasonable forecast: while we expected some increase in participation from an encouraged worker effect because of solid employment growth, we thought this would be offset by the ageing of the population.

Since then, things have turned out quite differently. Employment growth has been much stronger than expected and the participation rate has risen by 1½ percentage points, which is a large change over a fairly short period. Put simply, the strong demand for labour has been met by more labour supply.

It is useful to consider the following thought experiment. Suppose the participation rate had still risen materially, but by ¾ per cent, rather than 1½ per cent. All else constant, this would have meant the unemployment rate today would have been well below 5 per cent.

This flexibility of labour supply is a positive development and has meant that strong employment growth has not tested the economy’s supply capacity. More demand for workers has been met with more labour supply. This has contributed to the subdued wage outcomes over recent times, which in turn has contributed to the low inflation outcomes.

The more flexible supply side means that employment growth can be stronger without fears of overheating. At the same time, the unemployment rate that would put upward pressure on inflation is also lower than it once was.

As the evidence accumulated in support of these propositions, the outlook for monetary policy changed and the Board lowered the cash rate in June and July. In making these decisions the Board also recognised that the earlier concerns about the trajectory of household debt had lessened. The Board has also paid attention to the shift in the outlook for monetary policy globally.

These two recent reductions in the cash rate will support demand in the Australian economy. So too will recent tax cuts, higher commodity prices, some stabilisation in the housing market, ongoing investment in infrastructure and a lift in resource sector investment. We also need to remember that the underlying foundations of the Australian economy remain strong.

It remains to be seen if future growth in demand will be sufficient to put pressure on the economy’s supply capacity and lift inflation in a reasonable timeframe. It is certainly possible that this is the outcome. But if demand growth is not sufficient, the Board is prepared to provide additional support by easing monetary policy further. However, as I have discussed on other occasions, other arms of public policy could also play a role in this scenario.

Whether or not further monetary easing is needed, it is reasonable to expect an extended period of low interest rates. On current projections, it will be some time before inflation is comfortably back within the target range. The Board is strongly committed to making sure we get there and continuing to deliver an average rate of inflation of between 2 and 3 per cent. It is highly unlikely that we will be contemplating higher interest rates until we are confident that inflation will return to around the midpoint of the target range.

The RBA On The Committed Liquidity Facility

The RBA’s Christopher Kent, Assistant Governor (Financial Markets) spoke about the CLF today. Look carefully, as banks effectively can cross collateralise via each others mortgage backed securities – what could possibly go wrong?

I’d like to thank Bloomberg for the opportunity to speak to you about the committed liquidity facility (CLF). The CLF has been in place now for almost five years.

As we announced in June, after a careful review, the RBA will be adjusting the settings of the CLF starting from next year.^[1] Today, I thought it would be helpful to discuss the developments that have led us to make these adjustments. We have also published a detailed article on this on the RBA’s website.^[2] But first, let’s review why we needed the CLF in the first place.

Why Do We Need a CLF?

The global financial crisis highlighted how important it is for banks to manage their liquidity risk. During the crisis, many banks overseas faced significant liquidity problems having not paid enough attention to their liquidity management in the lead up to the crisis.

Following this experience, the Basel Committee on Banking Supervision proposed tougher liquidity requirements as part of its broader package of reforms, known as the Basel III regulations. These changes have made the banking system more resilient to periods of financial market stress.

One of the key planks of the requirement to increase liquidity of the banks was the introduction of the liquidity coverage ratio (LCR). The LCR requires banks to have enough high-quality liquid assets (HQLA) to cover their estimated net cash outflows during a scenario that entails a 30-day period of stress. The idea is that a bank experiencing stress will have enough liquid assets that they can use to meet their short-term liquidity needs. In this way, each bank holds a sufficient amount of HQLA as self-insurance against liquidity risk. Like all insurance, this comes at a cost. In this case, the cost to each bank is incurred because the HQLA earn a lower yield than alternative, less liquid assets that the bank could otherwise hold, such as mortgages or business loans.

