Minutes of the Monetary Policy Meeting of the Reserve Bank Board

International economic development

Members discussed international economic developments by noting that the global outlook had improved, and risks had become more balanced because of progress in vaccinations and additional fiscal support. Growth in the global economy was expected to rebound solidly in the current and the following year. Even so, the global recovery remained uneven. Output remained well below pre-pandemic levels in some countries because of recurring outbreaks of COVID-19. There was limited scope for ongoing large-scale fiscal support in some emerging market economies, where financial conditions had tightened. The output level was expected to remain below its pre-pandemic trajectory in many economies over the forecast period, with notable exceptions for the United States and China.

Substantial spare capacity was likely to persist in most economies, including the services sector, keeping underlying inflation pressures subdued for some time. It was possible that supply bottlenecks for some goods would be more persistent than generally assumed. However, members noted that the upswing in commodity prices would boost inflation readings in the near term.

Members observed that a significant share of the population had been vaccinated in only a few countries, notably the United States, Uthe United Kingdom, and Israel. In some other countries where infection rates had been relatively low through the pandemic, including Australia and East Asia, we’re expected to achieve high levels of vaccination by the end of 2021 or early 2022. However, vaccine supplies remained limited in many emerging market countries, hampering their economic recoveries. India experienced a serious infection surge accounting for a large share of new cases globally and prompting curfews and partial lockdowns in the worst-affected states. This would weigh on the Indian economy in the June quarter.

Members observed that the global fiscal policy response to the pandemic had been the largest since the Second World War and continued to evolve. Governments prioritized direct fiscal support for health systems and households in the pandemic’s most acute phase. They targeted measures to reduce layoffs, such as wage subsidies for firms. The latter had limited the extent of economic scarring. The size and composition of the fiscal response had also varied considerably across countries, reflecting differences in health outcomes and the nature of automatic stabilizers already in place. Fiscal support had been huge in the United States. In countries where health outcomes were becoming more favorable, the focus of this budgetary support was likely to turn toward boosting public and private investment and other longer-term priorities. Fiscal policy was likely to remain supportive in most advanced economies after the pandemic.

In recent months, a critical development in the global economy has been the rebound in commodity and producer prices. Highly expansionary fiscal and monetary policy settings, a surge in global demand for goods, and a strong recovery in industrial production in China and elsewhere had contributed to a sharp increase in the prices of commodities and other inputs. In some cases, the rebound in global goods trade had outstripped the ability of global supply chains to cope, which had contributed to delays and upward price pressures for critical components such as semiconductors; this, in turn, had hampered downstream production for a variety of goods, such as motor vehicles.

The increase in commodity and other input prices was expected to contribute to higher inflation globally in subsequent months. Strong demand for steel in China and international supply disruptions had also pushed iron ore prices to their highest levels in a decade and boosted Australia’s terms of trade. Members noted that inflation expectations in advanced economies had also increased to be closer to central banks’ targets.

Domestic economic developments

In the domestic outlook, members noted that the Australian economy was transitioning from recovery to expansion earlier and with more momentum than anticipated. GDP was expected to have returned to its pre-pandemic level in the March quarter, and tmore people were employed in March than before the onset of the pandemic. The unique features of the pandemic and the policy response have seen the economy to rebound much faster than in previous downturns.

In response to the more vital starting point and improved outlook further out, the forecast for GDP under the baseline scenario had been revised upwards. GDP growth of 4¾ percent was expected in oin2021 and 3½ percent in oin2022. If realized, this would leave the level of GDP a little below that forecast before the pandemic, mainly owing to lower population growth. Members noted that the release of the Australian Government Budget in May would contain further information relevant to the outlook for public demand.

Members agreed that an essential source of uncertainty for the domestic outlook was the path for household consumption. In the baseline scenario, household consumption was expected to be supported by the further lifting of restrictions on services, a more robust employment outlook and, thus, labor income, wealth effects from higher housing prices, and reduced uncertainty generally. In this scenario, households were assumed to treat the savings accumulated in the preceding year as wealth and therefore were expected to consume only a tiny share of these savings over the forecast period; the household saving ratio was also expected to decline further.

Conditions in the housing market had continued to strengthen. Housing prices had increased further in April. Strong demand encouraged an increase in new listings, although the total stock was below the average of recent years because new listings were being sold quickly. In recent months, housing prices upswingshhasbecome more broadly based across capital cities and regional areas. Turnover had also increased to its highest level in several years, with many properties staying on the market for short periods.

