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RBNZ cut OCR but little mention of Trump

November 10, 2016 Leave a comment

Although the attention this morning was on the election of Donald Trump as US President the RBNZ cut the OCR to 1.75% with a mild easing bias of “numerous uncertainties remain, particularly in respect of the international outlook, and policy may need to adjust accordingly”. nz-cpi-nov-16

It is expected that the OCR will remain at this level in the near future with inflation expected to be back within the 1-3% Policy Target Agreement (PTA) by the end of January next year – see graph from ASB Bank. The reason for this is that:

  • Dairy prices have recovered considerably.
  • The labour market is tightening.
  • Growth is running at an above-trend pace.
  • The OCR is already at an expansionary rate and the economy.

Could there be another cut in the OCR? There would be pressure if the following eventuated:

  • there is a strengthening of the NZ dollar,
  • increasing bank funding costs,
  • any further weakness in inflation expectations,
  • any deterioration in the global growth outlook.

The change of US Presidency will also be a wildcard over the longer term, with its mix of potential fiscal stimulus and trade protectionism. Trump has already signaled that he is not keen to sign TPP and he wants to reopen the NAFTA – North America Free Trade Agreement. Furthermore, he might take umbrage on the Chinese with their manipulation of the Yuan to advantage its exports and put a large tariff on its goods coming into the US. For New Zealand it may mean that they have to go down the bi-lateral agreement option in order to increase trade.

Other than the US election, Graeme Wheeler needs to be aware of the following:

  • Theresa May has indicated she wants to trigger Article 50 by May 2017 – it is very unclear what the process will be and the negotiating strategy of both the UK and the EU. This could have implications for NZ trade.
  • In China the increasing of centalised  power of the President.
  • China has a huge amount of corporate debt relative to GDP – see graph below.
  • Brazil is still in recession
  • Russia still has issues in the Middle East

China Corporate debt.png

RBNZ cut OCR but NZ$ on the rise

August 15, 2016 Leave a comment

Last Thursday it was no real surprise that the RBNZ cut the official cash rate to 2%. With this cut you would have expected some fall in the value of the $NZ but instead it appreciated. So why did the $NZ appreciate? Graeme Wheeler was interviewed by NZ Herald reporter Liam Dann and explained to him that we live in a phenomenal situation. Global interest rates have been incredible low especially in countries like Japan, the UK and Australia – see table below. Add to that the impact of quantitive easing since 2009 and negative interest rates in countries which account for 25% of world GDP and you have a very unusual situation.

CB Rate Aug 16

Some key assumptions from the RBNZ are that:

The global economy will start to pick-up which will mean that there will be less pressure on the NZ$ as investors look to other currencies to invest in. Remember that the NZ$ is the 10th most traded currency in the world and at uncertain times in the global economy it is seen as safe place to ‘park’ your money. This therefore increases the demand for NZ$’s appreciating its value.

Also the growth of the domestic economy with GDP expanding by 2.4 percent over the year ended in the March 2016 quarter, could mean a rise in inflationary expectations which should bring the inflation rate closer to the 2% mid point method in the policy target agreement. However this is a drop from 3.2% from the previous year.

According to Stephen Toplis of the BNZ 

Clearly, the NZD is already higher than anticipated and inflation expectations could well be constrained for longer as annual headline inflation falls, potentially, sub-zero. It was also interesting that the RBNZ did not repeat its upside scenario for interest rates due to higher house prices. This reaffirms the Bank’s easing bias.

All things considered then, and noting there is still significant uncertainty as to the exact way ahead, we can reasonably comfortably conclude that:

–  There will be at least one more rate cut;

–  The balance of risk is for even more;

–  The cash rate is going to be at least as low as it is now for a long time;

–  Inflation is likely to continue surprising to the downside in the near term;

–  Only when the rest of the world plays ball will the NZD wilt.

Brexit Result – what does it mean for New Zealand, the RBNZ, Gold and Sterling?