For HQLA securities to be of sufficient quality and liquidity, they should be both low risk and actively traded in markets. In Australia’s case, Australian Government Securities (AGS) and securities issued by the state and territory borrowing authorities (semis) meet this test. In contrast, there is relatively little trading in other Australian dollar securities, such as those issued by foreign agencies (supras), banks and securitisation trusts (Graph 1).

Graph 1: Monthly Turnover Ratio for AUD Bonds — Graph 1

However, there is less government debt in Australia relative to the size of the banking system, and the economy more generally, than is the case in many other countries (Graph 2). This means that there are fewer HQLA in Australia. Indeed, back in 2015, if there had been no other way for Australian banks to meet their LCR, collectively they would have had to have held around two-thirds of the total stock of AGS and semis. And if the banks had held such a high share of those government securities, the liquidity of those markets would have been substantially impaired, thereby defeating the purpose of them being counted on as HQLA.

Graph 2: Gross Government Debt — Graph 2

In recognition of this issue, the Basel liquidity standards allow jurisdictions with limited HQLA to use alternative approaches. One of those approaches is for the central bank to offer a facility to provide banks with a guaranteed source of liquidity.^[3] And so the CLF was born. This entails the central bank committing to stand ready to provide a bank with liquidity against high-quality collateral that would otherwise be illiquid in the market. This commitment can be counted by banks towards meeting their LCR. In return for the CLF, banks are charged a fee on the entire committed amount, whether or not it is actually drawn upon. This fee is akin to the insurance premium that banks would implicitly pay if instead of the CLF, they had to hold additional HQLA.

Starting from 2015, the RBA has provided the CLF as part of Australia’s implementation of the Basel III liquidity reforms.^[4]

The First Five Years of the CLF

Under the CLF, the RBA commits to provide liquidity under repo against securities eligible in its operations. To access the CLF, a bank must meet several conditions: it must have paid its CLF fee; the bank’s CEO has to have attested that the bank has positive net worth; and the RBA has to have judged that this is indeed the case.^[5]

In the five years since the CLF was introduced, 15 banks have applied to APRA for access to the CLF. None of these banks have needed to draw on the facility in response to a period of financial stress.

Each year, APRA determines the total size of the CLF. It’s the difference between the banking system’s liquidity needs and the amount of AGS and semis that the RBA assesses that the banks can hold without impairing the functioning of the market. The size of the CLF was set at $274 billion in 2015. As an input to this, the RBA assessed that the banks could reasonably hold 25 per cent of the stock of AGS and semis. This was a sizeable step up from their holdings earlier in the decade (Graph 3).

Graph 3: CLF ADIs’ Holdings of AUD HQLA Securities — Graph 3

However, since then, the stock of AGS and semis has increased by almost a third. In comparison, the LCR requirements of the banks have been little changed. So the banks can hold more HQLA securities compared to their liquidity needs. As a result, the size of the CLF has declined to just below $250 billion. The increase in AGS and semis also means that the shortage of HQLA securities is not as large as it once was, although there is still a shortage.

Reassessing the Banks’ Reasonable Holdings of HQLA Securities

To assess the amount of HQLA securities that the banks can reasonably hold, the RBA takes into account the behaviour of other holders of these securities, along with conditions in bond and repo markets.

In 2015, a large share of Australian government debt was held by what can be described as ‘buy and hold’ investors. That is, these investors were not particularly sensitive to the prices of these securities, and typically they did not contribute to liquidity in the market. Many of these investors were non-residents, which were holding nearly 60 per cent of the total stock of HQLA securities earlier in the decade (Graph 4).

Graph 4: Non-resident holdings of HQLA Securities — Graph 4

However, over recent years more HQLA securities have become available for use as collateral. In particular, the Australian repo market has grown substantially, driven by more HQLA securities being sold under repo. Of note, non-residents have been lending more of their holdings of AGS and semis back into the domestic market (Graph 5).

Graph 5: Repurchase Agreements — Graph 5

Also, our analysis of transactions in bond and repo markets demonstrates that most HQLA securities were being actively traded. Turnover ratios for individual AGS bond lines were well above zero and much higher than for other Australian dollar securities. Although semis were traded less frequently than AGS, only a small share of the bond lines of semis had low turnover ratios (Graph 6). Given this, it appears unlikely that a moderate increase in banks’ holdings of AGS and semis would present a problem for liquidity in these markets.

