RBNZ Official Cash Rate unchanged at 1.75 percent

The Reserve Bank today left the Official Cash Rate (OCR) unchanged at 1.75 percent.

Macroeconomic indicators in advanced economies have been positive over the past two months.  However, major challenges remain with on-going surplus capacity in the global economy and extensive geo-political uncertainty.

Global headline inflation has increased, partly due to a rise in commodity prices, although oil prices have fallen more recently.  Core inflation has been low and stable. Monetary policy is expected to remain stimulatory, but less so going forward, particularly in the US.

The trade-weighted exchange rate has fallen 4 percent since February, partly in response to weaker dairy prices and reduced interest rate differentials.  This is an encouraging move, but further depreciation is needed to achieve more balanced growth.

Quarterly GDP was weaker than expected in the December quarter, but some of this is considered to be due to temporary factors.  The growth outlook remains positive, supported by on-going accommodative monetary policy, strong population growth, and high levels of household spending and construction activity.  Dairy prices have been volatile in recent auctions and uncertainty remains around future outcomes.

House price inflation has moderated, and in part reflects loan-to-value ratio restrictions and tighter lending conditions.  It is uncertain whether this moderation will be sustained given the continued imbalance between supply and demand.

Headline inflation has returned to the target band as past declines in oil prices dropped out of the annual calculation.  Headline CPI will be variable over the next 12 months due to one-off effects from recent food and import price movements, but is expected to return to the midpoint of the target band over the medium term. Longer-term inflation expectations remain well-anchored at around 2 percent.

Monetary policy will remain accommodative for a considerable period.  Numerous uncertainties remain, particularly in respect of the international outlook, and policy may need to adjust accordingly.

Headline inflation has returned to the target band as past declines in oil prices dropped out of the annual calculation.  Headline CPI will be variable over the next 12 months due to one-off effects from recent food and import price movements, but is expected to return to the midpoint of the target band over the medium term. Longer-term inflation expectations remain well-anchored at around 2 percent.

Monetary policy will remain accommodative for a considerable period.  Numerous uncertainties remain, particularly in respect of the international outlook, and policy may need to adjust accordingly.

RBNZ Announces Banking Capital Review

The New Zealand Reserve Bank has announced a review on Bank Capital.

They plan to release a high level Issues Paper in April, outlining the areas of the capital framework that the Reserve Bank intends to examine, followed by more detailed consultation papers. They will be seeking stakeholders’ views in three broad areas: what sorts of capital instruments should qualify (the numerator); how risk exposures should be measured (the denominator); and the minimum capital ratios and buffers.

The Issues Paper will request stakeholders’ initial views on the areas we intend to cover and issues that might warrant particular attention. Further consultation documents with options for changes to the framework and recommended policy positions will be targeted for the third quarter. They plan to conclude the Review by the first quarter of 2018.

The Purpose of the Review

The aim of the Capital Review is to identify the most appropriate regulatory framework for setting capital requirements for New Zealand banks. Consistent with the Reserve Bank’s legislative purposes, minimum capital requirements should promote the maintenance of a sound and efficient financial system.  In broad terms, higher levels of capital will improve the soundness of the financial system as the likelihood of bank failures is reduced and the potential impact of credit cycles is moderated.

However, the capital regime may reduce the efficiency of financial intermediation if ratios are pushed too high or standards are made overly complex. Capital is a more expensive form of funding for the banks and so higher capital ratios can potentially increase the overall cost of funding the system as well as improving its soundness.

Our aim is to agree a capital regime that ensures a very high level of confidence in the solvency of the banking system, while avoiding unnecessary economic inefficiency.

In pursuing this objective, the Capital Review will look at the three key components of the regulatory capital regime:

  • The definition of eligible capital instruments
  • The measurement of risk, in particular the risk weights attached to credit exposures
  • The minimum capital ratios and buffers

These three factors are interdependent and the links between them must be carefully considered. The calibration of the capital ratios needs to be set in the context of the risk weights applying to exposures as well as the capacity of eligible capital instruments to absorb losses. Also, the role of capital buffers versus hard minimum requirements needs to be considered.

The Capital Review will examine how well the Reserve Bank’s current framework operates and consider potential improvements. The Reserve Bank will consult the banks and the public on its findings and on any proposed changes to the capital framework.

Outcomes of the Review will be heavily influenced by the international regulatory context, the risk characteristics of the New Zealand system and the Reserve Bank’s regulatory approach.