Rental markets had tightened in recent months, but conditions remained uneven. Rents increased more robustly for houses than for units and in regional areas compared with capital cities. Rental vacancy rates remained high in Melbourne and, to a lesser extent, Sydney, depressing advertised rents there. In other capital cities, vacancy rates were low, and advertised rents increased quickly. The outlook for dwelling investment remained strong. Approvals for detached dwellings and alterations & additions had risen to record high levels in the March quarter, boosting the pipeline of construction activity over 2021.

In addition to the support provided by low-interest rates, the increase in approvals had been driven by the HomeBuilder program and other state-based grants; the commencement of construction on many of the large number of projects being approved under these programs had only recently begun. Some construction firms in the Bank’s business liaison program reported cost pressures and delays to construction timelines due to difficulties securing materials and labor.

Members noted that the strong recovery in domestic activity and policy support had lifted the outlook for non-mining business investment. However, this hollowed a lengthy period in which it had been weak. Strong profitability and a reported increase in capacity utilization and business confidence were expected to provide further support for machinery & equipment investment in the near term, following a solid response to the tax incentives offered by the Australian Government. Recent indicators, such as building approvals, pointed to a more gradual recovery in private non-residential construction activity. The forecast profile for mining investment had been revised upwards a little, but there were signs that major mining firms were planning to expand iron ore-related investment in response to higher prices.

Members discussed the continued improvement in labor market conditions. Employment and total hours worked in March were higher than before the pandemic, underemployment had returned to pre-pandemic levels, and the decline in the unemployment rate to 5.6 percent in March had occurred considerably faster than expected earlier. Employment growth was expected to remain firm in the months ahead, given the solid momentum inactivity and positive forward indicators of labor demand. Some surveyed firms reported a lack of available labor as a constraint on output. While job losses from the end of the JobKeeper program were likely, these were expected to be more than offset by demand for labor elsewhere in the economy.

Further out, the more robust forecast profile for growth in output and employment was expected to reduce spare capacity in the labor market gradually. In the baseline scenario, the unemployment rate was expected to continue to decline to around its pre-pandemic level of 5 percent by the end of 2021 and to 4½ percent by mid-2023. This lower forecast unemployment rate was expected to put some modest upward pressure on wage growth over time. Led by private-sector wages, change in the Wage Price Index was expected to increase to under 2 percent over 2021 and to around 2¼ percent by mid-2023.

Despite the strong recovery in economic activity, the recent Consumer Price Index (CPI) confirmed that inflation pressures remain subdued in most parts of the Australian economy. The forecast for inflation had been revised upwards slightly, in line with the more robust outlook for activity, but inflation was still expected to increase only gradually. In the baseline scenario, underlying inflation was expected to grow from 1½ percent over 2021 to 2 percent by mid-2023. Headline inflation was expected to spike above 3 percent over the year to June 2021, partly as the effect of COVID-19-related one-off price changes dropped out of the calculation before declining back below 2 percent over the remainder of the forecast period.

Wage and price inflation were much lower than over the preceding decade, Members noted that the extent of spare capacity in the economy at the end of the forecast period was uncertain, which meant that the gradual increase in inflation could be slower or faster than envisaged in the baseline scenario. Because of inertia in compensation- and price-setting practices, it was possible that price pressures could be slow to build even if spare capacity were absorbed more quickly than expected. Alternatively, higher commodity prices, persistent supply chain bottlenecks, and firms’ reduced ability to address labor shortages through access to workers from abroad could mean that wage growth and inflation picked up earlier and more rapidly than expected as the economy continued to expand.

Although households had been adjusting well to the tapering of fiscal and other temporary support measures, members concluded their discussion of the domestic economy by considering 2twoalternative scenarios based on different assumptions for household consumption. A more robust economic trajectory than the one envisaged in the baseline scenario was possible if households increased spending more than expected. This could be in response to more substantial wealth effects and a decline in uncertainty, which boosted households’ willingness to consume from earlier savings and recurring labor income. As a result, private investment and employment would be stronger. The unemployment rate would decline faster and lower, around 3¾ ppercent compared with the baseline. In this upside scenario, inflation would increase to around 2¼ percent by mid-2023

Alternatively, members noted that a weaker economic path could eventuate if households consumed a smaller share of their income and accumulated savings than assumed in the baseline scenario. In this downside scenario, spending would be stimulated by less than implied by historical wealth effects, with households supposed to continue strengthening their balance sheets by paying down debt. Subdued consumption and private business investment would contribute to this downside scenario’s relatively high unemployment rate, with inflation remaining around 1½ percent over much of the forecast period.

