Minutes of the Monetary Policy Meeting of the Reserve Bank Board

Videoconference – 7 September 2021

Members present

Philip Lowe (Governor and Chair), Guy Debelle (Deputy Governor), Mark Barnaba AM, Wendy Craik AM, Ian Harper AO, Carolyn Hewson AO, Steven Kennedy PSM, Carol Schwartz AO, Alison Watkins

Others participating

Luci Ellis (Assistant Governor, Economic), Christopher Kent (Assistant Governor, Financial Markets)

Anthony Dickman (Secretary), Penelope Smith (Deputy Secretary), Alexandra Heath (Head, International Department), Bradley Jones (Head, Economic Analysis Department), Jonathan Kearns (Head, Financial Stability Department), Marion Kohler (Head, Domestic Markets Department)

International economic developments

Members commenced their discussion of international economic developments by noting that momentum in the global economic recovery had eased in recent months. The global recovery also remained uneven, reflecting cross-country differences in policy support and vaccination rates. However, by year end, output in many economies was expected to have recovered to, or surpassed, pre-pandemic levels.

In countries with high vaccination rates, the recovery had been supported by the lifting of restrictions on mobility in recent months; rates of hospitalisation and recent deaths were relatively low despite an increase in case numbers of COVID-19. Consumption of services in the United States, Canada and several European countries had largely recovered from earlier declines, with high-frequency indicators of activity in the services sector (such as retail foot traffic and restaurant dining) returning to around pre-pandemic levels.

Members noted that unemployment rates in advanced economies had continued to decline over recent months. Demand for labour was high, although the supply of labour had been slower to respond to the lifting of restrictions, particularly in the services sector; these mismatches were contributing to pockets of labour shortages and wage pressures in some industries. Overall, wages growth had picked up in the United States, the United Kingdom and New Zealand, but remained modest in the euro area and Canada. Members noted that there was higher-than-usual uncertainty surrounding projections of spare capacity in the labour market, reflecting government support schemes and the medium-term effects of COVID-19 on labour supply.

Headline consumer price inflation remained high in advanced economies and it was likely that global supply chain disruptions would be more persistent than initially envisaged. Strong demand for goods continued to result in long supply times and high container freight rates. This had been exacerbated recently by disruptions to supply caused by virus outbreaks in key international trading ports. Members noted that once pandemic-related shocks to demand and supply begin to subside, the transitory inflationary pressures would ease and inflation would depend mostly on the extent of spare capacity in the labour market and the speed at which it was absorbed. Central banks' forecasts were for inflation to decline over the following year, and measures of underlying inflation and medium-term inflation expectations were broadly in line with central banks' targets in many advanced economies.

Members noted that health and economic outcomes across emerging Asian economies had been mixed in recent months. An increase in case numbers had prompted renewed containment measures in some countries in Asia. Restrictions in some middle-income east Asian countries had recently led to sharp declines in population mobility, which were expected to have dampened services activity in affected regions. Intermittent restrictions had also continued to weigh on activity in high-income east Asian countries. In contrast, mobility in India had recovered substantially as the earlier outbreak of the Delta variant of COVID-19 subsided, pointing to a strong recovery in economic activity in the September quarter.

Members noted that data on economic activity in China had softened in recent months and the outlook had become more uncertain than it had been for some time. Low tolerance for the community spread of COVID-19 had resulted in intermittent targeted lockdowns and restrictions on movement, which had weighed on activity and been disruptive for some key ports. There was also uncertainty about the effects of a range of recent policy measures, including those aimed at curbing financial stability risks, reducing carbon emissions and achieving broader social objectives.

The price of iron ore had fallen from high levels in recent times as Chinese authorities intensified efforts to restrict steel production. However, prices for coal and liquefied natural gas had continued to increase in recent months alongside strength in industrial output in China and elsewhere, and a boost to electricity demand from an unseasonably warm northern hemisphere summer. As a result, Australia's terms of trade were likely to remain at a high level in the September quarter, after reaching a record high in the June quarter.

Domestic economic developments

Turning to domestic economic developments, members noted that the national accounts confirmed the recovery had established strong momentum prior to the recent outbreak of the Delta variant of COVID-19. Domestic final demand increased by 1.7 per cent in the June quarter, to be 3.2 per cent above its pre-pandemic level. Growth in household consumption of just over 1 per cent in the quarter had been led by a rebound in the consumption of services. Growth in dwelling investment had slowed in response to capacity constraints, with a large pipeline of work still to be completed. Growth in business investment of around 2 per cent had been led by non-mining investment, while mining investment had declined in the quarter. Overall, GDP increased by 0.7 per cent in the June quarter, broadly in line with the most recent set of Bank forecasts, as strong growth in private and public consumption and investment had been partly offset by a decline in resource exports.