Graph 6: Bonds with Low Turnover Ratios — Graph 6

Another issue we considered in 2015 was the ‘scarcity premium’ that was present for AGS. Australia’s relatively strong economic performance and AAA credit rating have been very appealing for investors globally. The scarcity premium was prominent in the years leading up to 2015, when the yield on AGS was well below the expected cash rate over the period to maturity (Graph 7). Since then, however, the scarcity premium has gradually dissipated. This has occurred alongside an increase in the stock of AGS. It is also consistent with these securities being less tightly held. The combination of these changes suggests that the banks can now hold a higher share of the AGS on issue without impairing the functioning of the market.

Graph 7: Spread of Three-year AGS to OIS — Graph 7

This brings us to the first of two changes that we have made to the settings of the CLF. We have assessed that banks can increase their holdings of HQLA securities from 25 to 30 per cent of the outstanding stock. This will result in the CLF being smaller than it otherwise would have been. To minimise the effect of this change on the market, the increase will occur at the gradual pace of 1 percentage point each year, beginning with an increase to 26 per cent in 2020.

Setting the CLF Fee

The second change we are implementing relates to the CLF fee.

The CLF fee should be set at a level at which banks will face similar financial incentives to meet their LCR through the CLF or by holding HQLA (if there were enough available). However, determining this level of the fee is easier to do in theory than in practice.

The starting point for determining the fee is to make use of the spread between the yields on HQLA securities and the collateral that the banks hold for the CLF. This collateral is all eligible for the RBA’s market operations, and is mainly the banks’ self-securitised residential mortgage backed securities. We have estimated that this spread was around 90 basis points earlier this year. But the higher yield on CLF collateral reflects compensation for a variety of risks. In particular, a sizeable share of the spread owes to the higher credit risk on these securities. However, the CLF fee should only reflect the liquidity risk component of the spread, and that is very difficult to identify separately.^[6]

When the Reserve Bank set the CLF fee earlier this decade, it looked at repo rates on some CLF-eligible securities to gauge how much a one-month liquidity premium might be worth. The answer was not very much in normal circumstances. Based on data from the RBA’s open market operations, it was estimated to be around 10 basis points. However, given that part of the point of the liquidity reforms was to recognise that the market had underpriced liquidity in the past, it was judged to have been appropriate to set the fee at 15 basis points.

Now that we have several years of experience with the CLF, we can look back and see how the banks have responded to the existing framework. Since the CLF was introduced, the banks, in total, have consistently overestimated their ‘net cash outflow’ projections in their CLF applications for the following year.^[7] These projections were used by APRA to determine the size of the CLF. As a result, the banks have been granted a larger CLF than would have been the case had the net cash outflow projections been more accurate ex ante (Graph 8). In recent years, the banks have also been holding fewer HQLA securities than the RBA judged that they could reasonably hold. Taken together, these observations suggest that the CLF fee should be set at a higher rate in the future.

Graph 8: Banks’ Liquidity Needs and HQLA — Graph 8

A higher CLF fee will help to make the banks indifferent between holding more HQLA securities and asking for a larger CLF. However, if the fee is too high, this could trigger a disruptive shift away from using the CLF facility and create distortions in the markets that use HQLA. Accordingly, we have concluded that the fee should be increased moderately and occur in two steps. The fee will rise from 15 to 17 basis points in January 2020 and to 20 basis points in January 2021.

When taken together, these two changes to the settings for the CLF will result in a small increase in the cost of the CLF for the banks. To show this, we can fully apply the new settings to the current CLF amounts, assuming everything else is held constant. If the banks were holding the higher level of AGS and semis that the RBA has assessed would be reasonable, this would reduce the size of the CLF from just below $250 billion to around $200 billion. If we then apply the 5 basis points total increase in the CLF fee, collectively the banks would pay around $30 million more than they do currently for the liquidity commitment they receive from the RBA.^[8]

Conclusion

In conclusion, the CLF is important for Australia’s implementation of the Basel III liquidity reforms. The facility has been working well, but after five years it is time to make some modest and gradual adjustments to the settings, in a way that reduces the need of the banks to make use of the CLF while also increasing their cost of doing so a little. In combination, these changes will help to ensure that the banks continue to have strong incentives to manage their liquidity risk appropriately.

