RBNZ Official Cash Rate unchanged at 1.75 percent

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

Global economic growth has increased and become more broad-based.  However, major challenges remain with on-going surplus capacity and extensive political uncertainty.

Headline inflation has increased over the past year in several countries, but moderated recently with the fall in energy prices.  Core inflation and long-term bond yields remain low.  Monetary policy is expected to remain stimulatory in the advanced economies, but less so going forward.

The trade-weighted exchange rate has increased by around 3 percent since May, partly in response to higher export prices.  A lower New Zealand dollar would help rebalance the growth outlook towards the tradables sector.

GDP growth in the March quarter was lower than expected, with weaker export volumes and residential construction partially offset by stronger consumption.  Nevertheless, the growth outlook remains positive, supported by accommodative monetary policy, strong population growth, and high terms of trade.  Recent changes announced in Budget 2017 should support the outlook for growth.

House price inflation has moderated further, especially in Auckland.  The slowdown in house price inflation partly reflects loan-to-value ratio restrictions, and tighter lending conditions.  This moderation is projected to continue, although there is a risk of resurgence given the on-going imbalance between supply and demand.

The increase in headline inflation in the March quarter was mainly due to higher tradables inflation, particularly petrol and food prices.  These effects are temporary and may lead to some variability in headline inflation.  Non-tradables and wage inflation remain moderate but are expected to increase gradually.  This will bring future headline inflation 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 and policy may need to adjust accordingly.

New Zealand’s financial system is sound but continues to face risks

New Zealand’s financial system remains sound and the risks facing the system have reduced in the past six months, Reserve Bank Governor Graeme Wheeler said today when releasing the Bank’s May Financial Stability Report.

“The outlook for the global economy has been improving but global political and policy uncertainty remains elevated and debt burdens are high in a number of countries. A sharp reversal in risk sentiment could lead to higher funding costs for New Zealand banks and an increase in domestic borrowing costs. New Zealand’s banks are vulnerable to these risks because of their increasing reliance on offshore funding for credit growth,” Mr Wheeler said.

“House price growth has slowed in the past eight months, in response to tighter loan-to-value ratio (LVR) restrictions, and a more general tightening in credit and affordability pressures in parts of the country.

While residential building activity has continued to increase, the rate of house building remains insufficient to meet rapid population growth and the existing housing shortage. House prices remain elevated relative to incomes and rents, and any resurgence would be of concern.

“Dairy prices have recovered significantly in the past 12 months, and the majority of dairy farms are likely to have returned to profitability in the 2016/17 season. However, parts of the dairy sector are carrying excessive debt burdens, and remain vulnerable to a fall in income or an increase in costs. Banks should continue to closely monitor and maintain full provisioning against lending to high risk farms,” he said.

Deputy Governor Grant Spencer said “The banking system maintains strong capital and funding buffers, and profitability remains robust. The banking system appears to be operating efficiently when compared with other OECD countries, based on metrics such as cost-to-income ratios, non-performing loans and interest rate spreads.

“Banks have generally tightened credit conditions in light of funding constraints and the increasing risks around housing. Banks are seeking to reduce their reliance on offshore funding and have raised deposit rates.

The Reserve Bank supports a cautious approach to managing foreign debt, in light of lessons learned in the GFC.

“While the LVR restrictions have increased the banks’ resilience to any fall in house prices, a significant share of housing loans are being made at high debt-to-income (DTI) ratios.

Such borrowers tend to be more vulnerable to any increase in interest rates or declines in income. There is evidence that borrowers with high DTI ratios are the most vulnerable to rising mortgage rates. At a mortgage rate of 7 percent, around half of existing borrowers with DTI ratios above 5 are expected to face severe stress. However, this represents just 3 percent of borrowers.

Overall, this analysis suggests that a significant proportion of New Zealand borrowers are vulnerable to a material increase in mortgage rates. A sharp and unexpected rise in mortgage rates could see the most vulnerable households default, sell their houses or reduce consumption to repay debt. Recent borrowers in Auckland and borrowers with high DTI ratios appear most vulnerable, signalling that a continued high share of lending at high DTI ratios is concerning and may present a risk to the housing market and financial stability.

The Reserve Bank will soon release a consultation paper proposing the addition of DTI restrictions to our macro-prudential toolkit.