The outbreak of the Delta variant had interrupted the recovery in a manner that was more severe than expected a month earlier. While private demand had increased solidly in the June quarter, the spread of the Delta variant in New South Wales and Victoria had set back the recovery and created uneven conditions across states and industries. GDP was expected to decline materially in the September quarter; the near-term outlook resembled the downside scenario presented in the most recent forecasts. Measures of population mobility in New South Wales and Victoria had declined to around the low levels reached during earlier lockdowns. As in previous lockdowns, household consumption had been curtailed by reduced opportunities for households to spend. Dwelling and business investment were also likely to decline in the September quarter in response to restrictions in New South Wales and Victoria. Information from the Bank's liaison program suggested that restrictions affecting the construction industry could delay activity for a period, with limited scope to make up for this in light of ongoing capacity constraints.

Conditions in the established housing market had remained more robust in recent months compared with the Melbourne lockdown in the second half of 2020. Nevertheless, growth in housing prices had slowed a little in Sydney and Melbourne following the rapid increases over the first half of 2021. Housing prices had continued to increase strongly in most other markets. Growth in advertised rents also remained strong in most capital cities and regional areas. Building approvals data indicated that demand for new housing and alterations and additions had continued to ease after the conclusion of the HomeBuilder application period, but remained high compared with pre-pandemic activity.

Consistent with the effect of the lockdowns on activity, members assessed that further improvement in the labour market would be delayed. Hours worked and employment were little changed in July at a national level, but this masked the offsetting effects of declines in New South Wales and a recovery in Victoria from a previous lockdown early in June. Large declines in hours worked and employment were expected in both states in coming months before rebounding later in the year. Members noted that workers in New South Wales and Victoria who were stood down without pay for longer than four weeks were likely to be classified as not employed even if they were still attached to their employer; this differed from the treatment of workers who were stood down but received the JobKeeper payment in 2020, and would affect measured employment while restrictions remained in place. The decline in the unemployment rate in July was mainly due to people exiting the labour force. Alternative measures, which included employees working zero hours, rose in July and further increases were expected in the near term as more workers are stood down for longer than four weeks. Members noted that the measured unemployment rate would be a less useful indicator of labour market underutilisation over coming months compared with hours-based measures.

Members also noted that, prior to the recent outbreak of the Delta variant, notwithstanding the strong rebound in economic activity and employment, there had been little sign of upward pressure on wages growth. Increases in the Wage Price Index in the June quarter were modest for almost all industries, including those where there had been some reports of labour shortages amid strong labour demand, such as construction and mining. Business liaison suggested that most firms did not expect the recent lockdowns to have a significant effect on wages growth in the year ahead.

Beyond the September quarter, members agreed that the timing and pace of the rebound in economic activity would depend largely on the lifting of restrictions in response to health outcomes. Vaccination rates had been increasing swiftly in the period leading up to the meeting, especially in New South Wales. As vaccination coverage increased, this would allow restrictions to be eased and recovery from the recent setback to begin in the December quarter. As restrictions were likely to be lifted gradually, the recovery could be slower than experienced earlier in the pandemic, when the end of community transmission of COVID-19 allowed for a more rapid lifting of restrictions. It was possible that precautionary behaviour by households and firms after lengthy lockdowns would also contribute to a slower rebound, although there had been little evidence of this from the international experience or from domestic spending patterns outside of lockdown areas. Information from liaison also suggested that many firms were preparing to look beyond the near-term uncertainty and were committing to previous hiring and investment decisions. In the central scenario, activity was expected to return to its pre-Delta path in the second half of 2022, with the health situation the key source of uncertainty around this scenario.

Members agreed that the substantial increase in pandemic support by the Australian Government and state and territory governments would be one of the factors supporting the recovery into 2022. This support was more targeted than earlier in the pandemic, but for many individuals the COVID-19 disaster relief payments were offering the same level of income support as the earlier JobKeeper payments. This income support was expected to boost the household saving rate in the near term, and would eventually boost consumption when restrictions are eased later in the year. Business support grants, payroll tax deferrals and rental forbearance had also supported the cash flows of many businesses affected by lockdowns. More generally, members noted that business conditions across and within states remained uneven, with some industries experiencing very challenging conditions, while others, including professional services, appeared to have weathered the recent period reasonably well.

