Archive | Reserve Bank

Reserve Bank raises question of new debt:income loan limits

The Reserve Bank published a consultation paper yesterday seeking feedback on serviceability restrictions such as debt:income (DTI) limits on loans being added to its macro-prudential toolkit.

The notion immediately drew fire, but the bank said it wanted feedback from stakeholders on alternatives as well. The 3 questions:

  • the risks posed by high debt:income lending and the potential for a debt:income limit or similar policy to ameliorate these risks
  • alternative policies under the Reserve Bank’s control and how they would compare to a debt:income limit, and
  • desirable design features for any debt:income policy and the potential costs & benefits.

The bank has outlined its views on these issues in the consultation and said it wouldn’t implement a debt:income policy in current market conditions, but that it considered debt:income limits could be a useful option in the future.

The consultation paper includes a cost:benefit analysis for a debt:income policy and found there could be significant net benefits.

Feedback closes with the bank on Friday 18 August.

Property Institute warning

Property Institute chief executive Ashley Church repeated his warning that such limits on mortgage lending “would have the potential to do significant damage to the Auckland housing market & the wider New Zealand economy”.

Mr Church said a similar policy introduced in the UK in July 2014 theoretically restricted a buyer to a mortgage that didn’t exceed 4.5 times their annual earnings, but it wasn’t compulsory for banks to impose it and it only applied to a section of the market: “The Brits wisely chose to use this tool as a way to protect those who were at most risk of a market crash rather than as a blunt tool to curb house price inflation. But our Reserve Bank already has that ability in the form of the LVR restrictions – so you’d have to question why they would want this tool unless they want to kill the market – something they’ve repeatedly tried, and failed, to do.” 

Mr Church says the probable consequences of such a policy would be disastrous: “The number of new homes being built – the very thing that Auckland needs most – would plunge as the number of people earning enough to build or buy them would dwindle to a trickle. So the policy could very well kill off the one thing that can fix the Auckland housing crisis – the construction of new homes.”

He said the policy would also lead to a dramatic increase in rents over a relatively short space of time as property investors looked for ways to increase income so they could buy more property: “In an environment where every extra dollar enhances borrowing power, landlords will want to maximum rentals and they’ll be able to do it because the Reserve Bank policy will exacerbate the current housing shortage.”

Mr Church said a debt:income policy could also:

  • create a further barrier to young people looking to buy their first home, “a prospect already made almost impossible by the Reserve Bank clampdown on loan:value lending”, and
  • restrict or eliminate the ability of small business owners to use the equity in their home as security for cashflow, potentially putting thousands of small businesses at risk.

Mr Church said recent house price inflation in Auckland was the result of strong demand and a severe lack of supply, and that the Reserve Bank’s efforts to artificially slow down demand had made the situation much worse.

Reserve Bank says loan:value restrictions have worked

The Reserve Bank introduced loan:value ratio restrictions in 2013 to mitigate the risks to financial system stability posed by a growing proportion of residential mortgage loans with high loan:value ratio (ie, low deposit or low equity loans).

The bank said in its summary of the new paper: “This increase in borrower leverage had gone hand in hand with significant increases in house prices, particularly in Auckland. The Reserve Bank’s concern was the possibility of a sharp fall in house prices, in adverse economic circumstances where some borrowers had trouble servicing loans. Such an event had the potential to undermine bank asset quality given the limited equity held by some borrowers.”

The bank said it believed loan:value ratio restrictions had been effective in reducing the risk to financial system stability.

The bank has produced evidence in its paper that a debt:income limit “would reduce credit growth during the upswing and reduce the risk of a significant rise in mortgage defaults during a subsequent severe economic downturn.

“A debt:income limit could also reduce the severity of the decline in house prices & economic growth in that severe downturn (since fewer households would be forced to sharply constrain their consumption or sell their house, even if they avoided actual default). The strongest evidence that these channels could materially worsen an economic downturn tends to come from countries that have experienced a housing crisis in recent history, (including the UK & Ireland.”