RBA On Household Debt And Financial Stress – FOI

The RBA released a freedom of information request today. They say:

Household debt-to-income has drifted up, to 190 per cent (Graph 1 – broad measure, includes debt of unincorporated enterprises, new migrants’ offshore debt, HECS and to non-financials).
More frequently we cite housing debt-to-income which has increased to over 140 per cent (up 23 percentage points over five years) (Graph 2); net of offset accounts this is around 130 per cent (up 16 percentage points over five years).
High income and wealthy households hold a large proportion of household debt (Graph 3). In 2015-16 the top income quintile accounted for about 40 per cent of total debt and the top wealth quintile owed one-third of total debt; this share has been stable over time.
Debt servicing ratios have been broadly steady: falling rates offset rising debt.
Aggregate mortgage prepayments (offsets and redraws) are equivalent to 18 per cent of outstanding mortgages and nearly 3 years of scheduled repayments at current interest rates (Graph 4). One-third have no buffer: many are investors, on fixed-rate or new borrowers. Largest buffers typically: wealthier, higher income and more seasoned mortgages.

The housing non-performing loan (NPL) ratio has increased since the end of 2015 (mostly WA), but remains below the most recent peak in 2011 (Graphs 5 and 6).
NPL ratios for personal loans and credit cards remain high relative to recent history (personal credit is only about 4 per cent of banks’ household lending).
Broad data sources suggest the number of households experiencing financial stress has fallen over the past decade, but there are regional variations. Household Expenditure Survey (2015/16): the number of households experiencing financial stress has fallen steadily since the mid-2000s (Graph 7). HILDA (2016): measures of financial stress are little changed over the decade and are lower than the early 2000s (Graph 8).
ASIC’s recent report on credit cards links problematic debt with multiple credit card usage, corroborating messages from liaison (but overall more households are paying off each month).
Some private surveys point to rising mortgage stress. These surveys are timely but their methodologies often seem to overstate financial stress (e.g. using actual, rather than required mortgage payments, which include prepayments).

Concerns about stress when IO loan converts to a principal-and-interest (P&I) loan. Required repayments are estimated to increase by 30-40 per cent (about $7,000 per year) for a ‘representative interest-only borrower with a $400,000 mortgage converting to P&I.
Based on loans in the Securitisation Dataset, a large share of borrowers should qualify for an IO extension or could refinance with a different lender.
Borrowers that can’t meet new lending standards and are unable to service P&I repayments might sell their properties or default. We estimate this is a small group (eg borrowers with multiple highly leveraged investment properties).
Tighter lending standards are unlikely to bind for borrowers that: undertook a serviceability assessment at loan origination that already took into account the step up in repayments at the end of the interest-only periods (as APRA has required for all such assessments since end 2014); Did not borrow (close to) the maximum loan size available to them; Have experienced income growth since the loan was originated; Have made prepayments on their loans; and/or Were assessed for their original loans at significantly higher interest rates than current assessment rates.
Most borrowers will have positive equity given the rate of housing price growth over the last five years.

RBA Minutes A Bit Contradictory

The minutes out today spelled out the slowing momentum in the economy, and the cuts in rates would help with spare capacity, but would not lift risks emanating from higher debt in the medium term. Cannot see how both can be true, when the focus appears to be on rekindling the housing market! And given the calls from the RBA for the Government to spend more to assist in stronger growth. The sums just do not add up!

International Economic Conditions

Members commenced their discussion by noting that growth in the global economy had remained moderate over preceding months. Global trade and manufacturing activity had slowed over the preceding year. Trade tensions had remained elevated, although no new measures had been introduced since the previous meeting.

