The RBNZ will provide banks with cheaper funding.
- The RBNZ left the OCR and the LSAP unchanged. And the MPC made good on the promise to provide banks access to cheaper funding via an FLP.
- The success of the FLP will factor into the RBNZ’s decision on taking their next step, below zero. The probability of future OCR cuts has reduced. But we still expected the next move will be a cut.
- The RBNZ’s actions to date have fuelled the housing market, there is little doubt. Double digit price gains in the midst of the worst recession in 100 years has surprised us all. LVR restrictions will be back in March.
The RBNZ kept the cash rate at 0.25%, and the LSAP was left alone at $100bn. Neither the cash rate nor the LSAP were in play today. The decision centred on the introduction of a funding for lending programme, FLP. And the RBNZ delivered. The FLP will provide banks with a cheaper source of funding and enable banks to pass on lower lending rates to households and businesses. The initial funding allocation of 4% of total bank loans and advances, domestically, will be followed by an additional (and conditional) 2%, for a total available funding pool of 6% per bank. The funding will be available for 3 years on a floating rate (so to capture any cut into negative territory). The FLP will be effectively open for 24 months (18 months on the initial allocation plus 6 months for the additional 2% allocation).
“The Funding for Lending Programme (FLP) aims to lower the cost of borrowing for businesses and households, thereby supporting economic activity and employment, and helping keep prices stable. Through the FLP, the cost of borrowing for New Zealanders will be lowered via three channels: directly through cheaper FLP funding to finance lending by eligible participants; indirectly through a reduction in interest rates on other forms of funding; and by supporting the supply of credit to the economy.”
Since February, we have pounded the table in favour of bank lending facilities as the next best monetary policy option. Today’s FLP announcement was a well-orchestrated, well-telegraphed, but long-awaited policy move. Late, but in earnest.
With the FLP now in train, and the outlook slightly more upbeat, the probability of future OCR cuts by the RBNZ have reduced. The outlook remains highly uncertain, however. The return to full employment remains many moons away, and it is far too early to call an end to the easing cycle. It is still more likely than not that the RBNZ will be forced to do more in the recovery phase.
The balance of risks are still to the downside. We are still one covid outbreak away from another lockdown. And a cut in February can’t be ruled out if the FLP doesn’t induce the desired impact on retail lending rates. We maintain our view that the next move by the RBNZ will be a cut to the OCR. However, we have pushed out the likely timing of a rate cut. We have pencilled in a 50bp cut in the cash rate in May, previously we had a 75bp cut in February. A cut to -0.25% in May will still leave the RBNZ with ammunition (another 25-50bps) to cut further, if warranted.
Expanding headroom while lowering the ceiling
Earlier in the day, the RBNZ announced a further delay to the start of the increases in bank capital, until July 2022. The additional 12 months gives “banks continued headroom to respond to the effects of the Covid-19 pandemic and to support the economic recovery.” At the same time, the RBNZ will look to re-instate “loan-to-value (LVR) restrictions on high-risk lending with effect from 1 March 2021”. The LVR ceilings were removed in May, and were meant to be up for review in May 2021 (12 months off). The RB today said “Circumstances in the lending market have since improved and we are now observing rapid growth in higher-risk investor lending. We will consult about re-instating the restrictions we had in place pre-COVID, which limited the amount of high-risk lending that banks could make,” which may mean the LVRs come back on investor lending only. Reinstating the LVRs from March, instead of May, is a slightly more pre-emptive stance. Anyone considering a property purchase may act with a bit more urgency to get it all done before March. And the early reinstatement of the LVRs proves our point that the RBNZ is more than capable of delivering a negative cash rate at its February MPS – just a few weeks ahead of its “12 month” guidance to mid-March 2021.
Forecasts reflect the high level of Covid-19 uncertainty
The Reserve Bank has improved its near-term outlook for the Kiwi economy a smidge due to outsized policy support and the surprising strength of pent-up demand. The September bounce back in economic activity is forecast to be stronger (13.4%) compared to the August MPS (12.2%). And the peak for the unemployment track has been lowered to 6.4%, down from 8% in the August MPS.