New Zealand domestic context

The Capital Review will assess how our future capital framework might be shaped by domestic considerations. These relate to New Zealand’s risk profile, the shape of our financial system and also our regulatory approach.

New Zealand’s exports are concentrated in a small number of commodity-based sectors which can be subject to considerable price volatility. Bank exposures to commodity export industries are a key risk in the domestic system. Residential mortgage exposures are also a major source of risk given the system’s heavy exposure to housing and the capacity for house prices to become very stretched – as at present.

New Zealand is a net debtor country, having run current account deficits continuously over the past 40 years. About half of the country’s gross external debt is issued by the New Zealand banking system which then on-lends to businesses and households.  This reliance on external funding is an important vulnerability of the New Zealand system, as starkly demonstrated during the GFC. While liquidity buffers must be the first line of defence against funding market disruptions, a strongly capitalised system also helps to mitigate the risk of reduced market access.

New Zealand’s financial system is less diversified relative to peer countries. Financial intermediation is concentrated in a few large institutions and capital markets play a relatively minor role.

Rating agency risk assessments of the large New Zealand banks is heavily influenced by expectations of support from the Australian parent banks. Under the S&P regime, this factor lifts the ratings of the large New Zealand banks by an average of 4 notches from BBB+ on a standalone basis, to AA- , the rating applied to the Australian parents. While the implicit support of the parent banks is valuable for the New Zealand system, it is also a vulnerability. For example, in recent times the Australian parent banks have been on negative outlook and, separately, APRA has placed restrictions on the ability of the parent banks to give credit support to their international subsidiaries. Should implicit parental support be eroded, it is important that our banks be seen as strong on a standalone basis in order to maintain their international standing.

The Capital Review will draw on the emerging international literature on optimal capital and include an assessment of optimal capital that takes account of New Zealand-specific characteristics. The final calibration of capital requirements will also take account of the results and insights from bank stress-testing and other analytical work we are undertaking in support of the Capital Review.

RBNZ Explains Banking Sector Stress Testing

The Reserve Bank of NZ has released a short animated video.

Stress testing is a tool to assess how banks might cope with a severe economic downturn. This video explains how stress tests work and why the Reserve Bank of New Zealand uses them in its role as prudential regulator.

 

Changing dynamics in household behaviour help explain low inflation

The NZ Reserve Bank is taking account of changing household saving and spending behaviours in its inflation forecasts, Deputy Governor Geoff Bascand said in a speech to the Australia National University in Canberra.

Mr Bascand said that Australasian patterns of saving and spending are proving different from other advanced economies.

Figure 2: Gross national saving (share of GDP)

Internationally, demand dynamics have changed since the global financial crisis (GFC), challenging inflation modelling and, in some cases, inflation-targeting frameworks.

Some economists suggest that we are now in an era of “secular stagnation”, with persistent low demand due to higher saving and a reduced tendency to invest, driving down the long-term real neutral interest rate. Others point to an overhang from earlier excessive debt accumulation and suggest that demand is being depressed by a lengthy period of deleveraging (reduced borrowing).

Across advanced economies, investment has been weak and national saving rates on average haven’t altered significantly since the GFC.

But a different picture emerges in Australasia, which has witnessed an uplift in saving, especially by households, and steady output growth supported by robust investment.

Figure 11: Household debt and wealth

“In Australasia the current outlook looks a lot like that which prevailed before the 2000s. In other advanced economies, weak investment growth, coupled with a disappointing expansion in the supply side of the economy, points to a world more consistent with lower long-term growth expectations.

“To what extent heightened household saving preferences in Australasia represent a permanent shift or a prolonged deleveraging adjustment is uncertain. Some indicators provide tentative support to the view that it represents a prolonged cyclical correction.”

Mr Bascand says the rate of growth of consumption, including the relationship between consumption and wealth, is crucial to the Reserve Bank’s assessment of business cycle dynamics and inflation prospects.  Projections of demand arising from historical estimates of consumption from wealth have been over-optimistic. Weaker spending than expected out of higher housing wealth is part of the reason why inflation has been lower than forecast.

He says taking into account the increase in household saving we have seen, the links between interest rates, output and inflation appear stable.

“Currently, we are projecting per-capita consumption growth to improve and provide an impetus to output growth. The acceleration is modest compared to the previous cycle as household saving is expected to remain positive over the forecast horizon.”

NZ Official Cash Rate reduced to 1.75 percent

The New Zealand Reserve Bank today reduced the Official Cash Rate (OCR) by 25 basis points to 1.75 percent.

nz-ocr

Significant surplus capacity exists across the global economy despite improved economic indicators in some countries.  Global inflation remains weak even though commodity prices have come off their lows.  Political uncertainty remains heightened and market volatility is elevated.