In China, recent indicators of economic activity suggested that growth had slowed since the March quarter. Growth in industrial production had fallen following a strong reading in March and the level of fixed asset investment had declined. Conditions in the Chinese property market had also softened and underlying demand conditions were expected to moderate over time, given the ageing of the population and a slowing in the rate of urbanisation. Over the preceding month, the Chinese authorities had introduced additional measures to support growth, including more favourable financing conditions for local governments investing in infrastructure projects.

In east Asia, the combination of weaker Chinese growth, the downturn in global semiconductor demand and the trade and technology disputes had weighed on trade, although new export orders suggested that conditions might be stabilising. The effect of the US–China trade dispute had not been even across the region. Some economies, such as Thailand and Vietnam, had seen strong growth in their exports to the United States, which reflected some diversion of trade that had previously been between the United States and China.

Growth in output in the United States had continued to be supported by strong growth in consumption, while growth in investment appeared to have slowed further. Members noted that capital goods orders had slowed and that the stimulus to investment from tax cuts had largely run its course. Growth in domestic demand in the euro area had been relatively resilient in the March quarter, but more recent data had been mixed. Growth in Japanese domestic demand had slowed in early 2019, partly as a result of spillovers from weak external demand conditions, but growth was likely to be supported in the near term by a pick-up in consumption growth in the lead-up to an increase in the consumption tax in October 2019.

Labour markets remained tight in the major advanced economies. Members noted that participation rates for people aged between 15 and 64 years had increased significantly in recent years and unemployment rates were at historically low levels. This suggested that there was relatively little spare capacity in these labour markets. Members noted that participation rates of people aged 65 years and over had also been increasing. Wages growth had picked up, but this had not yet been translated into stronger inflationary pressures and inflation remained below target in most advanced economies. Although inflation had been around target in the United States, some measures suggested US inflation had shifted lower more recently. The decline in oil prices, by around 15 per cent since their peak in mid May, would weigh on headline inflation globally in the near term.

Iron ore prices had increased by more than 25 per cent since the previous meeting and had more than doubled over the previous year. Chinese steel production had continued to grow strongly in recent months, despite slowing industrial activity in China. At the same time, there was limited spare capacity in the seaborne market to increase supply and inventories of iron ore at Chinese ports had been declining. Rising iron ore prices had underpinned a 3 per cent increase in the Australian terms of trade in the March quarter.

Domestic Economic Conditions

Members noted that the main domestic economic news over the previous month had been the release of the national accounts for the March quarter and updates on the labour and housing markets.

The national accounts reported that the domestic economy had grown by 0.4 per cent in the March quarter. Public demand had continued to support growth in the quarter, with public consumption boosted by the rollout of the National Disability Insurance Scheme and increased spending on the Pharmaceutical Benefits Scheme. Growth in public sector investment had been positive despite a decline in defence spending. Members noted that there was a strong pipeline of public infrastructure projects that could support activity for some time.

Private demand had contracted for the third consecutive quarter because there had been further falls in mining investment and housing construction. Consumption growth had remained subdued.

Growth in business investment had been weaker than expected in the March quarter. This was partly because it had taken longer than expected for liquefied natural gas (LNG) projects to reach final completion. However, investment in automation and other productive efficiencies had supported machinery & equipment investment in the mining sector. Non-mining business investment had continued to expand in the March quarter, supported by a further increase in non-residential construction, while non-mining machinery & equipment investment had fallen. Members observed that there had been some differences in the findings of surveys of business conditions. In the main, surveyed measures of business conditions had declined to around or a little above average levels. However, both the retail and transportation sectors had experienced well below-average conditions.

Exports had increased in the March quarter, primarily driven by growth in rural and service exports. The boost to meat exports in the quarter as a result of ongoing drought conditions leading to destocking had been larger than the subtraction from lower crop exports. Resource exports (excluding non-monetary gold) had fallen in the March quarter because of temporary supply disruptions. More recent data on trade and shipments suggested that iron ore and LNG exports had increased since the March quarter, while coal exports appeared to have fallen. Higher iron ore prices had supported overall export values and the trade surplus had increased to almost 3 per cent of GDP in the March quarter. The trade surplus was at its highest level, and the current account deficit at its lowest level, measured as a share of GDP, since the 1970s.