International financial markets

Globally, financial conditions remained highly accommodative. Yields on long-term government bonds had risen a little over the previous month, having declined significantly in prior months as the spread of the Delta variant of COVID-19 moderated optimism about the global economic recovery. In general, yields on shorter-term bonds had remained at low levels.

Some central banks in advanced economies had reduced their highly stimulatory policy settings or signalled they would soon start doing so. The Bank of Korea had raised its policy rate in August, citing rising inflationary pressures and a desire to curb financial imbalances. Members noted that the Reserve Bank of New Zealand (RBNZ) had also been expected to increase its policy rate in August, but had chosen to hold the rate steady given the policy meeting had been held shortly after a lockdown had been announced. The RBNZ had indicated that an increase in its policy rate would be appropriate soon because the economy is experiencing capacity constraints, inflationary pressures are building and inflation is near the RBNZ's target. The RBNZ had also signalled that it was considering further restrictions on high loan-to-value lending in response to rapid growth in housing prices and housing credit.

Members noted that market pricing implied that market participants were expecting the Bank of Canada and the Bank of England to start increasing their policy rates around mid 2022. Both central banks were widely expected to have ceased net asset purchases by that time. For the United States, most members of the Federal Open Market Committee had indicated that a reduction in the pace of the Federal Reserve's asset purchases was likely to be appropriate before the end of the year, given the progress that had been made towards its macroeconomic goals. Market pricing suggested that the conditions the Federal Reserve had set itself for raising its policy rate were unlikely to be met before 2023.

Financing conditions for corporations in advanced economies had remained favourable. Over the preceding month, equity markets in advanced economies had been around all-time or post-pandemic highs, including in Australia, supported by the recent strength in earnings. The spread between yields on corporate bonds and yields on government bonds had generally remained narrow.

In China, some weaker-than-expected economic data suggested downside risks to the economic outlook, which had increased expectations for a further easing in monetary policy. Members noted that a number of risks to the outlook for growth and financial stability were receiving attention in China. In particular, regulatory changes aimed at reducing leverage among real estate developers, as well as restrictions on demand for real estate, had led to slower construction activity and liquidity difficulties for some large property developers. This had led to a heightened risk of fire sales of assets and raised concerns about the potential for financial stability issues. There had also been a tightening of regulation in some other sectors, notably information technology and private education. This had resulted in significant declines in the share prices of affected firms, particularly those listed in offshore markets.

Financial conditions in other emerging markets had generally remained stable, despite rising COVID-19 case numbers in many countries. Central banks in a number of emerging market economies, including Brazil, Mexico and Russia, had increased their policy rates since early 2021 in response to high and rising inflation, and were expected to increase their policy rates further before the end of the year. Inflation in Asia had remained relatively well contained, but some central banks in the region were expected to start increasing policy rates in the near future. Bank Indonesia had announced it would purchase more government debt in the primary debt market in a burden-sharing arrangement to support government spending on COVID-19 response measures, following a similar arrangement in 2020. Members noted that the recent allocation of Special Drawing Rights by the International Monetary Fund was expected to be used by some emerging market economies to access additional foreign exchange, partly to assist with their COVID-19 policy responses.

Although there had been little change in the Australian dollar exchange rate from a month earlier, the Australian dollar had depreciated over the course of 2021 both against the US dollar and in trade-weighted terms. Over the year to date, the difference between interest rates in Australia and in other major advanced economies had declined, while most commodity prices had increased.

Domestic financial markets

Domestically, interest rates on outstanding home and business loans had edged down to new lows, as new loans and refinancing of existing loans were taken out at lower rates than existing loans. Housing loan commitments remained at high levels and overall credit growth had picked up further in July in six-month-ended annualised terms. Members noted that the current lockdowns were likely to affect demand for new loans in the coming months. The recent strength in banks' lending to businesses had followed a period of little change since late in 2020 and was mirrored by a pick-up in other forms of business debt issuance, including corporate bonds. Banks had offered targeted support to those household and business borrowers affected by lockdown measures, and the Australian Prudential Regulation Authority (APRA) had provided regulatory relief for this support. To date, the uptake of payment deferrals by households and businesses had been much lower than in the previous year.