International financial markets

Members observed that financial market conditions had been broadly stable over the preceding month. Corporate bond issuance had remained robust in developed economy markets, and spreads on corporate bonds had declined to low levels, expecting the improved economic outlook to moderate the rise in default rates seen over the preceding year. Longer-term sovereign bond yields had settled around pre-pandemic levels in most developed markets after increasing noticeably earlier in the year in response to the improving economic outlook.

Most of the bond yield increases reflected expected inflation to levels consistent with or below central banks’ targets. Members noted that the rise in inflation expectations had been most marked in the United States. Corporate bonds were issued further in prior months and, in most major markets, were above pre-pandemic levels. Members noted that equity issuance, particularly initial public offerings by so-called ‘blank-cheque’ financing vehicles in the United States (which raise funds to invest in private companies to take public), had eased in recent weeks, having been very strong earlier in the year.

Major central banks had reiterated that their policy settings would remain highly accommodative until sustained progress toward their employment and inflation objectives had been attained. The Bank of Canada had upgraded its economic projections. It updated its expectations for the timing of the first increase in its policy rate, which was closely aligned with market expectations that the first increase would occur in the second half of 2022.

Market pricing suggested that policy rates would increase in New Zealand in late 2022 or early 2023 and the United States and Uthe United Kingdom in the first half of 2023. The Bank of Canada had also announced a reduction in the pace of its government bond purchases. This change had been anticipated, and there had not been a significant market reaction to the announcement.

The US dollar had depreciated as bond markets had stabilized over the prior month to return toits levels against other major currencies at the start of the year. The Australian dollar had continued to trade in a relatively narrow range and was slightly above its ranks at the beginning of the year on a trade-weighted basis and against the US dollar.

In emerging market economies (EMEs), financial conditions have generally stabilized in line with developments in the advanced economy markets. Flows into EME bond and equity funds had resumed, following some outflows during heightened market volatility earlier in the year. Financial conditions in China had remained accommodative, although concerns about a large state-owned financial firm had seen spreads widen on bonds issued into offshore markets by Chinese firms.

Domestic financial markets

In the domestic market, the Bank’s policy measures had continued to underpin very low-interest rates and the provision of credit. The 3-year Australian Government bond yield had remained around ten basis points, and no further purchases had been required to support the Bank’s yield target over the preceding two months. Nevertheless, yields on other 3-year financial instruments had increased since the start of 2021 and were consistent with market participants expecting the cash rate to begin rising from its current level during 2023. Yields on longer-dated Australian government bonds had moved roughly in line with US Treasuries over the prior month, and the spread between 10-year yields in the respective markets had remained close to zero.

The Bank’s bond purchase program continued to run smoothly, and in early April, the Bank concluded the initial $100 billion of purchases under the program. The second $100 billion of bond purchases was scheduled to be completed in September. Projections suggested the Bank would hold around 30 percent of outstanding Australian government bonds and 15 percent of bonds issued by the semi-government authorities by the program’s conclusion in September.

Bank funding costs and lending rates had remained at historic lows. Drawings on the Bank’s Term Funding Facility had increased as the 30 June deadline for accessing the 3-year funding program approached. Liaison had indicated that many banks would take up most, if not all, of their remaining allowances. Demand for housing finance had continued to pick up, driven by owner-occupiers, although new lending to investors had also increased. Members noted that there had been a pick-up in ithe issuance of residential mortgage-backed securities by non-banks at favorable spreads, which had been accompanied by an increase in their share of the household lending market. Lending to businesses had also increased slightly in preceding months, reflecting a pick-up in lending to large companies.

Considerations for monetary policy

In considering the policy decision, members observed that the global economy had continued to recover from the pandemic, and the outlook was for strong growth in output in 2021 and the following year. Although the pace of COVID-19 vaccinations supported the global economy’s rebound, the recovery remained uneven, and some countries were yet to contain the virus. Global goods trade continued to increase strength, and commodity prices were higher than at the beginning of 2021. Despite the positive real economic conditions, age growth and inflation in many countries remained low and below central banks’ targets.