Link: Consultation document: Serviceability restrictions as a potential macroprudential tool in NZ

Attribution: Bank & Property Institute releases, bank paper.

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Reserve Bank releases capital adequacy issues paper

The Reserve Bank published an issues paper today on regulation of banks’ capital adequacy.

It’s seeking feedback by Friday 9 June and will follow up with detailed consultation documents on policy proposals & options for each of 3 components later this year, with a view to concluding the review by the first quarter of 2018.

Deputy governor Grant Spencer foreshadowed the broad-ranging capital review in March, in a speech in which he compared the average housing risk weights of large banks in 6 countries.

New Zealand was clearly the most heavily weighted towards housing at 28.3%, followed by Australia at 23.5% (and its bank overseers also tightening the reins), then a long way back to Denmark 13.9%, the UK 11.7%, Canada 7.2%, Sweden 6.8%.

The Reserve Bank aims to identify the most appropriate capital adequacy framework, taking into account experience with the current framework & international developments.

The review will focus on the 3 key components of the current framework:

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

Paper sets out 2 sides

In its issues paper summary, the bank said it recognised the need to balance the benefits of higher capital against the costs, but set out 2 sides to the argument: “It is expected that a higher level of capital would reduce the probability & severity of bank failures and would smooth out credit cycles.

“But banks typically argue that capital is a costly source of funding and that if they had to seek more of it they would need to pass on costs to customers, leading to reduced investment & growth.

“There has been debate about the extent to which these costs reduce national welfare. In one view the capital levels of banks are inefficiently low because of implicit government guarantees of creditors or other incentives. Raising the minimum capital requirement restores efficiency by reversing the implicit subsidy to bank shareholders, and in this way improves overall welfare.

“A growing number of academics, most notably Anat Admati from Stanford University & Martin Hellwig from the Max Planck Institute for Research on Collective Goods (as well as some regulators) have argued that the costs to society as a whole of higher capital are very low and that capital requirements should be much higher than they are now.

“These authors are associated with the ‘big equity’ view and are distinguished by the extent to which they see significant increases in capital as being possible without net negative economic impacts.

“Empirical studies have attempted to quantify the costs & benefits of increasing capital requirements, and to determine the optimal capital ratio which has the greatest net benefit. In the more mainstream studies the Reserve Bank has considered so far, a typical optimal ratio is about 14%, but estimates do vary widely (the range is roughly 5-17%). The Reserve Bank will continue to review & assess these studies, but also welcomes the views of submitters on this issue.”

The bank said that, at this early stage of the review, it hadn’t formed a view on the final calibration of capital requirements, but said it was likely to take into account the studies it had seen, as well as empirical evidence.

Links:
Review of the capital adequacy framework for registered banks
Grant Spencer’s March speech

Attribution: Bank release.

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Housing supply the main concern as Reserve Bank holds cashrate

The Reserve Bank held the official cashrate at 1.75% today.

The bank cut its cashrate by 25 basis points in November, the third 25-point cut last year.

Bank governor Graeme Wheeler’s biggest concern was whether housing supply would start to address the imbalance in that market, but he noted that prices had drifted back.

Mr Wheeler said: 

“Macroeconomic indicators in advanced economies have been positive over the past 2 months. However, major challenges remain with ongoing surplus capacity in the global economy and extensive geopolitical 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 & 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% since February, partly in response to weaker dairy prices & 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 ongoing accommodative monetary policy, strong population growth and high levels of household spending & 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:value ratio restrictions & tighter lending conditions. It is uncertain whether this moderation will be sustained, given the continued imbalance between supply & 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 & 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%.

“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.”

Attribution: Bank release.

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Wheeler holds cashrate and sees change a long way off

The Reserve Bank left the official cashrate unchanged at 1.75% today, and indicated it would be a long time before change was needed.

Bank governor Graeme Wheeler pitted an improved global outlook against surplus capacity & geopolitical challenges, and once again argued that the $NZ was overvalued.