But that’s when the good times end. The RBNZ is forecasting a contraction in GDP in the December 2020 and March 2021 quarters on the back of fading wage subsidy impact and a lack of international tourist arrivals. The Reserve Bank also envisages a slow recovery for the labour market. The 6.4% peak in unemployment has been pushed out to the June 2021 quarter (previously end of 2020) and extended over two quarters. And there’s been no change to the inflation track. Inflation remains below the RBNZ’s 2% target midpoint for almost the length of the forecast period.
Since the August MPS, the global outlook has deteriorated with the Covid-19 pandemic continuing to roll on. Expected annual trading partner GDP growth over 2020 has been revised lower to -3.2%, down from -2.7%. Indeed, so long as the virus rages on here and abroad, the outlook for the Kiwi economy remains clouded with uncertainty. The Reserve Bank’s baseline scenario reflects the strong dependence of our economic recovery on the progression of the pandemic. A vaccine would be a major game-changer. But that aside, the risks remain to the downside.
Market Reaction
Today’s MPS propelled interest rates and the Kiwi currency higher. Rates markets reacted violently to the lack of explicit guidance on the cash rate. The reduced likelihood of future RBNZ rate cuts was stripped out of the Kiwi curve with dramatic effect. The 2-year swap rate surged and is a whopping 14bps higher, at +20bps, on yesterday's close. Ironically, the sharp lift in wholesale rates will blunten the potential impact of the FLP on lending rates.
On currencies, the Kiwi dollar has been flying high since the promising vaccine news from Pfizer and BioNtech announced Monday night. The Kiwi reached a 20-month high at 0.6855, and held above the 0.68 level heading into today’s announcement. The RBNZ’s dovish stance however wasn’t strong enough to stop the bull rush. At time of writing, the Kiwi has shot up to 0.69! Against the Aussie dollar, the cross is currently trading at 0.9436, up from 0.9379. The relative strength of our currency further dampens inflation expectations, and doesn’t help our exporters. “International prices for New Zealand’s exports have remain resilient, although export returns continue to be partly offset by the New Zealand dollar exchange rate”. Our exports could do much better with a weaker currency.
RBNZ Statement
Tēnā koutou katoa, welcome all.
The Monetary Policy Committee agreed to provide additional monetary stimulus to the economy in order to meet its consumer price inflation and employment remit. The Committee agreed that the additional stimulus would be provided through a Funding for Lending Programme (FLP), commencing in December. The FLP will reduce banks’ funding costs and lower interest rates.
The Committee will also continue with the Large Scale Asset Purchase (LSAP) Programme up to $100 billion, and retain the Official Cash Rate (OCR) at 0.25 percent in accordance with the guidance issued on 16 March.
Progress has been made on the Bank’s operational ability to deploy an FLP and a negative OCR. The Committee agreed that these instruments can be mutually supportive in bolstering economic activity if necessary.
Economic activity since the August Monetary Policy Statement, both international and domestic, has proved more resilient than earlier assumed. In New Zealand this trend was evident across a range of indicators, including employment, household spending, GDP, and asset prices. These outcomes reflect the effectiveness of the health and economic policy responses to the initial shock.
However, the COVID-19 shock to the economy is very large and persistent, and inflation and employment will remain below the remit targets for a prolonged period. These outcomes are despite the current significant fiscal and monetary stimulus.
The outlook for global economic activity remains dependent on the containment of the virus. While recent news on vaccine developments is positive, there remains a long and uncertain lag before any widespread vaccine deployment may be achieved. Meanwhile international border restrictions will continue to curtail international trade and migration, with variable impacts across industries and regions. International prices for New Zealand’s exports have remained resilient, although export returns continue to be partly offset by the New Zealand dollar exchange rate.
Domestically, fiscal stimulus remains significant even with the Wage Subsidy scheme having now run its course. Government spending on business assistance and household income support continues, and government investment will rise.
However, we expect an ongoing increase in unemployment as the economy adjusts. Consumer price inflation is also projected to remain at the lower-end of the remit target range for a period, and inflation expectations remain subdued.
The Committee agreed that monetary policy will need to remain stimulatory for a long time to meet the consumer price inflation and employment remit, and that it must remain prepared to provide additional support if necessary.