In preceding weeks, sovereign bond yields had been steady after rising earlier in the year in response to the positive news on vaccines and the additional sizeable fiscal stimulus in the United States. Inflation expectations had increased from around record lows to be closer to central banks’ inflation targets. However, central banks in major advanced economies had indicated no intention to dampen monetary stimulus until inflation outcomes were sustainably higher than currently. The economic recovery in Australia had been stronger than expected, and the central forecast for GDP growth had been revised upwards. The rally had been especially evident in the strong employment growth, with the unemployment rate expected to continue to decline from its current level of 5.6 percent.

Despite Australia’s strong economic activity, recovery, wage, and price pressures remained subdued. The recent CPI data confirmed that inflation pressures remained low in most parts of the economy. A pick-up in inflation and wage growth was expected, but this was likely to be only gradual and modest despite the lift in the forecast for output growth. Members noted that inflation would rise above three percent in the June quarter before falling below the target.

Spare capacity in the economy and a strong focus on cost containment by businesses were expected to contribute to continued subdued wage and price pressures. wouldIt would take some time for spare capacity to be reduced and the labor market to be tight enough to generate wage increases consistent with achieving the inflation target. Moreover, it was likely that wage growth would need to be sustainably above three percent, which was well above its current level. Members also noted that public sector wage policies would likely restrain aggregate wage outcomes.

Members noted that housing markets had strengthened further, with prices increasing in all major markets. Housing credit growth was also supported by strong demand from owner-occupiers, especially first-home buyers. Given the strong demand for housing, rising housing prices, and low-interest rates, members agreed on the importance of maintaining lending standards and carefully monitoring trends in borrowing.

In discussing specific elements of the current monetary policy settings, members agreed that, at the July 2021 meeting, the Board would consider whether to retain the April 2024 bond as the target bond for the 3-year yield target or to shift to the next maturity, the November 2024 bond. Members agreed that changing the target of 10 basis points was not warranted. Also, at the July meeting, the Board would consider future bond purchases following the completion of the second $100 billion purchase under the government bond purchase program. in September

The Board remained willing to undertake further bond purchases if doing so would assist with progress toward the Bank’s goals of full employment and inflation. Members agreed that a return to full work is a high priority for monetary policy and would assist with achieving the inflation target. Future policy decisions would be based on close attention to the flow of economic data and conditions in financial markets in Australia. Consequently, monetary policy would likely need to remain highly accommodative.

Members noted that the date for final drawings under the Term Funding Facility is 30 June 2021, that banks had drawn down $100 billion, and that a further $100 billion was available. The facility provides funding for three years, which means it will continue to support low funding costs in Australia until mid-2024. In an environment where financial markets in Australia are operating well, the Board did not see a case for a further extension of this facility.

Members concluded their discussion by observing that the current package of monetary policy measures had continued to support the economy by encouraging an ample supply of credit to businesses and keeping financing costs very low, thereby strengthening household and business balance sheets. The 3-year government bond yield remained at the Board’s target of around ten basis points, and lending rates on outstanding business and housing loans had continued to drift down from already low levels. As well as lowering domestic funding costs, the policy package contributed to a lower exchange rate than would otherwise have been the case. The Australian dollar had moved within a narrow range since the start of the year when commodity prices had tended to increase. Together, monetary and fiscal policies have 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 for employment and inflation were achieved. Members affirmed that the cash rate target would be held at ten basis points and the rate of remuneration on Exchange Settlement balances at zero for as long as necessary. The Board will not increase the cash rate until inflation is sustainably within the 2 to 3 percent target range. For this to occur, wage growth would need to be materially higher than it is currently. This would require significant employment gains and a tight labor market return. The Board viewed these conditions as unlikely until 2024 at the earliest.

The decision

The Board reaffirmed the existing policy settings, namely:

  • a target for the cash rate of 0.1 percent
  • an interest rate of zero on Exchange Settlement balances held by financial institutions at the Bank
  • a mark of around 0.1 percent 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 until 30 June 2021 of 0.1 percent
  • the purchase of an additional $100 billion of government bonds at the same rate of $5 billion per week after completing the first bond purchase program of $100 billion.
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