Weak global conditions and low interest rates relative to New Zealand are keeping upward pressure on the New Zealand dollar exchange rate.  The exchange rate remains higher than is sustainable for balanced economic growth and, together with low global inflation, continues to generate negative inflation in the tradables sector.  A decline in the exchange rate is needed.

Domestic growth is being supported by strong population growth, construction activity, tourism, and accommodative monetary policy.  Recent dairy auctions have been positive, but uncertainty remains around future outcomes.  High net immigration is supporting growth in labour supply and limiting wage pressure.

House price inflation remains excessive and is posing concerns for financial stability.  Although house price inflation has moderated in Auckland, it is uncertain whether this will be sustained given the continuing imbalance between supply and demand.

Headline inflation continues to be held below the target range by ongoing negative tradables inflation.  Annual CPI inflation was weak in the September quarter, in part due to lower fuel prices and cuts in ACC levies.  Annual inflation is expected to rise from the December quarter, reflecting the policy stimulus to date, the strength of the domestic economy, and reduced drag from tradables inflation.

Monetary policy will continue to be accommodative.  Our current projections and assumptions indicate that policy settings, including today’s easing, will see growth strong enough to have inflation settle near the middle of the target range.  Numerous uncertainties remain, particularly in respect of the international outlook, and policy may need to adjust accordingly.

 

NZ Reserve Bank Holds Rate

The Reserve Bank today left the Official Cash Rate (OCR) unchanged at 2.0 percent.

Bank-Cress

Global growth is below trend despite being supported by unprecedented levels of monetary stimulus. Significant surplus capacity remains across many economies and, along with low commodity prices, is suppressing global inflation. Volatility in global markets has increased in recent weeks, with government bond yields rising and equities coming off their highs. The prospects for global growth and commodity prices remain uncertain. Political uncertainty remains.

Weak global conditions and low interest rates relative to New Zealand are placing upward pressure on the New Zealand dollar exchange rate. The trade-weighted exchange rate is higher than assumed in the August Statement. Although this may partly reflect improved export prices, the high exchange rate continues to place pressure on the export and import-competing sectors and, together with low global inflation, is causing negative inflation in the tradables sector. A decline in the exchange rate is needed.

Second quarter GDP results were consistent with the Bank’s growth expectations. Domestic growth is expected to remain supported by strong net immigration, construction activity, tourism, and accommodative monetary policy. While dairy prices have firmed since early August, the outlook for the full season remains very uncertain. High net immigration is supporting strong growth in labour supply and limiting wage pressure.

House price inflation remains excessive, posing concerns for financial stability. There are indications that recent macro-prudential measures and tighter credit conditions in recent weeks are having a moderating influence.

Headline inflation is being held below the target band by continuing negative tradables inflation. Annual CPI inflation is expected to weaken in the September quarter, reflecting lower fuel prices and cuts in ACC levies. Annual inflation is expected to rise from the December quarter, reflecting the policy stimulus to date, the strength of the domestic economy, reduced drag from tradables inflation, and rising non-tradables inflation. Although long-term inflation expectations are well-anchored at 2 percent, the sustained weakness in headline inflation risks further declines in inflation expectations.

Monetary policy will continue to be accommodative. Our current projections and assumptions indicate that further policy easing will be required to ensure that future inflation settles near the middle of the target range. We will continue to watch closely the emerging economic data.

NZ Tightens Mortgage Lending Rules From 1 October

The NZ Reserve Bank today confirmed that new macroprudential rules tighten restrictions on bank lending to residential property buyers throughout New Zealand. Residential property investors will generally need a 40 percent deposit for a mortgage loan, and owner-occupiers will generally need a 20 percent deposit.

Investment-Pig

From 1 October, residential property investors will generally need a 40 percent deposit for a mortgage loan, and owner-occupiers will generally need a 20 percent deposit. In both cases, banks are still allowed to make a small proportion of their lending to borrowers with smaller deposits.

Confirmation of the new rules is in the Reserve Bank’s response to submissions to its public consultation about changes to Loan to Value Ratio (LVR) rules that was issued on 19 July.

The Reserve Bank is modifying its proposals in response to public consultation, and also through meetings and workshops with banks that are subject to the rules.

The new rules take effect on 1 October 2016, but banks have chosen to start following the new limits already.