Yields on 10-year Australian Government Securities (AGS) had been little changed over the preceding month but had declined relative to US 10-year yields since June, leaving a gap of around 10 basis points. Short-term yields on AGS out to the April 2024 bond had remained very low and in some cases had fallen a little below zero. In part, this had reflected the effects of the Bank's policies, including the bond purchases, which had contributed to further rises in system liquidity.

The Bank had completed the $200 billion of purchases under its bond purchase program at the time of the meeting. Around half of surveyed market economists expected the Bank to maintain the pace of bond purchases at $5 billion per week, in light of the economic effects of recent lockdowns and other containment measures. A similar proportion expected the Bank to taper purchases to $4 billion per week as was announced following the July 2021 meeting.

Expectations for the cash rate in the near term had been little changed. Market pricing continued to suggest that market participants expected the cash rate target to be increased to 25 basis points around the end of 2022.

Members reviewed the Term Funding Facility (TFF) following its closure to new drawdowns at the end of June 2021. The $188 billion of low-cost funding that had been drawn under the TFF will continue to support low borrowing costs until mid 2024. Business credit had held up since early 2020, which was a better outcome than seen in earlier periods of sizeable contractions in economic activity in Australia, when business credit had declined noticeably. The TFF had contributed to lower funding costs for banks, which had been passed through to lower borrowing rates. This suggested that the TFF had provided, and would continue to provide, significant support to the economy. Members noted that the banks' task of refinancing the maturing funding from the TFF in around three years' time would be sizeable, but manageable. Australian banks had issued similarly large volumes of bonds as a share of assets in the past, and currently have the capacity to smooth their funding arrangements.

Considerations for monetary policy

In considering the policy decision, members observed that the Australian economy had considerable momentum prior to the outbreak of the Delta variant of COVID-19. Business investment had been picking up and the labour market had strengthened, with the unemployment rate falling further in June. However, despite the strong economic and labour market outcomes, wage and price pressures had remained subdued.

The outbreak of the Delta variant had delayed, but not derailed, the recovery. GDP was expected to decline materially in the September quarter and the unemployment rate was expected to rise, but the economy was expected to bounce back as vaccination rates increase and restrictions are eased. However, there was considerable uncertainty about the timing and pace of the recovery, which was likely to be slower than experienced earlier in 2021. Much would depend on the health situation and the easing of restrictions on activity. In the central scenario, the economy would return to growth in the December quarter and to its pre-Delta path in the second half of 2022. Wages growth and underlying inflation were expected to pick-up gradually as the economy recovers.

Members noted that very accommodative financial conditions were supporting the recovery. Borrowing rates were at record lows, sovereign bond yields were at very low levels and the exchange rate had depreciated over preceding months. Members noted also that housing prices had continued to rise. Housing credit growth had increased, reflecting stronger demand for credit from both owner-occupiers and investors. Given the environment of rising housing prices and low interest rates, members continued to emphasise the importance of maintaining lending standards and carefully monitoring trends in borrowing.

Members discussed the implications of the outbreak of the Delta variant for the Bank's bond purchase program.

As part of their discussion, members considered the roles of fiscal and monetary policy in response to the current shock. They observed that fiscal policy is the more appropriate policy instrument for dealing with a temporary and sharp reduction in private sector incomes. In this context, they welcomed the fiscal responses by the Australian Government and the state and territory governments in supporting household and business balance sheets. While acknowledging that monetary policy can do little more to offset this type of temporary shock to aggregate demand, members recognised that the outbreak of the Delta variant was delaying the recovery and had added to the uncertainty about the future. As a result, progress towards the Bank's goals was likely to take longer and was less assured. In response, members judged that a modification to the previously announced plans was appropriate.

Two modifications were considered. The first was to maintain the recent rate of purchases at $5 billion a week to at least November 2021 and then review the program. The second was to taper purchases to $4 billion as had been announced, but to extend the period over which bonds would be purchased at this rate to mid February 2022. With the economy expected to return to its pre-Delta path by mid 2022, members assessed that, on balance, tapering remained appropriate. The Board also took account of the fact that a number of other central banks are tapering their bond purchases. In addition, at $4 billion a week, the Bank's bond purchase program is expanding faster relative to the stock of bonds outstanding than that of many other central banks. The Board also saw value in providing greater clarity regarding bond purchases after November 2021.

