Minutes of the Monetary Policy Meeting of the Reserve Bank Board

Sydney – 5 and 6 February 2024

Members present

Michele Bullock (Governor and Chair), Ian Harper AO, Carolyn Hewson AO, Steven Kennedy PSM, Iain Ross AO, Elana Rubin AM, Carol Schwartz AO, Alison Watkins AM

Others present

Christopher Kent (Assistant Governor, Financial Markets), Marion Kohler (Head, Economic Analysis Department), Tom Rosewall (Deputy Head, Economic Analysis Department)

Anthony Dickman (Secretary), David Norman (Deputy Secretary)

Sarah Hunter (Assistant Governor, Economic), Penelope Smith (Head, International Department), Carl Schwartz (Acting Head, Domestic Markets Department), Meredith Beechey Osterholm (Future Hub), Sally Cray (Chief Communications Officer)

International economic developments

Members began by observing that global inflation remained high but that there had been encouraging progress in reducing inflation towards central banks’ targets. Much of the easing in inflation in advanced economies had been due to movements in energy and goods prices. Members noted that global shipping costs had increased recently, partly related to attacks on vessels in the Red Sea. While this posed some upside risk to tradable goods inflation, the increases in shipping costs had been small relative to those seen during the pandemic.

Compared with goods price inflation, core services price inflation had continued to ease only gradually in most advanced economies. Rent inflation was yet to show clear signs of easing in many economies. On the other hand, inflation for services other than housing had eased from its peaks, consistent with the gradual easing in labour market conditions and an improvement in the balance of demand and supply for services. However, overall services price inflation remained high relative to pre-pandemic rates.

Economic growth had slowed to below-trend rates in many advanced economies in response to restrictive monetary policy settings. This had contributed to progress in returning inflation to target. Members noted that real household disposable income growth was positive in a number of advanced economies, yet consumption growth remained subdued. The United States was the main exception, with relatively firm growth in real incomes and consumption underpinning robust economic growth.

GDP growth in Australia’s major trading partners was expected to ease in 2024. Growth in China was expected to slow over 2024 and 2025 as the post-pandemic rebound in consumption of services fades and the property sector remains weak. Weakness in these areas was expected to be partly offset by continued strength in manufacturing investment and further policy support for infrastructure investment. Additional policy measures had supported Chinese steel production and, in turn, the prices of iron ore and coking coal received by Australian exporters.

Domestic economic conditions

Members observed that inflation in Australia had moderated, with both headline and underlying inflation lower in the December quarter 2023 than had been expected three months prior. Core goods price inflation had declined faster than expected, as also seen abroad. Services price inflation, which largely reflects conditions in the domestic economy, had declined to a lesser extent and remained high. Members discussed how much signal to take from the faster-than-expected decline in inflation in the December quarter and whether goods price inflation might fall further given ongoing excess capacity in the Chinese economy. They also considered the implications for inflation if various subsidies that were due to expire were extended.

Members discussed how high inflation, higher taxes and tighter monetary policy had contributed to a noticeable slowing in growth in aggregate demand over 2023. Looking through the volatility in monthly outcomes, retail sales volumes were expected to have been broadly unchanged in the December quarter. Retailers had reported that similar conditions had persisted into the first part of 2024. More broadly, weak household spending growth, particularly in per capita terms, had been only partly offset by strong growth in business investment and public demand. Labour market conditions had remained tight but had continued to ease over preceding months in response to slower economic growth. The unemployment rate and underemployment rate had both increased by around ½ percentage point since mid-2023, albeit from low levels. Overall, conditions in the labour market were assessed to be tight relative to what would be consistent with sustained full employment.

Wages growth had remained robust, although there were signs that it was slowing in some segments of the labour market. Very weak productivity outcomes over the preceding years had contributed to a sharp increase in labour costs per unit of output. Members acknowledged that it is too soon to determine the extent to which a fading of the lingering disruptions from the pandemic and the adoption of artificial intelligence would support a turnaround in productivity growth.

Members also discussed the staff’s assessment of spare capacity in the economy. Estimates of potential output, while subject to significant uncertainty, suggested that the level of aggregate demand remained above the economy’s supply capacity. This was also consistent with other indicators of spare capacity, such as survey measures of utilisation, metrics from the labour market and the rate of inflation.

Turning to the outlook, members noted that overall demand growth was expected to remain subdued in the near term as high inflation and earlier interest rate increases continue to weigh on household consumption. The near-term outlook for GDP growth had been revised down modestly from the outlook three months prior. This mainly reflected a weaker outlook for consumer spending, reflecting the decline in real incomes over recent years. As inflation moderates and real incomes start to rise from 2024, consumption growth was expected to recover gradually to its pre-pandemic average over 2025. Members considered the risk that consumers might not increase spending as real incomes begin to rise again; this could occur if the effect of the previous fall in real wages outweighs the support from the large stock of additional savings built up in 2020 and 2021 as well as the rise in housing wealth over the previous year. They concluded that the outlook for consumption remains a significant source of uncertainty, with risks to the upside and downside.