Consumption had grown by 1.8 per cent over the year to the March quarter, which was well below average. Members noted that, in per capita terms, consumption had been broadly flat. Growth in household spending on essential items had been relatively steady, while the level of spending on discretionary items had fallen in the March quarter. This weakness had been broadly based across the states and recent retail trade data suggested that discretionary spending had remained soft in the June quarter.

Members had a detailed discussion of the effects on price inflation in the retail trade sector of increased competition from foreign entrants and online retailers over the preceding decade or so. Members noted that the increase in the supply of retail items and lower retail prices in response to increased competition were positive developments for consumers, other things equal. Many retailers and wholesalers had also become more efficient in response to more intense competition, often using new technology (including in logistics), which had resulted in relatively rapid multifactor productivity growth in these sectors. Members noted that the adjustment in the retail sector had been protracted and had put downward pressure on inflation for some years. In the more recent period, the effects on prices of greater competition had been difficult to separate from the effects of the prevailing weak demand conditions.

Growth in household disposable income had increased in recent quarters, supported by growth in labour income, but had remained low in year-ended terms. Members noted that growth in labour income had been driven by strong employment growth and that growth in hourly earnings had remained subdued. New private sector enterprise bargaining agreements had incorporated slightly faster wages growth than agreements reached a year earlier. However, wages growth for workers on existing enterprise bargaining agreements had remained subdued, and there was little prospect of a near-term pick-up in public sector outcomes given the ongoing wage caps.

A small decline in growth in tax payments had also contributed to growth in household disposable income in the March quarter. By contrast, the income of unincorporated enterprises had remained weak, partly because of drought-related falls in farm incomes and the downturn in housing construction. Members noted that this weakness was likely to continue in the near term.

Dwelling investment had declined in the March quarter. Further falls were expected given the sharp decline in building approvals over the preceding year and a half. While the pipeline of construction work yet to be done in New South Wales and Victoria remained high, liaison contacts expected housing construction could drop off more sharply because pre-sales activity had been so weak.

Conditions in the established housing markets of Sydney and Melbourne had improved a little since the previous meeting. Housing prices had stabilised in June in these cities and auction clearance rates had picked up further, albeit still on low volumes. More generally, turnover in the housing market had remained low. Housing prices had continued to fall in Perth and Darwin.

Employment growth had remained strong, at 2.9 per cent over the year to May. Despite this, there was still spare capacity in the labour market. Some of the additional labour demand had been met by an increase in the participation rate, which had reached its highest level on record. Even so, forward-looking indicators, such as job advertisements and employment intentions, suggested that growth in employment would moderate over coming months. The unemployment rate had remained at 5.2 per cent in May and the underemployment rate had remained elevated.

In view of the fact the meeting was held in Darwin, members had a thorough discussion of economic conditions and future economic opportunities in the Northern Territory. They noted that the Northern Territory economy had experienced a significant cycle related to the construction and then completion of the INPEX LNG plant. The downturn in the mining cycle had had significant spillovers to other parts of the Northern Territory economy because, aside from the public sector, mining and construction are the largest industries in terms of gross value added. Employment had fallen in the Northern Territory over 2019 and this had been accompanied by large flows of people moving to other parts of the country. As a result, the unemployment rate for the Northern Territory had increased, but it remained lower than the national average. More generally, the Northern Territory had a relatively young population and high labour market participation rates. The decline in the Northern Territory population had also led to a significant decline in dwelling investment in the Northern Territory over recent years.

Members observed that the broad statistics on the labour market for the Northern Territory masked the relative disadvantage of the Indigenous population. The unemployment rate for Indigenous Australians on average was relatively high, and Indigenous Australians were less likely to complete school and more likely to experience poor health. These measures of Indigenous disadvantage were particularly acute in remote locations, where it is more difficult to deliver services.

Members noted that there were a number of opportunities for economic growth in the Northern Territory in the future, including tourism, agricultural exports (including live beef exports), the defence industry and mining. Higher mining investment in the Northern Territory in the future could come from some small-scale mining projects that had not yet reached final investment decision and the possibility of some onshore unconventional gas projects.