June 28, 2016 Leave a comment

The impact of Brexit on the New Zealand economy should be limited when you consider the following statistics:

  • 3.5% of total exports from NZ go to the UK – mainly sheep and wine.
  • 2.7% of total imports from the UK to NZ – mainly transport goods
  • 6.7% of all short-term visitor arrivals come from the UK

When the UK joined the EEC (as it was then know as) in 1973 there was a major shift away from trade with the Commonwealth. However New Zealand has been able to move away from the traditional dependency of the Commonwealth to become increasingly integrated to the Asia Pacific region.

Reserve Bank of New Zealand

The RBNZ is a good position even with a record low OCR of 2.25% which paradoxically is among the highest in the developed world. By not being aggressive with OCR cuts the RBNZ has the ammunition to stimulate aggregate demand further which is in contrast to the European Central Bank and the Bank of Japan who are in negative territory. With the turmoil in Europe over Brexit the US Fed will most likely hold off on a rate hike to ease the pressure on markets – it may even cut the US Fed rate.

Gold and Sterling – US$ rate

The graph below shows the reaction to the Brexit – GBP drops significantly against the US$ and gold, as a safe investment, appreciates in value. The uncertainty that surrounds Brexit saw more investors buy gold, which rose to about $1,315 an ounce on June 24th, up by 4.7% on the previous day. This was the largest increase since the global financial crisis in 2008. The rise was in stark contrast to the plunging pound, which tumbled to its lowest level in 30 years.

 

Brexit - Gold USD

Below is video from the FT looking at Five Consequences of the UK’s exit form the EU.

Categories: Euro, Trade Tags: ,

Low inflation in New Zealand not just about falling oil prices.

March 15, 2016 Leave a comment

The 0.1% inflation rate in New Zealand has largely been attributed to the 50% drop in oil prices since the start of last year – see chart. Although oil prices are referred to as a volatile item they have been low for sometime and are expected to remain subdued. Lower fuel costs have reduced prices for services such as air travel, and have dampened prices on shop floors as the distribution costs for retail items have declined.

World Commod Prices

However low inflation doesn’t just reflect movements in the price of oil. Even excluding petrol prices, inflation has been below 1% for most of the past year, and it’s set to remain low through 2016. The weak inflation figure has also been due to the low global inflation holding prices down and with the trend likely to continue for some time given the deterioration in global trade and widespread falls in commodity prices. Add to this the slowing growth of the Chinese economy and with its importance to global growth (see chart) you have a serious threat of deflation. This is particularly a concern if the Chinese authorities decide to further devalue their currency – the Renminbi. The RBNZ will have a tough job ahead of it to generate a sustained increase in inflation.

Screen Shot 2016-03-13 at 11.48.53 PM

New Zealand inflation not expected to hit 2% until March 2018

March 10, 2016 Leave a comment

Today Graeme Wheeler the RBNZ governor announced at 0.25% cut in the OCR – now 2.25%. He listed the following reasons for the cut:

  • Significant fall in inflationary expectations. The RBNZ has forecast that inflation will only reach 0.5% by September this year and 2% in March 2018. Since the GFC in 2008 weak inflation has been prevalent in the world economy and with the collapse in oil prices it has got weaker in the second half of last year.
  • Globally there is also decline in core inflation – a measure of inflation that excludes certain items that face volatile price movements. Therefore there is little or no imported inflation to talk about. A depreciation of the $NZ could mean an increase in the price of imports but would make New Zealand exports more price competitive – something that Graeme Wheeler is keen on given the weakness of New Zealand export prices.
  • A decline in the global outlook – interest rate cuts in Japan, EU and the UK accompanied by weaker growth in China. See graph below of Central Bank rates.

Surprisingly enough he said that the lower Fonterra milk payout was not a major factor in the bank’s decision as it was just a reflection of weaker global demand. Graeme Wheeler did suggest that one more rate cut might be on the cards – ‘monetary policy will continue to be accommodative’

CB rates

Smoothing out the boom bust cycles

November 4, 2015 Leave a comment

Below is a very informative video from the Reserve Bank of New Zealand about smoothing out the boom bust cycles in the New Zealand economy. There are some notes that follow which have been edited from the transcript.