Mr Wheeler said in his statement on the cashrate decision:

“The recovery in commodity prices and more positive business & consumer sentiment in advanced economies have improved the global outlook. However, major challenges remain, with ongoing surplus capacity in the global economy and rising geopolitical uncertainty.

“Global headline inflation has increased, partly due to rising commodity prices. Global long-term interest rates have increased. Monetary policy is expected to remain stimulatory, but less so going forward, particularly in the US.

“New Zealand’s financial conditions have firmed, with long-term interest rates rising and continued upward pressure on the $NZ exchange rate. The exchange rate remains higher than is sustainable for balanced growth and, together with low global inflation, continues to generate ‘negative inflation’ in the tradeables sector. A decline in the exchange rate is needed.

“Economic growth in New Zealand has increased as expected and is steadily drawing on spare resources. The outlook remains positive, supported by ongoing accommodative monetary policy, strong population growth, increased household spending and rising construction activity. Dairy prices have recovered in recent months, but uncertainty remains around future outcomes.

“Recent moderation in house price inflation is welcome and, in part, reflects loan:value ratio restrictions & higher mortgage rates. It is uncertain whether this moderation will be sustained, given the continued imbalance between supply & demand.

“Headline inflation has returned to the target band as past declines in oil prices dropped out of the annual calculation. Inflation is expected to return to the midpoint of the target band gradually, reflecting the strength of the domestic economy and despite persistent negative tradeables inflation. Longer-term inflation expectations remain well anchored at around 2%.

“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.”

Links:
Monetary policy statement
Monetary policy statement press conference live-stream at 10am
Graeme Wheeler reading statement

Attribution: Bank release.

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Wheeler cuts cashrate to 1.75%

The Reserve Bank reduced the official cashrate by 25 basis points today to 1.75%.

Bank governor Graeme Wheeler talked of adjusting to uncertainties, but without a timeframe.

In his release explaining the cut, he said: “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 & 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 & 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.”

Link:
Monetary policy statement
Monetary policy statement press conference live-stream

Attribution: Bank release.

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Reserve Bank holds cashrate at 2%

The Reserve Bank kept the official cashrate at 2% today, with nothing unusual to say about prospects.

Here’s how bank governor Graeme Wheeler summed up the world’s economic conditions: “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 & commodity prices remain uncertain. Political uncertainty remains.

“Weak global conditions & low interest rates relative to New Zealand are placing upward pressure on the $NZ 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 & 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 & 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 & 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 & 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%, the sustained weakness in headline inflation risks further declines in inflation expectations.

“Monetary policy will continue to be accommodative. Our current projections & 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.”

Attribution: Bank release.

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Reserve Bank confirms loan restrictions go nationwide

The Reserve Bank confirmed yesterday that new rules will tighten restrictions on bank lending to residential property buyers throughout New Zealand.

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

The bank confirmed the new rules in its response to submissions to its public consultation about changes to loan:value ratio (LVR) rules that it issued on 19 July. It said it was modifying its proposals in response to public consultation, and through meetings & workshops with banks that are subject to the rules.

Although the new rules take effect only on 1 October, the Reserve Bank said commercial banks had 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 & rental-property standards.

Summary of changes to LVR rules– main changes shown in red – first for borrowers who are owner-occupiers:

Previous: In Auckland, 10% of a bank’s total lending to owner-occupiers can be to borrowers with a deposit less than 20% of the house value. Outside Auckland, 15% of a bank’s total lending can be to borrowers with a deposit less than 20% of the house value

Change: For all of New Zealand, 10% of a bank’s total lending to owner-occupiers can be to borrowers with a deposit less than 20% of the house value

For borrowers who are residential property investors:

Previous: In Auckland, 5% of a bank’s total lending to residential property investors can be to borrowers with a deposit less than 30% of the house value. Outside Auckland, owner-occupiers & residential property investors are treated the same. 15% of a bank’s total lending can be to borrowers with a deposit less than 20% of the house value

Change: For all New Zealand, 5% of a bank’s total lending to residential property investors can be to borrowers with a deposit less than 40% of the house value. In Auckland, borrowers who include an owner-occupied residence in a portfolio of mortgaged houses are allowed to borrow up to 70% of the value of the entire property portfolio. For all New Zealand, borrowers who include an owner-occupied residence in a portfolio of mortgaged houses are allowed to borrow up to 80% of the value of their owner-occupier home and 60% of the value of their investment properties.