Existing exemptions to LVR restrictions will continue to apply under the new rules and have been extended to include borrowing for a newly-built home, or to do work needed for a residence to comply with new building codes and rental-property standards.

NZ-LVR-Changes

Monetary Policy Faces Challenges in Turbulent Times

Interesting speech from New Zealand, illustrating the difficulty in the current low growth, low rate, low inflation, high exchange rate environment. Expect more rate cuts!

Piggy-Bank-2

In a speech written for the Otago Chamber of Commerce, Mr Wheeler said the scope and influence of monetary policy, particularly in small, open economies, is heavily constrained by economic and financial developments outside their borders. As a result, expectations of what monetary policy can achieve often run ahead of reality.

“Nearly 10 years on from the Global Financial Crisis, economies face a difficult global economic and financial climate, with below-trend growth despite unprecedented monetary stimulus, declining merchandise trade and rising protectionism, very low inflation and interest rates, and high asset prices presenting financial stability risks. Many of these issues have complex structural elements that are unlikely to fully self-correct as global growth recovers.

“Central banks must make finely balanced judgements when setting monetary policy, based on evidence, research, scenario analysis, and continual review of their policy record and international experience,” he said.

“As is the case elsewhere, there are a range of views about what monetary policy can achieve and how it should be operated. In New Zealand, these include a view that flexible inflation targeting is no longer an appropriate framework for conducting monetary policy.”

Mr Wheeler said that flexible inflation targeting remains the most appropriate framework for conducting monetary policy in New Zealand. Provided sufficient flexibility is allowed to accommodate the frequent and often severe impact of external shocks, the most important contribution monetary policy can make to promoting efficiency and the long-run growth of incomes, output and employment is the pursuit of price stability.

“There is nothing sacrosanct about what particular inflation band or target should be adopted as a measure of price stability. However, changing a target when times become tougher reduces the incentives on central banks to achieve earlier agreed goals. It could damage the central bank’s credibility – particularly if a perception develops that the central bank will continually seek to respecify goals.”

The Bank also encounters a view that it should not lower interest rates, because current strong economic growth makes interest rate cuts unwarranted and undesirable.

However, if financial markets believe that the Bank is content with below-target inflation, they would conclude that the easing process is over and proceed to bid the exchange rate up, perhaps substantially.

“The TWI exchange rate is already at a high level based on the Bank’s models. A sizeable appreciation would further squeeze incomes in the tradables sector, and drive tradables inflation lower for longer, thereby lowering overall headline inflation.”

Low headline inflation could also bring down inflation expectations in a self-perpetuating spiral.

“If inflation expectations fall too far, it can be very difficult to raise them back up. In such a situation, even further cuts in interest rates would be needed to stimulate economic activity and increase inflationary pressures.”

Mr Wheeler said a third view maintains that the Bank should rapidly lower interest rates to bring inflation quickly back to the mid-point of the inflation band.

However, an aggressive monetary policy that is seen as exacerbating imbalances in the economy would not be regarded as sustainable, and would not deliver the exchange rate relief being sought.

Rapid ongoing decreases in interest rates would likely result in an unsustainable surge in growth, capacity bottlenecks, and further inflame an already seriously overheating property market. It would use up much of the Bank’s capacity to respond to the likely boom/bust situation that would follow, and place the Reserve Bank in a situation similar to many other central banks of having limited room to respond to future economic or financial shocks.

Mr Wheeler drew heavily on and emphasised the messaging contained in the recently released August Monetary Policy Statement.

“The key rationale for cutting the OCR in August was to lower the risk of a further decline in short-term inflation expectations.

“Our present judgement is that the current interest rate track, involving an expected 35 basis points of further interest rate cuts, balances a number of risks weighing on the economy, while generating an increase in CPI inflation back towards the mid-point of the 1 to 3 percent target range.

“We remain committed to the inflation goals in the Policy Targets Agreement. We do not believe that the outlook and balance of risks warrants a position of no policy change, nor a position of rapid easings. If the emerging information and risks unfold in a manner that warrants a change in our judgements, we will modify our policy settings and outlook.”

RBNZ Defers LVR Changes

The Reserve Bank NZ is deferring the start of the proposed changes to investor loan-to-value restrictions (LVRs) nationwide from 1 September to 1 October 2016, based on feedback from the banking industry from its recent consultation on the proposals.

RE-Jigsaw

Deputy Governor, Grant Spencer, said:  “Banks have indicated through their submissions that more time is required to enable them to meet the new restrictions that apply to investor loans nationwide, given the pipeline of loan pre-approvals made prior to our announcement in July.

