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Minutes of the Monetary Policy Meeting of the Reserve Bank Board

International economic developments

Members commenced their discussion of international developments with a cross-country review of economic activity and developments in labour markets during the pandemic. A recurring theme was that Australia had fared relatively well in terms of output levels and labour market outcomes. The December quarter 2020 national accounts showed that GDP in Australia had recovered to close to pre-pandemic levels, whereas GDP was still considerably below pre-pandemic levels in many other countries. The loss of output over 2020 as a whole had also been smaller in Australia than in many other countries. This reflected both the relatively smaller initial decline in output in Australia and the swift recovery since then.

Turning to labour market outcomes, members noted that most countries had experienced a large contraction in both employment and labour force participation since the pandemic. Australia's experience had been unusual in that employment and participation were now higher than the levels prevailing at the end of 2019. Favourable health outcomes in Australia, the design of the JobKeeper and other temporary support programs and the swift recovery in activity had all contributed to a strong bounce-back in the domestic labour market.

Despite the rapid recovery in employment in Australia, members noted that wages growth domestically had slowed to a greater extent and had been more subdued than in other countries. The labour market adjustment in Australia in response to the pandemic had principally taken the form of adjustment to hours worked and widespread wage restraint. In contrast, in some other countries, including the United States, the adjustment had mainly been through a decline in employment.

Members discussed cross-country differences in population growth stemming from international border closures. In some countries, including Canada, which had experienced high and rising rates of immigration in the years prior to the pandemic, population growth had slowed substantially. In New Zealand, some of the slowdown in population growth had been mitigated by the return of expatriate New Zealand citizens during the pandemic; in turn, it was likely that this had contributed to the increase in housing demand in New Zealand.

The decline in population growth in Australia had been particularly steep relative to other countries; in the 3 months to September, the Australian population had declined for the first time in several decades as a result of a reversal in net overseas migration. However, in countries where net migration had contributed less to population growth in the years before the pandemic, including the United States, population trends had been little changed in recent quarters.

Members observed that corporate profitability during the pandemic had varied considerably across countries. The size and composition of fiscal support for the corporate sector had contributed much to this outcome. In the euro area and the United Kingdom, subsidy payments had not offset the effect on business profits of the decline in output. In Australia, business profits had increased in 2020 as output had fallen by less than elsewhere and fiscal support had been targeted more towards wage subsidies than loan guarantees. The JobKeeper program had been particularly supportive of industries where labour costs comprise a high share of the total cost base.

Members concluded their discussion of recent international developments by noting that the global economic outlook remained more positive than a few months earlier, although the near-term outlook had become more variable across countries. This partly reflected cross-country differences in infections and progress with vaccine rollouts.

The outlook for growth in the United States had improved and inflation was expected to be a little higher as a result of the size and composition of fiscal stimulus there. While a more positive outlook in the United States would support global growth, the outlook for other advanced economies was less positive as the decline in output in 2020 had been more significant, less fiscal stimulus had been provided and some countries were still contending with lockdowns. As a result, substantial spare capacity was likely to persist in most advanced and emerging economies. In turn, this was likely to keep inflationary pressures well contained, despite the rebound in commodity and other input prices in recent months.

Domestic economic developments

Members noted that the strong recovery in the Australian economy had continued into 2021. The Australian economy grew by 3.1 per cent in the December quarter, following the 3.4 per cent rebound in the September quarter. This meant that GDP was around 1 per cent below its December 2019 level at the end of 2020. Consumption had continued to recover in the December quarter despite a decline in household income.

Growth in business and dwelling investment had been stronger than expected, supported by targeted fiscal measures. Exports had been supported by a sharp jump in rural production following the return of more favourable weather conditions. Public investment had increased in the December quarter, but by less than anticipated. Indications at the time of the meeting were that the rollout of public investment programs over the first half of 2021 would be slower than foreshadowed in state budgets. Overall, preliminary data suggested that GDP in the March quarter was likely to have recovered further to around its pre-pandemic level, earlier than previously expected.