Objectives macro prudential policy.

  • To build resilience of the financial system so that it can cope with the business cycle if it turns from boom to bust.
  • To be proactive in dampening the risk to begin with. This could include dampen the growth of credit, house prices or other asset prices. An example of this was in New Zealand in the late 1980’s – share market crash and the plunge in commercial property prices.

Macro Prudential Tool Kit – 4 Tools

1. Counter-cyclical capital buffer

This is where the banks are required to hold an extra margin of capital during the boom part of the cycle so that if the boom turns to bust the banks have an extra margin of capital that they can then call on to meet loan losses.

2. Sectorial capital overlay

This is very similar to a counter-cyclical capital buffer but it is about holding extra capital against a particular sector that the banks might be leaning to, for example the household sector, the farming sector, or potentially the commercial property sector.

3. Loan to value ratio for residential housing lending

This is a limit on the amount of high loan to value ratio lending or low deposit lending that the banks are able to do for the household sector. High LVR lending potentially fuels rapid house price growth and so that might be another reason why you would use that particular instrument.

4. Core funding ratio

This is a tool that has been a permanent fixture for the banks. There are a number of reasons why the core funding ratio might change. Potentially if the banks are facing an increase in risk, the Reserve Bank could require them to hold more core funding, funding that would be more likely to remain in the system during a downturn. By holding more of that stable funding, they’d be less likely to stop lending in a downturn because the funding would remain in the system.

Boom bust cycles are cycles in the economy and in the financial system are of course a fact of life. Macro-prudential policy certainly won’t prevent those cycles from occurring. What it will do is provide some cushioning to the cycle. It will hopefully clip the highs and the lows to some extent so that the flow of credit and the flow of financial services in the economy continue through time. It’s not about preventing the cycle or dampening it completely. It’s about taking some of the extremes out of the cycle.

RBNZ – 25 basis points drop works out!

September 10, 2015 Leave a comment

Just had a great day at the RBNZ for the Monetary Policy Statement this morning – as you may know the RBNZ dropped interest rates by 25 basis points. Below is a bit of humour as to how they arrived at their decision.

NY cartoon

And they say we are not thinking practically!

King’s College win Reserve Bank of New Zealand Monetary Policy Competition

August 13, 2015 2 comments

Congratulations to Martin Luk (Governor), Amanda Ngo, Jake McConnell, Shaan Keesha and Amay Aggarwal who won the Reserve Bank of New Zealand Monetary Policy Competition. The team made a 10 minute presentation on their OCR decision to three RBNZ economists Jed Armstrong and Hayden Skilling, and Assistant Governor John McDermott. They then had a 20 minute question and answer session in which they showed great teamwork in answering some very searching questions. There were 5 other schools in the national final.

RBNZ MPC Winners 2015 - King's College

Categories: Interest Rates Tags: ,

What is the economy?

July 31, 2015 Leave a comment

A short animated video by the Reserve Bank which shows how the economy works. It also outlines the role of the Reserve Bank of New Zealand. Good for an introductory lesson.

Categories: Economic Cycle Tags:

New Zealand – Resource Curse in reverse with falling dairy prices

July 7, 2015 Leave a comment

nz dairyI have mentioned the resource curse in previous posts especially those countries with natural resources. Below is an extract from a previous post.

Africa may have enormous natural reserves of oil, but so far most Africans haven’t felt the benefit. In Nigeria, for instance, what’s seen as a failure to spread the country’s oil wealth to the country’s poorest people has led to violent unrest. However, this economic paradox known as the resource curse has been paramount in Africa’s inability to benefit from oil. This refers to the fact that once countries start to export oil their exchange rate – sometimes know as a petrocurrency – appreciates making other exports uncompetitive and imports cheaper. At the same time there is a gravitation towards the petroleum industry which drains other sectors of the economy, including agriculture and traditional industries, as well as increasing its reliance on imports.

