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Minutes of the Monetary Policy Meeting

of the Reserve Bank Board


Sydney 4 July 2017

Members Present
Philip Lowe (Governor and Chair), Guy Debelle (Deputy Governor), John Akehurst, Kathryn Fagg,
John Fraser (Secretary to the Treasury), Ian Harper, Allan Moss AO, Carol Schwartz AM,
Catherine Tanna

Others present
Luci Ellis (Assistant Governor, Economic), Christopher Kent (Assistant Governor, Financial Markets),
Alexandra Heath (Head, Economic Analysis Department), Daniel Rees (Head of Macroeconomic
Modelling, Economic Analysis Department)

Anthony Dickman (Secretary), Andrea Brischetto (Deputy Secretary)

Domestic Economic Conditions


Members commenced their discussion of the Australian economy by noting that year-ended GDP
growth in the March quarter had slowed, largely reflecting temporary factors. GDP growth
remained below Bank estimates of potential output growth, consistent with spare capacity in the
labour market and low inflation. New South Wales and Victoria had continued to make the largest
contributions to year-ended growth in domestic demand. Although domestic demand had declined
again in Western Australia, there were some signs of improvement in that state. Quarterly growth
was expected to have increased in the June quarter despite the disruptions to coal export volumes
following Cyclone Debbie.

Growth in household consumption had slowed in the March quarter in line with subdued
household income growth. More timely indicators suggested that household spending had
strengthened in the June quarter. The value of retail sales had increased in April, consistent with
liaison reports that suggested conditions in the retail sector had improved. Members noted that
the recent pick-up in growth in employment should also support a pick-up in household income
growth, and therefore consumption growth, in the period ahead.

Members discussed the decline in dwelling investment in the March quarter, noting that it had
been concentrated in Queensland and in New South Wales, where activity had been affected by
wet weather. While the flow of new project approvals had been noticeably lower in prior months,
the large pipeline of projects was expected to support building activity at a high level over the
subsequent year or so.

Conditions in established housing markets and for new construction had continued to vary
significantly across the country and between dwelling types. Sydney and Melbourne remained the
strongest markets, consistent with relatively high population growth. Members observed that
population growth had been particularly high in Victoria, because of high migration from overseas
and interstate. In contrast, Western Australia had experienced a sharp decline in population
growth following the end of the mining investment boom. Auction clearance rates in Sydney and
Melbourne had softened recently, suggesting that conditions in these markets had eased
somewhat. Housing prices in Perth and apartment prices in Brisbane had fallen further. Members
noted that there had been several periods in the preceding decade in which housing prices had
fallen, or growth had slowed significantly, in different parts of the country.

Private business investment had increased in the March quarter, driven by an unexpected increase
in mining investment. Non-mining investment had declined a little in the quarter, but had been
gradually trending up for a number of years. Over the previous five years, most of the growth in
business investment had occurred in Victoria and New South Wales. Survey measures of current
business conditions had generally remained well above average and profits of the private non-
financial sector had risen again in the March quarter, to be 30 per cent higher over the prior year.
Most of the increase had been accounted for by the mining sector, but other industries had also
recorded higher profits.

Public demand had increased modestly in the March quarter. The most recent Australian and state
government budgets suggested that fiscal policy would be more expansionary in 2017/18 than
had previously been expected. Some of this expansion was expected to come from more spending
on public infrastructure, particularly in New South Wales. Reflecting this, work yet to be done on
public infrastructure had increased in recent quarters to a relatively high share of GDP. Members
noted that infrastructure investment was expected to have significant positive spillovers to other
parts of the economy. Non-residential building approvals had also risen in recent months.

The terms of trade had increased again in the March quarter, to be nearly 25 per cent higher over
the prior year, but were expected to have declined in the June quarter. A temporary decline in the
volume of resource exports in the March quarter had been offset to some extent by ongoing
strength in service exports and a pick-up in grain exports as a result of strong winter crop
production. The trade balance was recorded as having been in surplus for the second consecutive
quarter. Coal export volumes were expected to have fallen in the June quarter as a result of
Cyclone Debbie, while iron ore and liquefied natural gas (LNG) export volumes were expected to
have increased.
Recent data had provided further confirmation that labour market conditions had improved since
late 2016, consistent with signals from forward-looking indicators in previous months. Employment
growth had been strong in May for the third consecutive month. Members noted that growth in
the preceding few months had been driven entirely by full-time employment and that total hours
worked had trended higher as a result. The unemployment rate had declined by 0.3 percentage
points over the previous two months, to be at its lowest rate since early 2013. However, the
underemployment rate, which measures the number of part-time workers wanting to work more
hours, had remained elevated.

Over the preceding five years or so, the household services sector had contributed the most to
increases in full-time and part-time employment. Full-time employment had also increased
significantly in business services over this period, but had fallen in the goods-related sector.
Employment growth had remained highest in Victoria over the year and had started to pick up in
New South Wales in recent months, following soft conditions over the prior year. Labour market
conditions in Western Australia and Queensland appeared to have improved.