“The Reserve Bank is making progress on a number of other initiatives.  A review of bank capital requirements is underway and we recently released an issues paper on the intended scope of the review. We recently concluded a review of the outsourcing policy for registered banks, and the Bank and other agencies are assessing the recommendations from the International Monetary Fund’s recent (FSAP) review of New Zealand’s financial system.”

RBNZ Official Cash Rate unchanged at 1.75 percent

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

Global economic growth has increased and become more broad-based over recent months. However, major challenges remain with on-going surplus capacity and extensive political uncertainty.

Stronger global demand has helped to raise commodity prices over the past year, which has led to some increase in headline inflation across New Zealand’s trading partners. However, the level of core inflation has generally remained low. Monetary policy is expected to remain stimulatory in the advanced economies, but less so going forward.

The trade-weighted exchange rate has fallen by around 5 percent since February, partly in response to global developments and reduced interest rate differentials. This is encouraging and, if sustained, will help to rebalance the growth outlook towards the tradables sector.

GDP growth in the second half of 2016 was weaker than expected. Nevertheless, the growth outlook remains positive, supported by on-going accommodative monetary policy, strong population growth, and high levels of household spending and construction activity.

House price inflation has moderated further, especially in Auckland. The slowing in house price inflation partly reflects loan-to-value ratio restrictions and tighter lending conditions.
Despite ongoing strength in the fundamental drivers of housing demand,namely population growth and low mortgage interest rates, housing activity has slowed since mid-2016. This likely reflects a range of factors,including changes to LVR policy, and increases in mortgage rates in 2016, and increasing pressure on affordability. This moderation is projected to continue, although there is a risk of resurgence given the continuing imbalance between supply and demand.

Mortgage rates have stabilised since the February Statement,with reduced upward pressure from lower wholesale interest rates (figure 4.5). Mortgage rates remain at low levels relative to history, but recent changes to LVR policy have tightened credit availability for some households. Lending conditions for residential property development have tightened.
The increase in headline inflation in the March quarter was mainly due to higher tradables inflation, particularly petrol and food prices. These effects are temporary and may lead to some variability in headline inflation over the year ahead. Non-tradables and wage inflation remain moderate but are expected to increase gradually. This will bring future headline inflation to the midpoint of the target band over the medium term. Longer-term inflation expectations remain well-anchored at around 2 percent.

Developments since the February Monetary Policy Statement on balance are considered to be neutral for the stance of monetary policy.

Monetary policy will remain accommodative for a considerable period. Numerous uncertainties remain and policy may need to adjust accordingly.

RBNZ Reviews Capital Adequacy Framework

The New Zealand Reserve Bank has announced it is undertaking a comprehensive review of the capital adequacy framework applying to locally incorporated registered banks over 2017/18. The aim of the review is to identify the most appropriate framework for setting capital requirements for New Zealand banks, taking into account how the current framework has operated and international developments in bank capital requirements.

The Capital Review will focus on the three key components of the current framework:

  • The definition of eligible capital instruments
  • The measurement of risk
  • The minimum capital ratios and buffers

The purpose of this Issues Paper is to provide stakeholders with an outline of the areas of the capital adequacy framework that the Reserve Bank intends to cover in the Capital Review, and invite stakeholders to provide initial feedback on the intended scope of the review, and issues that might warrant particular attention. As feedback is received and decisions are made, some of these issues might fall away or be given a lower priority.

Detailed consultation documents on policy proposals and options for each of the three components will be released later in 2017, with a view to concluding the review by the first quarter of 2018.

Basis and framework for capital regulation

The Reserve Bank has powers under the Reserve Bank Act 1989 to impose capital requirements on registered banks. The Reserve Bank exercises these powers to promote the maintenance of a sound and efficient financial system, and to avoid significant damage to the financial system that could result from the failure of a registered bank.

The capital adequacy framework for locally incorporated registered banks is set out mainly in documents BS2A and BS2B of the Reserve Bank’s Banking Supervision Handbook. The framework is based on, but not identical to, an international set of standards produced by the Basel Committee on Banking Supervision.

The framework imposes minimum capital ratios. These are ratios of eligible capital to loans and other exposures. Exposures are adjusted (risk-weighted) so that more capital is required to meet the minimum requirement if the bank has riskier exposures.

The high-level policy options raised in this Issues Paper have the potential to result in reasonably significant changes to the New Zealand capital framework. It is expected, however, that any changes are likely to occur within a Basel-like framework.

The Reserve Bank invites submissions on this Issues Paper by 5pm on 9 June 2017

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.