Members also discussed the implications of the announced changes to the Stage 3 income tax cuts. They noted that the aggregate reduction in income tax payable was similar to the legislated Stage 3 tax cuts already incorporated in the staff’s forecasts. Members were briefed on the potential for the different distribution of income tax reductions across households to affect the forecasts and concluded that the effect would be negligible for plausible assumptions about differences in marginal propensities to consume.

Conditions in the labour market were expected to ease further over the coming year or so, to levels consistent with sustained full employment. Employment was expected to continue to grow moderately, though slower than the working-age population, and the unemployment rate and the broader underutilisation rate were expected to increase further. Nominal wages growth was expected to remain robust in the near term before moderating in response to further easing in the labour market. Members noted that the outlook for wages growth was consistent with the inflation target, on the assumption that productivity growth increases to around its long-run average.

Members observed that inflation was expected to return to the target range of 2–3 per cent in 2025 and to the midpoint in 2026. Inflation was anticipated to decline a little quicker than previously thought, because goods price inflation had declined more than expected and domestic demand was also a little softer than previously anticipated. But services inflation remained high and was still expected to decline only gradually as aggregate demand moderates and growth in labour and non-labour costs eases.

Financial conditions

Members noted that global financial conditions had eased over prior months.

Market participants’ expectations for reductions in central banks’ policy rates had been brought forward since the previous meeting. This had occurred in response to lower-than-expected inflation and central bank communication that further policy rate increases were less likely. However, members noted that this had reversed in late January after a number of central bank officials stated that policy rate cuts were not imminent because they were looking for more evidence that low inflation would be sustained. Stronger-than-expected US labour market data had also pushed out market expectations for reductions in policy rates in the days prior to the meeting. At the time of the meeting, market pricing implied an expectation that advanced economy central banks would start reducing policy rates from around the middle of the year.

Members noted that fewer reductions in the policy rate were expected in Australia than in many other advanced economies. Market pricing suggested that market participants believed the cash rate had probably reached its peak, with rate cuts of around 50 basis points expected by the end of 2024. This was broadly consistent with the median forecast of market economists. These expectations suggested that the policy rate in Australia would peak at a lower level than in a number of other advanced economies and decline later.

Sovereign bond yields in advanced economies had declined over preceding months in response to the improved inflation outlook and changing expectations for the paths of central bank policy rates. Other measures of financial conditions had also eased. Equity prices had risen to record highs in a number of advanced economies, including Australia, though members noted that the gains in US share prices were narrowly based and valuations there looked stretched. Spreads on corporate bonds had also declined. Nonetheless, the demand for credit generally remained subdued. Corporate bond issuance was below average in the United States and Europe, especially for lower rated corporations, and credit growth in those economies remained low. In discussing these developments, members observed that longer term interest rates were less relevant for financial conditions in Australia than in economies such as the United States. Members also observed that corporate bond issuance was robust in Australia, in contrast to other advanced economies.

In China, financial conditions had eased a little alongside some further policy support to address significant economic headwinds, including considerable stress in the property sector. Overall, the scale of monetary policy easing in China had been moderate, with more substantive support for the economy having been delivered through fiscal policy.

The Australian dollar had appreciated through late 2023. This had occurred against a backdrop of general US dollar weakness that was underpinned by expectations of near-term cuts to the federal funds rate target. The Australian dollar had since depreciated as these expectations were unwound and had been little changed since early November. The trade-weighted Australian dollar was trading near early 2022 levels.

In Australia, financial conditions were considered to be restrictive overall. The tightening of monetary policy had led to a significant rise in household debt payments, which, in combination with other factors, was weighing on disposable incomes and consumption.

Required mortgage payments had risen to a historical high as a share of household disposable income. Members noted this share would rise further as remaining low fixed-rate mortgages expire and roll onto higher rates, and the increase in the cash rate in November continues to flow through to payments. By contrast, a broader measure of total household debt payments (relative to disposable income) remained below its estimated peak, as personal credit had declined significantly since 2008. Extra payments into mortgage offset and redraw accounts had also declined since 2022, though they had increased in the second half of 2023. When viewed alongside weak consumption, this increase suggested that many borrowers might be responding to the incentive from higher interest rates to save more and limit their consumption.

Members noted that the sharp rise in interest rates had also underpinned a large decline in credit growth from its peak in early 2022. Both housing and business credit growth had stabilised at a lower level over the preceding year. Business credit had been growing a little above its post-2008 average, while housing credit growth was below its average over the same period. Even so, new housing lending had picked up over the preceding year, consistent with the rebound in national housing prices.

Considerations for monetary policy

Turning to the policy decision, members noted that there had been further progress towards the Board’s objectives but that more progress was required and the outlook remained uncertain.