Members discussed the unusual behaviour of household disposable income during 2020. Growth in incomes had been particularly strong in the June and September quarters of 2020, as fiscal transfers such as social assistance and subsidy payments had more than offset the declines in labour and financial income. Part of this increase in household disposable income had been unwound in the December quarter, and further declines were expected over the first half of 2021 as fiscal transfer payments and other temporary support measures expired.

Households appeared to have smoothed their spending through a period where household income had declined. Timely indicators suggested that growth in household consumption had moderated in the March quarter following the strong rebound over the second half of 2020.

Short, sharp lockdowns in several states in the early months of 2021 were likely to have had a relatively minor effect on consumption, and the recovery in spending on services evident in the December quarter appeared to have carried over into subsequent months. Despite this recovery, consumption was still likely to have been a little below its pre-pandemic level in the March quarter, in part because of some continuing restrictions on activity and the international border remaining closed.

Members noted that reduced uncertainty and higher net wealth for many households were likely to support the recovery in consumption in the period ahead. However, much would depend on the extent to which households consume or invest the savings accumulated in 2020.

Survey data suggested that income and savings had increased for most household income groups, with most of the additional saving being undertaken by higher-income households. This was partly because higher-income households spend more on the types of discretionary services that had been unavailable during the pandemic. Fiscal programs had also supported the incomes of self-employed people and business proprietors.

Turning to the labour market, members noted that both the initial increase and the subsequent decline in the unemployment rate had been much sharper than observed during the economic downturns of the 1980s and 1990s. This was likely to limit the longer-term scarring effects that had hampered the recovery in labour market conditions following those downturns.

Members discussed the strength in the recent run of labour market outcomes. Employment had returned to pre-pandemic levels considerably faster than expected. There had also been a shift in growth from part-time to full-time employment. Forward-looking indicators of labour demand had remained strong, with job vacancies and advertisements above pre-pandemic levels, and employment intentions trending higher.

This partly reflected the need for firms to rehire for positions vacated during the pandemic and a period of catch-up in hiring that had been delayed in 2020. These indicators suggested that at least some of the job losses that were likely to follow the end of the JobKeeper program would be offset by new hiring. As a result, while the overall recovery in the labour market was expected to pause in the period ahead, this was expected to be only temporary. Members also noted it was likely that the full effect of the end of the JobKeeper program would become apparent over several months.

Members noted that housing prices had increased significantly in recent months. Growth in housing prices had been especially strong for detached housing, particularly in outer metropolitan and regional areas. This had partly reflected strong demand from first-home buyers and owner-occupiers seeking more space.

The momentum in housing price increases had broadened recently to include the largest capital cities and the more expensive segments of these markets, although the increase in overall housing prices in Australia during the pandemic had been more modest than in a number of other countries. Members noted that low interest rates had been one of the factors contributing to the increase in demand for housing, alongside other policies such as government grants.

Advertised rents had also picked up in a number of capital cities recently, although, as in other countries, housing prices had increased by more than rents. Rents and overall conditions in the apartment market in Melbourne, and to a lesser extent in Sydney, remained subdued as the reduction in net overseas migration was still lowering demand.

International financial markets

Members commenced their discussion of developments in financial markets by noting that, over the prior month, long-term sovereign bond yields had risen further in the United States and the US dollar had appreciated. This had been in response to an improved economic outlook, aided by the rollout of vaccines and the passing of a large fiscal stimulus in the United States.

In contrast, sovereign bond yields in most other advanced economies had been little changed or had even declined a little. While bond markets had been strained in February and early March as bond yields rose rapidly, the stresses had not been as great as a year earlier and conditions had settled more recently. Global financial conditions remained accommodative.

Much of the rise in sovereign yields since late 2020 had reflected investors revising up their expectations for inflation to be more consistent with central banks' inflation targets. Real yields had also risen at longer horizons. Members noted that this was consistent with guidance from central banks that their policy settings would remain highly stimulatory until after inflation had risen in a sustained manner.