Forward-looking indicators of labour demand, such as job advertisements and business hiring
intentions, had remained positive and generally consistent with the patterns of employment across
states and industries.

Wage measures in the March quarter national accounts had continued to suggest that labour cost
pressures remained subdued. The Fair Work Commission had announced a 3.3 per cent increase
in award wages and the national minimum wage, effective from 1 July 2017. This followed an
increase of 2.4 per cent in 2016 and was likely to affect the wages of around two-fifths of
workers.

Members noted that wholesale electricity prices had risen sharply over the first half of 2017 and
that this had led to significant increases in prices for retail customers. Members discussed these
increases in the context of efforts to address climate change and to alter Australias energy mix.
Concerns about energy security, reliability and costs had been heightened over the preceding six
months or so, partly reflecting policy uncertainty and its effect on the investment decisions of
electricity generators. Members also discussed how developments in the LNG sector had affected
the costs and decisions of electricity generators.

International Economic Conditions


Members observed that the improvement in the world economy was continuing and that output
growth in some economies in the March quarter had been a little stronger than expected.
Merchandise trade and industrial production had increased further in the preceding months.
Higher trade volumes had spurred investment and supported growth, particularly in Japan and
other high-income economies in east Asia. Members noted that the ongoing growth in business
investment in the major advanced economies and east Asia was a positive sign for the
sustainability of global growth in the period ahead. Labour markets in the major advanced
economies had continued to strengthen, which was also a positive development for more
sustained global growth.

Core inflation had remained low and headline inflation had turned down in a number of
economies, as the effect of higher energy prices in 2016 had dissipated. Members noted that non-
OPEC countries had increased oil production, placing downward pressure on oil prices and
headline inflation.

The pace of growth in the Chinese economy had been maintained in prior months, assisted by the
accommodative stance of policy. Growth in investment had been stable, as a solid rise in private
investment growth had more than offset a slowing in public investment growth. Consistent with
this, Chinese demand for commodities had been resilient. Imports of iron ore had increased since
late 2016 and coal imports had stabilised at a relatively high level. Chinese domestic production
had increased following a relaxation of policies to restrict output. Members noted that growth in
business financing had been stable over 2017 to date, as higher growth in business loans had
offset a moderation in the growth of securities financing.

The slowdown in GDP growth in the United States in the March quarter appeared to have been
temporary. Consumption growth had picked up in recent months and investment intentions had
remained high. The unemployment rate had declined further in May and was below most
estimates of full employment. Members noted that wage and unit labour cost growth had
increased over the previous two years.

In the euro area, robust growth in retail sales and very high levels of consumer confidence
suggested that consumption growth had picked up in the June quarter. Conditions had been
supportive of a pick-up in investment and surveys had suggested that firms intend to increase
investment accordingly. Increased business confidence had translated into more demand for
labour; employment growth had strengthened and had been reasonably broadly based, while the
unemployment rate for the euro area had declined to its lowest level since 2009. However, wage
growth had remained subdued.

The Japanese labour market had also continued to improve, with strong growth in employment
and a large increase in participation by the 65+ age cohort and women. Although total average
wage growth had remained subdued in Japan, wage growth for part-time workers had increased.

Financial Markets
Members noted that financial markets had generally experienced low volatility over preceding
months. The implications of statements by central banks in the major economies for the future
path of monetary policy had been a focus for financial market participants more recently.

In the United States, the Federal Open Market Committee (FOMC) had increased its target for the
US federal funds rate by 25 basis points in June, as had been widely expected. The FOMC had also
outlined some details regarding the plan for a gradual and predictable reduction in the Federal
Reserves balance sheet, which is expected to begin later this year. Members noted that financial
market participants continued to expect further increases in the US federal funds rate to occur
more slowly than implied by the median projections of FOMC members.

Following its meeting in June, the European Central Bank had removed the easing bias from its
forward guidance on interest rates, on the basis of a more positive economic outlook. In response,
financial market prices had shifted to suggest that a small increase in the euro area policy rate
was expected by the end of 2018. Also, the market-implied probability of near-term policy rate
increases in Canada and the United Kingdom had increased in the preceding month in response to
statements by senior central bank officials in those economies.

Long-term government bond yields in most of the major financial markets had increased over the
preceding month in response to changing expectations about monetary policy. Members noted
that yields on 10-year Japanese government bonds had remained close to the Bank of Japans
target of around 0 per cent under its yield curve control policy. Yields on long-term Australian
government bonds had increased a little over June, as had their spread to US Treasury bond
yields, although both remained at low levels.

Most foreign exchange rates were little changed over the preceding month. On a trade-weighted
basis, the US dollar had remained around its level immediately prior to the US election, having
depreciated over the first half of 2017. The euro had appreciated a little further over the preceding
month in trade-weighted terms. The Australian dollar had appreciated somewhat since the
previous meeting, consistent with slightly better-than-expected domestic economic news, but had
remained in the narrow range of the prior year or so in both US dollar and trade-weighted terms.