“We understand that banks have been applying the new LVR restrictions to new loan applications since the LVR changes were announced. On that basis we will defer the formal introduction of the changes to 1 October in order to accommodate the backlog of pre-approvals.”

Mr Spencer noted there had been a number of queries related to exemptions. He clarified that the range of existing exemptions to LVR restrictions will continue to apply under the proposed changes.  These exemptions permit the banks to make high LVR loans that would otherwise be limited by the restrictions.  Exemptions apply where:

  • Owner-occupiers or investors are constructing or purchasing a new dwelling (provided the loan commitment occurs prior to, or at an early stage of, construction of the dwelling).
  • Owner-occupiers or investors require bridging finance to complete the purchase of a residential property on a date prior to the completion of a sale of another property.
  • Owner-occupiers or investors are re-financing an existing high LVR loan, or shifting an existing high LVR loan from one property to another (provided the total value of the new loan does not increase).
  • Owner-occupiers or investors are borrowing to fund extensive repairs or remediation that is not routine or deferred maintenance.  This includes events such as a fire, natural disaster, weather tightness issues or seismic strengthening).
  • A loan is made under Housing New Zealand’s Mortgage Insurance Scheme, including the Welcome Home Loans scheme.
  • Borrowers with owner occupied and investor collateral can use the combined collateral exemption to obtain finance up to 60% of the value of the investment properties and 80% on their owner occupied property.

“It is important to emphasise that these exemptions are permissive but do not create an obligation on the banks to make such loans.  The banks will still apply their own lending criteria to individual borrowers and may choose to not provide finance in these circumstances or to provide it only at lower LVRs.

“The consultation process closed on 10 August and we are continuing to analyse submissions.  Further adjustments to the proposals, including the exemptions, are still possible and we expect to publish a final policy position later this month,” Mr Spencer said.

Under the proposed new restrictions:

  • No more than 5 percent of bank lending to residential property investors across New Zealand would be permitted with an LVR of greater than 60 percent (i.e. a deposit of less than 40 percent).
  • No more than 10 percent of lending to owner-occupiers across New Zealand would be permitted with an LVR of greater than 80 percent (i.e. a deposit of less than 20 percent).
  • Loans that are exempt from the existing LVR restrictions, including loans to construct new dwellings, would continue to be exempt.

 

NZ Cash Rate Reduced To 2%

The Reserve Bank today reduced the Official Cash Rate (OCR) by 25 basis points to 2.0 percent.

Global growth is below trend despite being supported by unprecedented levels of monetary stimulus.  Significant surplus capacity remains across many economies and, along with low commodity prices, is suppressing global inflation.  Some central banks have eased policy further since the June Monetary Policy Statement, and long-term interest rates are at record lows.  The prospects for global growth and commodity prices remain uncertain.  Political risks are also heightened.

Weak global conditions and low interest rates relative to New Zealand are placing upward pressure on the New Zealand dollar exchange rate.  The trade-weighted exchange rate is significantly higher than assumed in the June Statement.  The high exchange rate is adding further pressure to the export and import-competing sectors and, together with low global inflation, is causing negative inflation in the tradables sector.  This makes it difficult for the Bank to meet its inflation objective.  A decline in the exchange rate is needed.RBNZAug162

Domestic growth is expected to remain supported by strong inward migration, construction activity, tourism, and accommodative monetary policy.  However, low dairy prices are depressing incomes in the dairy sector and reducing farm spending and investment.  High net immigration is supporting strong growth in labour supply and limiting wage pressure.

House price inflation remains excessive and has become more broad-based across the regions, adding to concerns about financial stability. The Bank is consulting on stronger macro-prudential measures that should help to mitigate financial system risks arising from the rapid escalation in house prices.

RBNZAug163Headline inflation is being held below the target band by continuing negative tradables inflation.  Annual CPI inflation is expected to weaken in the September quarter, reflecting lower fuel prices and cuts in ACC levies.  Annual inflation is expected to rise from the December quarter, reflecting the policy stimulus to date, the strength of the domestic economy, reduced drag from tradables inflation, and rising non-tradables inflation.  Although long-term inflation expectations are well-anchored at 2 percent, the sustained weakness in headline inflation risks further declines in inflation expectations.

RBNZAug161Monetary policy will continue to be accommodative.  Our current projections and assumptions indicate that further policy easing will be required to ensure that future inflation settles near the middle of the target range.  We will continue to watch closely the emerging economic data.