Financial Markets

Members commenced their discussion of financial markets by noting the significant change in the expected path of monetary policy around the world, particularly in the United States. This change had reflected a combination of weaker-than-expected economic activity and inflation over recent months, as well as the downside risks from the trade and technology disputes between the United States and China.

Monetary policy in the United States had been unchanged in June, but the Federal Reserve had indicated that it was prepared to act to sustain the economic expansion. Members of the Federal Open Market Committee (FOMC) saw a stronger case to reduce the federal funds rate during 2019, in contrast with the earlier ‘patient’ stance as the FOMC had awaited further data. Market pricing had moved to imply an expectation that the federal funds rate would decline by 100 basis points over the following year, compared with 50 basis points a month earlier.

In other major economies, the European Central Bank had indicated that it was prepared to add more monetary stimulus if the outlook for growth and inflation did not improve, including by expanding its bond-buying program. The Bank of Japan had intimated that it would allow bond yields to move below the lower end of its ‘yield curve control’ target and reiterated that there was scope to ease monetary policy further if needed. And in China, market participants expected the People’s Bank of China to ease monetary policy further in the period ahead.

As expectations for monetary policy easing had firmed over the course of this year, government bond yields had declined further in major markets, to a record low in Germany and further into negative territory in Japan. In the United States, lower bond yields reflected lower expected real policy rates for an extended period, as well as persistently low inflation and term premia. Yields on 10-year Australian government bonds had reached a historical low of 1.3 per cent, with yields remaining around 70 basis points below US treasury bond yields of similar maturity. Compensation for risk on corporate bonds globally remained compressed, as market participants judged that policy easing would support growth in economic activity and profits. Members noted that, as a result, the cost of funds for corporations remained low, including in Australia.

Equity prices had increased in major markets over the preceding month, to a record high level in the United States, despite prominent downside risks. Higher equity prices owed primarily to a lowering of discount rates, reflecting the expected easing of monetary policies, whereas the outlook for corporate earnings had been little changed. Recent movements in equity prices in Australia had broadly followed international trends, with increases in equity prices in all main sectors over the preceding month. Members noted that analysts’ forecasts of earnings of Australian non-resource companies had declined over the course of the past year, consistent with broader surveys of business conditions.

Members noted that bank liquidity conditions in China had remained accommodative overall. However, the solvency and liquidity of small banks (which account for one-quarter of banking assets) had been attracting more scrutiny from both investors and the authorities after a period of rapid asset growth, amid wider financial stability concerns.

In foreign exchange markets, the US dollar had remained around multi-year highs on a trade-weighted basis, although it had depreciated somewhat in the weeks leading up to the meeting as US bond yields had declined relative to those in other major economies. The euro had remained within the relatively narrow range of the preceding few years on a trade-weighted basis, while the yen had broadly appreciated over recent months. The Australian dollar had been largely unchanged following the decision to lower the cash rate in June. Nevertheless, having depreciated by about 3 per cent in TWI terms since late 2018, the Australian dollar was around its lows of recent years, with the effect of the decline in Australian bond yields relative to other major markets over that period partly offset by the unexpected strength in commodity prices.

In Australia, monthly housing credit growth had remained broadly stable in recent months, particularly for lending for owner-occupation. Aggregate housing credit had been growing at an annualised rate of around 3 per cent, with much of the decline in the rate of growth over the preceding year driven by weaker demand for finance associated with the correction in the housing market. Loan approvals by both owner-occupiers and investors had continued to decline in May. However, an easing in the loan serviceability interest-rate floor was likely to see a boost in borrowing capacity for many new borrowers, which would be in addition to the positive effect on the cash flow of the household sector overall following the reduction in the cash rate at the previous meeting.

The three-month bank bill swap rate (BBSW) had declined further over the preceding month. Accordingly, the increase in the spreads of BBSW and other short-term money market rates to the overnight indexed swap rate in 2018 had been fully unwound. Wholesale funding costs (which affect two-thirds of banks’ debt funding) had also declined in line with the cash rate. As a result, the major banks’ debt funding costs had reached a historic low.