For New Zealand it seems to be working in reverse. New Zealand’s biggest export earner is dairy and with prices dropping by 23% since last year and the outlook of continued monetary easing from the RBNZ the dollar has dropped from US$0.77 on 27th April to US$0.67 today – a level not seen since 2010.

However, going against what the resource curse suggests, the weaker exchange rate will provide extra revenue for exports like the tourism industry which has been enjoying high numbers especially from Asia. Furthermore, there have been suggestions that it could surpass the dairy industry as the biggest earner of export receipts. There are further benefits for domestic companies competing against imports as the weaker dollar makes competing overseas goods more expensive relative to those produced in New Zealand.

OECD Deflation

January 7, 2015 Leave a comment

In 2014, 9 of the 34 members of the OECD experienced deflation whilst 3 others had zero inflation. Over the whole area consumer prices rose by only 1.7% mainly due to the fall in oil prices.

However in the Euro area inflation was only 0.4% over the year which is worrying especially as the European Central Bank (ECB) targets an annual rate of 2%. With interest rates at the ECB at 0.05% there is little scope for any stimulatory activity to increase inflation. Furthermore they are also charging banks deposits on money in the bank through a negative rate of 0.2%. Although lower oil prices will benefits businesses and consumers alike it maybe paradoxical if people expect lower inflation as cheaper energy pushes the headline rate into negative territory. So, the ECB has taken a leaf out of the US Fed’s book and decided on a form of quantitative easing by purchasing covered bonds and asset-backed securities.

Mario Draghi, President of the ECB, has not ruled out using additional measures “should it become necessary to further address risks of too prolonged a period of low inflation”.

Although Japan has an annual rate of inflation of 2.9% this has been largely due to an increase in the retail sales tax – if you exclude it from the calculation the inflation rate would be 0.9%. The Japanese Central Bank has a target of 2% inflation. As with the ECB interest rates in Japan are very low – 0.1% – so this leaves no scope for any stimulatory cuts. They are hoping that a further stimulus package of ¥3.5 trillion (NZ$ 37.41billion) on 27th December will boost the economy.

In New Zealand the annual inflation rate in September was 1% – the Reserve Bank Act 1989 stipulates a band of 1-3% while targeting future inflation at 2%. Unlike their counterparts at the ECB and the Bank of Japan they do have scope for stimulatory cuts as the official cash rate is currently 3.5%.

Deflation OECD

Categories: Deflation Tags: , , ,

The New Zealand economy cannot live on debt forever

July 26, 2014 1 comment

Brian Gaynor in the NZ Herald wrote a piece on the amount of debt in the New Zealand economy and the fact that the Reserve Bank needs some fresh ideas to stem the increasing trend. With the OCR increasing this week to 3.5% the disposable income of the floating mortgage holder will reduce and ultimately impact on their ability to spend – floating mortgages represent 33% of all mortgages in dollar terms. Although higher rates help those that have money in the bank however a lot of this is from overseas investors so interest payments leave the economy. Furthermore the elderly tend to have savings in banks but they are not seen as significant spenders. The higher interest rates also attract ‘hot money’ as NZ’s rates are higher than most other industrialised countries.

The amount of debt in the economy is a major concern especially when you consider how much is mortgage debt – see below. Also the fact that debt as % GDP is now 88.5% and 145% of disposable income – this is putting pressure on inflation not forgetting that people are living very much beyond their means.

NZ debt 2014

The RBNZ is concerned with this debt and introduced restrictions on high loan-to-value residential mortgage lending. They see that there is too much emphasis on housing which is being fuelled by greater access to debt. One only has to look at the Irish property to see how things can wrong – house prices dropped 50% between 2007 and 2012.