Exemptions from the LVR restrictions:

Previous: Loans to borrowers building a new residence are exempt. The exemption doesn’t apply for a borrower buying a residence where construction has progressed beyond ground works. The exemption applies for borrowers who are owner-occupiers and who are residential property investors

Loans to borrowers building a new residence are exempt.

Change: The loan must be for a residence that has been completed within the previous 6 months and it must be bought from the developer. The exemption applies for borrowers who are owner-occupiers and who are residential property investors. The LVR rules do not prescribe the size of a deposit for new residences.

Previous: Loans are exempt if used for remediation after a fire, earthquake, or to bring a residence up to new building codes. The exemption applies for owner-occupiers and for residential property investors

Change: Loans are exempt if used for remediation after a fire, earthquake, to bring a residence up to new building codes, or to comply with new rental property standards (for example, insulation). The exemption applies for owner-occupiers and for residential property investors

Unchanged: Low-deposit borrowers using the Housing NZ Welcome Home Loan scheme to buy their first home are exempt from the LVR rules.

Links:
Loan:valuation ratio restrictions
Summary of submissions & responses

Attribution: Bank release.

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Changes to LVR restrictions deferred a month

The Reserve Bank said on Friday it was deferring the start of the proposed changes to investor loan:value restrictions (LVRs) nationwide from 1 September to 1 October, based on feedback from banks.

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 said there had been a number of queries related to exemptions, and said the range of existing exemptions to LVR restrictions would 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 buying a new dwelling (provided the loan commitment occurs before, or at an early stage of, construction)
  • Owner-occupiers or investors require bridging finance to complete the purchase of a residential property on a date before the completion of a sale of another property
  • Owner-occupiers or investors are refinancing 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 NZ’s mortgage insurance scheme, including the Welcome Home Loans scheme
  • Borrowers with owner-occupied & 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.

Mr Spencer emphasised that these exemptions didn’t create an obligation on 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.”

He said the Reserve Bank was still analysing submissions, which closed last Wednesday, and further adjustments to the proposals, including the exemptions, were still possible. The bank expects to publish a final policy position this month.

Under the proposed new restrictions:

  • No more than 5% of bank lending to residential property investors would be permitted with an LVR over 60% (ie, a deposit under 40%)
  • No more than 10% of lending to owner-occupiers would be permitted with an LVR over 80% (ie, a deposit under 20%)
  • Loans that are exempt from the existing LVR restrictions, including loans to construct new dwellings, would continue to be exempt.

Attribution: Bank release.

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Wheeler makes 25-point cut & warns of more

The Reserve Bank reduced the official cashrate by 25 basis points to 2% today, and warned of further cuts. Its previous cut, also by 25 points, was in March.

The primary concern is that inflation isn’t rising. The bank has an abundance of inflation in the housing sector, in large part caused by its own decisions, but that’s a piece of inflation not entered in the official count.

Bank governor Graeme Wheeler said on today’s decision:

“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 & commodity prices remain uncertain. Political risks are also heightened.

“Weak global conditions & low interest rates relative to New Zealand are placing upward pressure on the $NZ 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 & 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.

“Domestic growth is expected to remain supported by strong inward migration, construction activity, tourism & accommodative monetary policy. However, low dairy prices are depressing incomes in the dairy sector and reducing farm spending & 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.

“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 & 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%, the sustained weakness in headline inflation risks further declines in inflation expectations.

“Monetary policy will continue to be accommodative. Our current projections & 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.”