Share prices in the advanced economies, including Australia, had been little changed over June.
Members observed that Australian share prices had underperformed relative to those in other
developed markets over preceding months, largely reflecting a substantial decline in bank share
prices. There had been a small partial retracement of this decline in June.

Financial market conditions had remained favourable in most emerging markets, with the decline
in government bond yields and the increase in equity prices since early 2017 having continued
over the preceding month.

In China, financial market conditions had been tightened during 2017 as the authorities worked
towards reducing leverage in the financial system. The renminbi exchange rate had been relatively
stable in the first half of the year, following a depreciation over the preceding few years. The stock
of foreign currency reserves had also remained steady at around US$3 trillion, after a period of
persistent declines.

Members discussed trends in the composition and cost of Australian banks funding. Deposits,
which are generally a relatively low-cost form of funding, had increased as a share of funding over
recent years, to around 60 per cent, while the share of debt funding, particularly at short
maturities, had declined. The cost of both types of funding had declined further since late 2016.
Members noted that, over the same period, banks lending rates had increased slightly, driven by
increases in housing lending rates for investors and on interest-only loans. As a result, the implied
spread between the estimated average outstanding lending and funding rates for banks was
estimated to have increased slightly.

Members observed that housing credit growth overall had been steady during the first part of
2017, with slower growth in lending to investors largely offset by a pick-up in the growth of
lending to owner-occupiers.

Financial market pricing continued to suggest that the cash rate was expected to remain
unchanged over the remainder of 2017, but had shifted to indicate some probability of an increase
in the cash rate by mid 2018.

Considerations for Monetary Policy


Members discussed the neutral real interest rate and its decline over the preceding decade. The
neutral real interest rate is the interest rate at which output growth is at potential and inflation is
stable. Members noted that it is not possible to measure the neutral real interest rate directly, but
that it can be inferred from the behaviour of other variables.

Members discussed the Banks work estimating the neutral real interest rate for Australia. The
various estimates suggested that the rate had been broadly stable until around 2007, but had
since fallen by around 150 basis points to around 1 per cent. This equated to a neutral nominal
cash rate of around 3 per cent, given that medium-term inflation expectations were well
anchored around 2 per cent, although there is significant uncertainty around this estimate.
Members noted that some of this decline could be attributed to lower potential output growth, but
the increase in risk aversion around the time of the global financial crisis was likely to have been a
more important factor, given that the bulk of the decline in the estimated neutral real interest rate
had occurred around that time. Estimates of neutral real interest rates for other economies had
shown a similar decline. All estimates of the neutral real interest rate for Australia suggested that
monetary policy had been clearly expansionary for the preceding five years or so. It was also
noted that a reduction in risk aversion and/or an increase in the potential growth rate could see
the neutral real interest rate rise again.

Turning to the immediate decision regarding the level of the cash rate, members noted that the
broad-based recovery in the global economy had continued. There had been further signs that
investment was increasing and labour markets had tightened further in many advanced
economies. This was expected to lead to a pick-up in growth in wages and prices over time. In
this context, members noted that a number of central banks had become more positive about
domestic economic conditions, and financial market pricing suggested that there had been upward
revisions to the expected path of future monetary policy in these economies.

Domestically, the data available for the June quarter had generally been positive, following the
slower growth recorded for the March quarter. Although recent indicators suggested that
consumption growth had increased in the June quarter, members noted that there were still risks
to consumption growth should household income growth remain subdued, particularly given the
high levels of household debt. Against this background, the recent improvement in labour market
data had been a positive development. Members noted that the strength of recent labour market
data had removed some of the downside risk in the Banks forecast of wage growth.

Business surveys had continued to suggest that business conditions were above average. Recent
state budgets and data on non-residential construction suggested that the contribution to growth
from infrastructure investment would rise. The pipeline of residential construction was expected to
support dwelling investment over the forecast period. The economic outlook continued to be
supported by the low level of interest rates. The depreciation of the exchange rate since 2013 had
also assisted the economy in its transition following the mining investment boom. An appreciating
exchange rate would complicate this adjustment.

Conditions in established housing markets had continued to vary considerably across the country.
Members recognised that it was too early for the prudential supervision measures announced by
the Australian Prudential Regulation Authority, which were designed to help address the risks
associated with high and rising levels of indebtedness, to have had their full effect.

Members regarded the improvement in the world economy over the preceding months as a
welcome development. Nevertheless, they assessed that current economic conditions in Australia,
and the outlook for growth and inflation, meant that developments in the labour and housing
markets continued to warrant careful monitoring. Taking into account all the available information,
the Board judged that holding the accommodative stance of monetary policy unchanged at this
meeting would be consistent with sustainable growth in the economy and achieving the inflation
target over time.

The Decision
The Board decided to leave the cash rate unchanged at 1.5 per cent.

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