Members noted that the favourable financing conditions for non-financial corporations had supported corporate bond issuance. Although business credit growth had declined over recent months, growth in total business debt had remained little changed. Meanwhile, yields on residential mortgage-backed securities had also been at low levels and issuance by non-banks in this market had increased significantly in the June quarter, to levels not seen since prior to the global financial crisis.

Members noted that most lenders had passed on the 25 basis points reduction in the cash rate in June to mortgage rates. Business borrowing rates had declined in line with the decline in BBSW. Members also noted that the reduction in the cash rate had been passed through to many retail deposit rates, although some of these rates were already very low.

Market pricing implied that further monetary policy easing was expected following recent data and the Bank’s communication since the previous meeting. A 25 basis points reduction in the cash rate had been fully priced in by August 2019, with a further easing expected by the end of the year.

Considerations for Monetary Policy

Members observed that the outlook for the global economy remained reasonable, although the risks from the international trade and technology disputes remained high. Growth in trade had remained weak and there had been further signs that heightened uncertainty was affecting investment decisions. Despite tight labour markets and rising wages growth, inflation had generally remained low in the advanced economies. Both the trade-related downside risks to global growth and ongoing subdued inflation had spurred an increased expectation that major central banks would ease monetary policy. This had reinforced already very accommodative conditions in global financial markets.

In considering the policy decision, members discussed the recent data on output and the labour market. On the former, GDP growth had been well below trend over the year to the March quarter. Despite strong growth in employment, growth in household disposable income had remained low and this had contributed to low growth in consumption. Members noted the near-term prospects for a lift in income growth and the contribution of the low and middle income tax offset. Higher growth in disposable income was expected to support consumption, although the outlook for consumption remained uncertain. Accommodative monetary policy, strong public demand, a renewed expansion in the resources sector and growth in exports were also expected to support a return of GDP growth to trend over coming years.

Members observed that employment growth continued to outpace growth in the working-age population. However, most of the strength in labour demand over preceding months had been met by an increase in participation, which had risen to a record high level, rather than a decline in the unemployment rate. Although there had been a modest pick-up in wages growth in the private sector, wages growth had remained low overall. In combination, these factors suggested that spare capacity was likely to remain in the labour market for some time.

Declining housing prices had also contributed to low growth in consumption, although there were signs that conditions in some housing markets, notably in Sydney and Melbourne, had stabilised. Members noted that mortgage rates were at record lows and that there was strong competition for borrowers of high credit quality. However, demand for credit by investors continued to be subdued and credit conditions for small and medium-sized businesses remained tight.

In assessing the outlook for inflation, members agreed that further improvements in the labour market would be required for wages growth to increase materially. As assessed at the previous meeting, members agreed that the Australian economy could sustain a lower rate of unemployment, while achieving inflation consistent with the target. In light of this, the recent run of data and the lower level of interest rates resulting from the decision taken at the previous meeting, the case for a further reduction in the cash rate was considered.

Members recognised that, in the current environment, the main channels through which lower interest rates would support the economy were a lower value of the exchange rate than otherwise would be the case and lower required interest payments on borrowing, which would free up cash for other expenditure by households and businesses.

Members judged that a further reduction in the level of interest rates would support the necessary growth in employment and incomes, and promote stronger overall economic conditions, which would in turn support a gradual increase in underlying inflation. Members also judged that the extent of spare capacity in the economy, and the likely pace at which it would be absorbed, meant that a decline in interest rates was unlikely to encourage an unwelcome material pick-up in borrowing by households that would add to medium-term risks in the economy. Members recognised the uneven effect of lower interest rates on different households.

Taking into account all the available information, the Board decided that it was appropriate to lower the cash rate by 25 basis points. This decision, together with the reduction in the cash rate decided at the previous meeting, would assist in reducing spare capacity in the economy and making faster progress in reducing the unemployment rate. Lower interest rates would provide more Australians with jobs and assist with achieving more assured progress towards the inflation target. The Board would continue to monitor developments in the labour market closely and adjust monetary policy if needed to support sustainable growth in the economy and the achievement of the inflation target over time.