NZ Debt % GDP

RBNZ rate increase towards neutrality

April 25, 2014 Leave a comment

With the recent increase in the OCR by 25 basis points to 3% interest rates are now heading to towards a neutral rate – one that is neither contractionary or expansionary. The macroeconomic indicators reflect the following:

* Annual inflation at 1.5% is not that far from the mid- point of the RBNZ target band, especially considering the temporary effect that an appreciating currency has on headline inflation. See graph below from BNZ.

* The economy has limited spare capacity – capacity utilisation is close to long term average and firms are having more difficulty than normal in finding labour.

* Economic growth is above trend and looks set to push further above trend this year.

These economic indicators suggest that the economy is in reasonable shape and will be able to avoid a severe correction over the nest couple of years.

NZ CPI

Categories: Inflation Tags: , ,

Bank Funding Costs

March 30, 2014 Leave a comment

From the BNZ Economy Watch.

In the Post-GFC environment, heightened bank funding costs have driven a wedge between the OCR and borrowing costs. The key contributor has been RBNZ regulation requiring banks to source more secure forms of funding. Some relief in costs was experienced last year as some expensive funding from the GFC rolled off, and some reduced competition in the domestic deposit market was experienced. At the margin there is potential for a little further decline in funding costs. However, greater stability is now expected. Therefore more of the rise the underlying OCR will ultimately be felt by borrowers.

Business Lending and OCR

“Beware the Ides of March” – RBNZ

February 2, 2014 Leave a comment

Although the Ides of March refer to the 15th March, the next Monetary Policy Statement from the Reserve Bank Governor is on the 13th March and most commentators believe that this will be the first of many hikes that will see the OCR hit 4.5% by late 2015. There was a belief that RBNZ Governor Graeme Wheeler would start hiking last week but central banks don’t like giving exact dates. But the Christchurch rebuild and the increase in Auckland house prices will warrant higher costs of borrowing

Central Banks have often used the term ‘the neutral rate’ which refers to a rate of interest that neither stimulates the economy nor restrains economic growth. This rate is often defined as the rate which is consistent with full employment, trend growth, and stable prices – an economy where neither expansionary nor contractionary measures need to be implemented. In most economies post GFC the neutral rate of interest fell as they have required lower rates to try and encourage growth. The graph from the BNZ below shows that the neutral rate in NZ has dropped form 6% to 4.5%.

OCR Forecasts

Categories: Inflation Tags: ,

NZ net immigration highest for 10 years

October 23, 2013 Leave a comment

The BNZ Markets Outlook reported an annualised increase in net immigration by 33,000 the highest since 2003. The boost mainly comes from the fall in migrant departures. This will impact on aggregate demand and the RBNZ have talked in monetary policy statements about increases in potential growth (like the housing market) and the impact it will have on a tightening of monetary policy later next year – remember also the Christchurch rebuild.

NZ Pop

NZ household deleveraging – will it last?

October 6, 2013 Leave a comment

New Zealand households have gone through a period of deleveraging since the GFC in 2007 in which borrowing against the house has dropped significantly. Consequently household savings has gone up. However the increase in household debt from 2000 to 2007 was rapid and is forecast to increase further especially with house price inflation on the rise. But this house inflation doesn’t correlate to the economic conditions of the country and RBNZ Governor can be justified in saying that house prices are over-valued. Graph below from the BNZ Economy Watch.

Debt to disposable income

New Zealand’s Foreign Debt Servicing

June 26, 2013 Leave a comment

Lower interest rates has a positive effect on debt servicing costs. As a % of exports foreign debt servicing has fallen from 20.8% in 2007 to 10.6% at the start of 2013. However there is concern about the longer term effects of lower interest rates and the impact it will have on the housing market in NZ. If the CPI is pushes up towards the 3% the RBNZ may be forced to increase interest rates which influences the strength of the NZD and debt servicing. Furthermore, because net debt continues to increase indefinitely in the historic trends scenario, financing costs also increase exponentially. Below are graphs showing NZ’s debt servicing costs and explaining the debt spiral.

Foreign debt servicing

Debt spiral

Categories: Fiscal Policy Tags: , ,
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