The rise in inflation expectations had also been associated with markets bringing forward their expectations for policy rate increases for a number of advanced economies; policy rates were expected to rise in early 2023 in the United States, Canada and New Zealand, and in late 2023 or early 2024 in the United Kingdom. For New Zealand, this was a little later than had been expected prior to the Government's announcement of a range of measures to address upward pressure on housing prices.

While the rise in sovereign bond yields had lifted costs for issuers of corporate bonds, yields had remained very low. Moreover, credit spreads had been little changed, suggesting no significant changes in the market's expectations for defaults, consistent with the more positive economic outlook. Meanwhile, corporate bond issuance had remained robust. At the same time, equity prices in advanced economies, including in Australia, had increased further.

Members observed that rising bond yields in advanced economies had led to tighter financial conditions in many emerging market economies (EMEs). Borrowing costs for governments had risen and a few central banks had lifted policy rates in response to rising inflation and the pressures of exchange rate depreciation, which had been significant for some EMEs.

While most EMEs were expected to benefit from the improved outlook for advanced economies, some had much slower vaccine rollout programs and their economic recoveries had been slower; as a consequence, they were exposed to a premature tightening in financial conditions. Members noted that financial markets in some EMEs, such as Turkey and Brazil, had also been affected more by these developments than others because of pre-existing macro-financial vulnerabilities. In contrast, financial conditions in China had remained accommodative and largely unaffected by developments elsewhere.

Domestic financial markets

In Australia, the Bank's policy measures continued to underpin low interest rates in the domestic economy and support the availability of credit to households and businesses. Banks' funding costs and lending rates were at historic lows.

Yields on Australian government bonds had been little changed over the course of March, after a sharp rise in yields through February. Market conditions had been strained immediately prior to the March meeting, but had improved since then, in part owing to the Bank having brought forward purchases under the bond purchase program.

Market conditions had improved over the prior month and the 3-year yield had settled around 10 basis points, unwinding the earlier increase. Liquidity conditions in bond markets had improved, with bid-offer spreads narrowing for Australian Government Securities (AGS) and bonds issued by the states and territories (semis). Members observed that market pricing implied that the cash rate was expected to remain unchanged in 2021 and 2022, before rising to around 50 basis points by the end of 2023. The Australian dollar had depreciated from its recent highs to be back around its levels at the turn of the year.

Members noted that the first $100 billion phase of the bond purchase program was scheduled to be completed in early April. At the end of the further $100 billion phase in September, the Bank was projected to own 30 per cent of the AGS market and 15 per cent of the semis market.

In their discussion of financing conditions, members noted that demand for new business loans remained subdued.

Financial stability

Members were briefed on the Bank's regular half-yearly assessment of financial stability risks.

Australian banks had remained resilient. The reforms that followed the global financial crisis had resulted in the banks having high capital levels and substantially higher holdings of liquid assets. This had reinforced their ability to support their customers during the pandemic.

Members noted that smaller banks had even higher capital ratios than the major banks. In addition, the banks had strong profitability prior to the pandemic, which had enabled them steadily to increase their capital. Their return on equity had dropped in the first half of 2020 as provisions had been increased to account for expected higher loan losses, but profitability had increased in the second half of the year as expectations of improved economic conditions resulted in lower provisions being added. Banks' non-performing loans had drifted up and were expected to increase further, but they had remained much lower than the peak that followed the global financial crisis.

Members noted that banks have a sizeable refinancing task in 2023–24, with the maturing of their 3-year loans under the Term Funding Facility, but the banks were planning for this and there had been strong demand for the smaller volume of wholesale debt that banks had issued recently.

Globally, most banks were also resilient, but there were exceptions. Some banks that had relatively low profitability at the onset of the pandemic could struggle to generate sufficient capital to cover losses, and therefore might curtail their lending. Moreover, in Europe the intertwined credit risk between banks and their home country sovereign had increased with banks holding more government debt and government-guaranteed bank loans. Provisioning was also lower for some European banks. Globally, cyber attacks were also a growing risk facing banks.