Link:
Monetary policy statement

Earlier stories:
22 July 2016: Reserve Bank governor sets off on wrong premise
8 July 2016: Housing: Alexander tips the direction, Spencer talks cautious measures, Church warns of investment flurry
10 June 2016: Reserve Bank leaves cashrate unchanged and suggests no action
10 March 2016: Cashrate cut to 2.25%
4 February 2016: A central banker’s view of stimulus

Attribution: Bank release.

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Reserve Bank governor sets off on wrong premise

The Reserve Bank released an economic update yesterday which began on what can only be a wrong premise: “Prospects for growth in the global economy have diminished despite very stimulatory monetary policy & low oil prices.”

The word shouldn’t be ‘despite’ but ‘because of’.

Independent economist Rodney Dickens said the economic update laid the groundwork for an official cashrate cut on 11 August, and labelled it “a misguided propaganda statement”.

Continuing my view that Reserve Bank governor Graeme Wheeler [correcting the original, where I promoted deputy governor Grant Spencer] is basing policy on a wrong premise:

The chosen way out of the global financial crisis was to throw money at the people who instigated the problem, US bankers. The aim was to stimulate. But have you ever heard of stimulation lasting the best part of a decade (my start point is that the wind down began toward the end of 2007, not when everybody noticed it in 2008)?

Stimulation is a misnomer in any case. It was actually about bringing forward activity that would have occurred several years later. When you do that, there still has to be a cyclical lull, eventually.

And, into the mix, the word ‘cycle’ got lost. Out of the tech boom of the early 2000s and into the housing boom that followed in the US, central bankers got the idea that they could prevent a downturn in the cycle with a little manipulation.

Less manipulation, more natural would have got the world through the worst of that global crisis. ‘More natural’ would have included some austerity – but, again, not austerity that lasts a decade.

Now that the quantitative easing has been well & truly overdone, and austerity has also been overdone in some places, trade cycles are out of kilter. It will be a slow journey back to a norm.

New Zealand’s Reserve Bank remains concerned that the $NZ is overvalued. It has also been trying valiantly, but in vain, to encourage participants in the housing market to behave less enthusiastically – as in encouraging investors not to chase obvious windfall gains while nobody has taken the trouble to change the rules to prevent those gains arising.

In a market economy, the currency is in play, assets are in play, the record net migrant inflow (now over 69,000 for the last year) adds to the pressure for asset values to rise, and the requirement for Auckland to set consistent rules for property development over the whole region has meant a process has coincided, albeit taking much less time than it has historically.

For every currency that’s overvalued, another is undervalued. Unfortunately for New Zealand, there are other nations which can swing the valuation where they want it rather than where we want it. They win. There are also nations which argue about this & get offside with each other, as in China & the US at the moment. Not to so long ago, numerous Americans were slagging China for manipulating its currency, which is loosely tied to the greenback.

Overnight, I read (Jim Rickards in Agora Financial’s 5-minute forecast) how hawkish US Federal Reserve talk about this being a good time to raise interest rates had pushed the $US higher, thus taking China’s yuan upward too. Mr Rickards says a deal hatched outside the G20 meeting in Shanghai in February meant the euro & yen would strengthen, greenback would fall and yuan would stay put. But the Fed started talking up the $US in May, the Chinese felt double-crossed and began looking at a third devaluation following 2 last year.

Now, the US is also trying to pressure China into accepting the ruling of an international tribunal on the South China Sea, and China has raised a US-promoted push to question cheap sales of Chinese steel. Thus currency, political positions & trade interact, and New Zealand is not in a position to control any of that.

It’s proved impossible for the Reserve Bank to use one tool to deal with all economic events, so it should have been using separate tools for housing & exports. The bank has tried to wend a way between being kind to exporters and encouraging housebuyers, but low interest rates have helped raise house prices and haven’t held the exchange rate down, so the bank’s appeased neither of its main target groups. In neither case is the low level of CPI inflation an issue, yet it remains a central focus of the bank.

Wheeler’s view

In his release yesterday, Mr Wheeler said: “Significant downside risks remain. Financial market volatility increased following the UK referendum and long-term interest rates have fallen.