Inflation in Australia had declined but was still well above target. Members noted that the moderation in inflation had been driven by softer goods price inflation and that any further slowing in this component was likely to be modest. By contrast, services price inflation remained high and had declined only a little. Members observed that while some components of services inflation were unlikely to be responsive to monetary policy in the near term, there was still a large element that reflected excess demand.

Members noted that consumption growth had remained subdued and was a little weaker than previously expected. The slowing in consumer spending reflected the impact on growth in real household disposable income of high inflation and a higher tax and interest burden. Real household disposable income was expected to grow in the period ahead, including because of the anticipated decline in inflation. Despite subdued consumption growth, overall growth in GDP remained modest, supported by a number of other parts of the economy that had been growing strongly. While overall growth had been modest, members agreed that aggregate demand was still high relative to the economy’s supply potential, which was generating inflationary pressures.

Members acknowledged the significant uncertainties around the economic outlook. The most material risks were the potential for inflation to be more persistent than anticipated, productivity growth not to recover as assumed and consumption to weaken more markedly than in the staff’s central forecast. Members noted that the staff’s central forecasts were for inflation to return to the target range of 2–3 per cent in 2025 and to the midpoint in 2026, with the unemployment rate rising modestly as growth in labour supply outpaces growth in employment. This was predicated, however, on inflation expectations remaining anchored around the midpoint of the target range and some assumed recovery in productivity. Members considered the policy implications of a scenario in which inflation expectations instead gradually drift up and another where consumption is materially weaker than in the central forecasts.

Members discussed the extent of the tightness in financial conditions. They noted that financial conditions appeared to be quite restrictive on some measures, but less restrictive on others. Members observed that this is consistent with growth in activity varying quite significantly across parts of the economy.

In light of these observations, members considered whether to raise the cash rate target by a further 25 basis points at this meeting or to leave it unchanged.

The case to raise the cash rate further centred on the observation that it would take some time for inflation to return to target and the labour market to full employment. Inflation was expected to take a further two years or so to return towards the midpoint of the target range under the central forecast. This was consistent with the staff’s assessment that aggregate demand remains above the economy’s supply potential. Members noted that an increase in the cash rate target at this meeting could slow the growth of demand further and reduce the risk of inflation not returning to target in an acceptable timeframe. Increasing the cash rate target now would not prevent the Board from easing monetary policy if the economy were to weaken more sharply than envisaged.

The case to leave the cash rate target unchanged at this meeting centred on the observation that the risk of inflation not returning to the Board’s target within a reasonable timeframe had eased. The moderation in inflation over preceding months had been slightly larger than previously expected, and global inflation outcomes had provided additional confidence that inflation in Australia would moderate further. Data on the labour market and consumer spending had also been weaker than previously expected. Members noted that it was possible that conditions in the labour market were already consistent with full employment, although this was judged to be unlikely.

Members noted that the staff’s central forecasts were for inflation to return to target within the timeframe that they had previously concluded was acceptable, and for conditions in the labour market to be broadly consistent with full employment in a year or so. Both of these forecasts were predicated on a technical assumption for the cash rate, derived from market economists’ forecasts and market pricing, that include no additional increase in the cash rate. Members observed that the risks around the outlook were broadly balanced; there was a risk that inflation proves more persistent but there was also a risk that consumer spending weakens more sharply than it had to date. Given these observations, it was reasonable to conclude that leaving the cash rate unchanged at this meeting, and continuing to monitor how risks to the outlook evolve, was the most appropriate course of action.

In weighing up these two options, members judged that the case to leave the cash rate target unchanged was the stronger one. They agreed that doing so would best balance the Board’s objectives for price stability and full employment. Members noted that the data had evolved in a manner that gave them more confidence that inflation would return to target within a reasonable timeframe while allowing employment to continue to grow.

Members then considered the options for how to communicate the Board’s decision in the post-meeting statement. They agreed to communicate that there had been progress towards meeting the Board’s inflation objective. At the same time, members noted that it would take some time before they could have sufficient confidence that inflation would return to target within a reasonable timeframe. Uncertainty about the outlook for the economy was high. Members also observed that the costs of inflation not returning to target within the envisaged timeframe were potentially very high. Given this, members agreed that it was appropriate not to rule out a further increase in the cash rate target. They also agreed that it would be important to continue to pay close attention to developments in the global economy, trends in domestic demand, and the outlook for inflation and the labour market. Members reiterated their resolve to do what is necessary to return inflation to target.

In light of these conclusions, members agreed that it was important for the Board’s public statement to make clear that inflation had moderated but was still high, and that it was not yet possible to rule in or out further increases in interest rates. Members also agreed on the importance of highlighting the uncertainty surrounding the economic outlook and the need for monetary policy to be driven by developments in relevant data, the outlook for the economy and the evolving risks.

The decision

The Board decided to leave the cash rate target unchanged at 4.35 per cent, and the interest rate on Exchange Settlement balances unchanged at 4.25 per cent.