In Australia, household balance sheets were generally in a stronger position than a year earlier. At an aggregate level, and for many individual households, debt had fallen relative to income. Growth in household debt, while positive, had been less than the strong growth in income as a result of the government policy response. Household savings had increased substantially, with households increasing their financial assets, particularly deposits. A sizeable share of these deposits was in mortgage offset accounts, which increased the buffers available to households with a mortgage. An additional source of increased liquid asset holdings for households had been early withdrawals from superannuation.

Members noted that business revenue had increased across all industries in the December quarter 2020, but revenue had declined over 2020 in industries most affected by the pandemic, especially arts and recreation and those related to tourism. Businesses overall had increased their holdings of deposits, which would provide a buffer in the period ahead as government support payments are wound down. Insolvencies and firm closures in 2020 had been supressed by a range of support measures, including stimulus payments, loan repayment deferrals, rent reductions and a moratorium on insolvencies. However, insolvencies and firm closures were expected to increase through 2021 as the support measures are wound down.

In Australia, with the strong recovery in economic activity, income for most borrowers had recovered to at least its level a year earlier. However, for some businesses and households, income remained lower, which could lead to difficulties in making debt repayments.

In some other countries, particularly some EMEs where the recovery had been slower, aggregate income remained below pre-pandemic levels. With more households and businesses having lower income than when they borrowed, a larger share would struggle to make debt repayments, which would be likely to lead to larger increases in non-performing loans.

More generally, if the recovery in EMEs continued to lag that in key advanced economies, they could experience capital outflow, exchange rate depreciation and rising domestic interest rates as global yields increase. These factors would not only impede the economic recovery, but could be a source of financial instability.

Globally, asset prices had been increasing given the low levels of interest rates. Housing prices, in particular, had increased strongly in a number of countries in the latter part of 2020 and early 2021. Growth in housing credit had increased in a number of these countries, but it generally remained slower than growth in housing prices. In Australia, growth in both housing credit and housing prices had picked up, but to a lesser extent.

Annualised growth in housing credit had been around 4½ per cent over the 6 months to February, driven by demand from owner-occupiers. Demand for new housing finance had been strong, and the high level of loan commitments indicated that housing credit growth was likely to increase in the months ahead. However, there was no notable evidence of a deterioration in housing lending standards. The share of loans with higher loan-to-valuation ratios had increased, but this was in part explained by the larger share of first-home buyers.

The share of loans with high debt-to-income ratios had been relatively stable. Members agreed that it would be important to watch carefully for increased risk-taking by lenders and any deterioration in lending standards and larger shares of higher-risk loans.

Members agreed to have a broader discussion of the implications of climate change for financial stability in coming months.

Considerations for monetary policy

In considering the policy decision, members observed that the rollout of COVID-19 vaccines was supporting the recovery of the global economy. While the path ahead remained uneven, there were better prospects for a sustained recovery. Global trade had picked up and commodity prices were generally higher than at the start of the year.

The global outlook remained dependent on responses to the pandemic and the risks of further outbreaks of COVID-19 infections, as well as on the significant fiscal and monetary support around the world. Inflation remained low and below central banks' targets in many economies.

Financial markets had responded to the positive news on vaccines and the additional fiscal stimulus in the United States. Sovereign bond yields had increased over recent months, including in Australia. This increase partly reflected inflation expectations lifting from near record lows to be closer to central banks' targets. The Australian dollar was around its level at the beginning of the year.

The economic recovery in Australia was well under way and had been stronger than previously expected. There had been a welcome fall in the unemployment rate to 5.8 per cent in February, and the number of employed people had returned to the pre-pandemic level. GDP had increased by a strong 3.1 per cent in the December quarter 2020, boosted by a lift in consumption as the health situation improved.