“Domestic growth is expected to remain supported by strong inward migration, construction activity, tourism & accommodative monetary policy. However, low dairy prices are depressing incomes in the dairy sector and weighing on farm spending & investment.

“There continue to be many uncertainties around the outlook. Internationally, these relate to the prospects for global growth & commodity prices, the fragility of global financial markets and political risks. Domestic uncertainties relate to inflation expectations & the potential for continued high net immigration, ongoing pressures in the housing market and the high $NZ exchange rate.

“The trade-weighted exchange rate is 6% higher than assumed in the June Statement, and is notably higher than in the alternative scenario presented in that Statement. The high exchange rate is adding further pressure to the dairy & manufacturing sectors and, together with weak global inflation, is holding down tradable goods inflation. This makes it difficult for the bank to meet its inflation objective. A decline in the exchange rate is needed.

“House price inflation remains excessive and has become more broad-based across the regions, adding to concerns about financial stability. The bank is currently consulting on stronger macro-prudential measures aimed at mitigating risks to financial stability from the current boom in house prices.

“Annual CPI inflation was 0.4% in the year to June 2016. Headline inflation is being held below the target band by continuing negative tradables inflation. Long-term inflation expectations are well anchored at 2%, but short-term inflation expectations remain low.

“Despite rising capacity pressures and some recent increase in fuel prices, the stronger exchange rate implies that the outlook for inflation has weakened since the June Statement.

“Monetary policy will continue to be accommodative. At this stage it seems likely that further policy easing will be required to ensure that future average inflation settles near the middle of the target range. We will continue to watch closely the emerging economic data.”

Dickens: Reserve Bank committed to driving another boom-bust cycle

Independent economist Rodney Dickens, who runs Strategic Risk Analysis Ltd, said the economic update laid the groundwork for an official cashrate cut on 11 August, and labelled it “a misguided propaganda statement”.

He seized on the comment at the end of the statement and argued against the sense of it. That sentence: “At this stage it seems likely that further policy easing will be required to ensure that future average inflation settles near the middle of the target range.”

Mr Dickens commented: “To me, the ‘economic update’ is no more than a propaganda exercise aimed at trying to talk the exchange rate down in line with Governor Wheeler’s longstanding crusade. My last Raving highlighted that the official cashrate cuts since July 2015 have been followed by a higher, not lower, exchange rate and that the forex market is smarter than the Reserve Bank.

“The Reserve Bank is, unfortunately, repeating past mistakes. Lower interest rates in 1993 & 2003 were followed by an appreciating, not depreciating, exchange rate. But today’s statement by the Reserve Bank should ring more warning bells than just the risk excessive official cashrate cuts will drive the exchange rate higher, not lower.

“The ‘economic update’ had a lopsided focus on a few issues, and especially the exchange rate, but didn’t mention once the most important issue of relevance to the medium-term inflation prospects Governor Wheeler is supposed to focus on most.  It is no more than a misguided propaganda statement…

“It included no mention of the inflationary threat developing in the labour market as a result of overly stimulatory monetary policy. This follows in the footsteps of the June monetary policy statement that severely lacked quality analysis of labour market prospects. By contrast, one of the key findings of BNZ chief economist Tony Alexander’s latest quarterly survey of businesses was: ‘Across many sectors, employers are finding it difficult to source skilled staff, especially construction & engineering.’

“The Reserve Bank is out of touch with what is happening at the coal-face of the labour market, just as was the case in the early-to-mid-2000s. Consequently, the odds are high that interest rate & exchange rate prospects are very different to what the Reserve Bank & bank economists are predicting, as was the case last decade.

“There is a real risk Governor Wheeler’s misguided monetary policy experiment, like Governor Bollard’s misguided go-for-growth experiment last decade, will result in boom-bust cycles for the economy & housing market.”

Links: Reserve Bank
Strategic Risk Analysis
Rodney’s Raving

Attribution: Bank & Dickens releases, own comment.

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