The Board therefore decided on the second option – namely, to purchase bonds at $4 billion a week until at least mid February 2022. The Board will continue to review the bond purchase program in light of economic conditions and the health situation, and their implications for the expected progress towards full employment and inflation reaching the target. The bond purchases – together with the low level of the cash rate, the yield target and the funding under the TFF – were providing substantial and ongoing support to the Australian economy.

The Board remains committed to maintaining highly supportive monetary conditions to achieve a return to full employment in Australia and inflation consistent with the target. It will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range. The central scenario for the economy is that this condition will not be met before 2024. Meeting this condition will require the labour market to be tight enough to generate wages growth that is materially higher than it was at the time of the meeting.

The decision

The Board decided upon the following policy settings:

• maintain the cash rate target at 10 basis points and the interest rate on Exchange Settlement balances of zero per cent
• maintain the target of 10 basis points for the April 2024 Australian Government bond
• purchase government securities at the rate of $4 billion a week and to continue the purchases at this rate until at least mid February 2022.

Other policy matters

The Board discussed the Bank's arrangements for Exceptional Liquidity Assistance (ELA). This was prompted by ongoing developments in the international regulatory architecture, where it has become increasingly common for central banks to provide more detailed information on ELA arrangements to assist banks in their contingency planning. This transparency can assist banks in their recovery and resolution planning and thereby support financial stability. In Australia, APRA intends to release its new prudential framework for recovery and resolution for consultation later in 2021. Australia's financial institutions currently have high liquidity buffers and are strongly capitalised. Against this background, the Board discussed current arrangements for ELA in Australia.

The provision of ELA to illiquid but solvent banks is a core responsibility of central banks. While each financial institution is responsible for managing its own liquidity, situations can arise when the provision of liquidity to a specific institution by the central bank can be in the public interest. Doing so can reduce unnecessary disruptions to the financial system and help preserve financial stability.

The regulatory framework for authorised deposit-taking institutions (ADIs) in Australia anticipates that institutions may at times face unexpected outflows or difficulty accessing liquidity. ADIs are required to maintain holdings of liquid assets above a regulatory minimum and to plan how they would respond to liquidity stress. Larger ADIs are also expected to hold additional ‘contingent liquidity’ assets that could be used in a crisis situation to access liquidity from the Bank via repurchase agreements (repos) of self-securitised mortgages – that is, debt securities backed by pools of mortgages created and held by ADIs specifically to be used in repos with the Bank.

In situations of market-wide liquidity stress, the Bank can boost system-wide liquidity through open market operations, reducing uncertainty about the availability of liquidity in the banking system and contributing to a lower cost of liquidity than otherwise. The Bank has done this on multiple occasions in the past, notably during the global financial crisis and during a period of pandemic-related stress in March and April 2020.

However, where liquidity pressures arise in an individual institution, or in parts of the financial system where open market operations are less well suited, the Bank can consider providing ELA directly to individual financial institutions. Liquidity risk has generally been well managed by ADIs, which suggests that the provision of ELA would be exceptionally rare.

While risk to the Bank from providing ELA is managed by holding collateral, with appropriate ‘haircuts’, the Bank would consider providing ELA only if it was considered to be in the public interest. Further, it would need to be clear that the recipient was experiencing acute liquidity difficulties and had made reasonable efforts to obtain liquidity from private sources, and the Bank would need to judge that the entity was solvent. The recipient would be expected to have informed its regulator of its liquidity concerns before approaching the Bank, and the Bank would liaise closely with the regulator in making judgements about the entity's situation and solvency. The provision of ELA and the terms of that assistance would be at the Bank's discretion.

The focus of liquidity support is generally on ADIs, but in principle it could also be provided to a domestic clearing and settlement facility, where the facility is unable to obtain liquidity from its collateral holdings for market or operational reasons. This could occur either as part of the facility's normal default management arrangements, or during recovery or resolution when extraordinary measures were being taken to secure the facility's viability. The arrangements for providing liquidity would be broadly similar to those for ADIs.

Members endorsed the proposal for the Bank to publish information on its website regarding technical requirements and other considerations for ELA, in order to increase the transparency of ELA arrangements. This information will note the Bank's expectation that entities should: inform their regulator of any liquidity concerns and their intention to request ELA before approaching the Bank; have made reasonable efforts to obtain liquidity from the private sector; and be able to demonstrate their solvency. It will also emphasise that the Bank retains full discretion over the provision and terms of ELA. As in other countries, this information will assist institutions with their recovery and resolution plans.