The economic recovery was expected to continue, with above-trend growth forecast in 2021 and 2022. Household and business balance sheets were in good shape overall and this was expected to continue to support spending. An important near-term issue was how households and businesses would adjust to the tapering of several fiscal support measures. Members noted that there might be a temporary pause in the pace of improvement in labour market conditions.

Despite these generally positive developments, wage and price pressures had remained subdued and were expected to remain so for several years. The economy had been operating with considerable spare capacity and the unemployment rate was still too high. It would take some time to reduce this spare capacity and for the labour market to be tight enough to generate wage increases consistent with achieving the inflation target. It was likely that wages growth would need to be sustainably above 3 per cent, which was well above its current level.

While annual CPI inflation was expected to rise temporarily to around 3 per cent around the middle of the year as a result of the reversal of some pandemic-related price reductions, in underlying terms inflation was expected to remain below 2 per cent over both 2021 and 2022.

Members noted that housing market conditions had strengthened further over preceding months, with prices rising in most markets. Growth in housing credit to owner-occupiers had risen, with strong demand from first-home buyers. In contrast, growth in housing credit to investors had remained subdued. Given the environment of rising housing prices and low interest rates, the Bank would be monitoring trends in housing borrowing and the maintenance of lending standards carefully.

Since the start of 2020, the Bank's balance sheet had increased by around $215 billion and a further substantial increase was in prospect. The initial $100 billion government bond purchase program was almost complete and the second $100 billion program would commence the following week. Beyond this program, the Bank was prepared to undertake further bond purchases if doing so would assist with progress towards the goals of full employment and inflation.

$95 billion of low-cost funding had been accessed through the Term Funding Facility and a further $95 billion was available to be drawn down under the facility until the end of June 2021. This low-cost funding would continue to provide support through to mid 2024. The Board would consider extending the facility if there were a marked deterioration in funding and credit conditions in the Australian financial system. However, there were no such signs currently. Members noted that the Australian banking system, with its strong capital and liquidity buffers, had remained resilient and was helping to support the economic recovery.

The Board remains committed to the 3-year Australian Government bond yield target of 10 basis points. The Bank had not purchased bonds in support of the 3-year yield target since late February. Later in the year, members would need to consider whether to maintain the April 2024 bond as the target bond or shift the focus of the yield target to the November 2024 bond.

If the Board were to maintain the April 2024 bond as the target bond, rather than move to the next bond, the maturity of the yield target would gradually decline until the bond matured in April 2024. In considering this issue, members would give close attention to the flow of economic data and the outlook for inflation and employment.

The Bank's monetary policy settings had continued to support the economy by keeping financing costs very low, contributing to a lower exchange rate than otherwise, encouraging the supply of credit to businesses and strengthening household and business balance sheets. Monetary and fiscal policy had supported the recovery in aggregate demand and the pick-up in employment. The Board remained committed to doing what it reasonably could to support the Australian economy, and would maintain highly supportive monetary conditions until its goals were achieved.

Members affirmed that the cash rate target would be maintained at 10 basis points, and the rate of remuneration on Exchange Settlement balances at zero, for as long as necessary. They continued to view a negative policy rate as extraordinarily unlikely. The Board will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range. For this to occur, wages growth would need to be materially higher than it is currently. This would require significant gains in employment and a return to a tight labour market. The Board does not expect these conditions to be met until 2024 at the earliest.

The decision

The Board reaffirmed the existing policy settings, namely:

  • a target for the cash rate of 0.1 per cent
  • an interest rate of zero on Exchange Settlement balances held by financial institutions at the Bank
  • a target of around 0.1 per cent for the yield on the 3-year Australian Government bond
  • the expanded Term Funding Facility to support credit to businesses, particularly small and medium-sized businesses, with an interest rate on new drawings of 0.1 per cent
  • the purchase of $100 billion of government bonds of maturities of around 5 to 10 years at a rate of $5 billion per week following the Board meeting on 3 November 2020
  • the purchase of an additional $100 billion of government bonds when the existing bond purchase program is completed in April 2021 at the same rate of $5 billion per week.

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