It’s all about the preparedness to package alternative tools.
- The RBNZ left the OCR unchanged at 25bps. And the LSAP programme was extended to $100b, as we expected. But what could the RBNZ do next?
- Lowering interest rates to the lowest possible levels may involve a NEGATIVE OCR, and term funding to banks. The ‘package’ would squash retail rates closer to zero (but not below zero).
- The preparedness of the RBNZ suggests the combination of a negative OCR and term lending could come as early as November (if the lockdown extents).
The RBNZ kept the cash rate at 0.25%, as everyone expected. The RBNZ also expanded the LSAP program to $100bn, as we expected. The extension of the LSAP program to June 2022 (an extra 13 months) was a little more than market expectations of $80-90bn, but the natural next step in our view. In order to avoid any awkward limits, the RBNZ now has the remit to buy 60% of total outstanding Government bonds. The changes allow for the 100b size and front loading of purchases (without expanding the pool of assets to buy). The assertive changes were designed to keep the pedal to the metal, and flatten market interest rates.
The Kiwi Government bond curve has been steam-rolled by the announcement. Job done, again. Before the global pandemic, the NZGB curve was 60% owned by foreigners. It seems we’re wary of our borders again, with 60% of NZGBs potentially being bought by the RBNZ over coming years. Local fund managers, insurance firms, and investors will have to pay up to beat foreigners for the remaining 40%. It’s safe to say the interest paid by the Government on debt issuance will remain very low indeed.
Beyond the inevitable LSAP extension, the focus turned to the RBNZ’s positioning on “other” alternative measures. We have long argued that the next best option is a Bank Term Lending (funding for lending) programme. A term lending facility would be a sure-fire way to reduce all retail rates (deposit and lending). “A term lending programme would lower bank funding costs, both directly and indirectly, by reducing banks’ demand for, and hence the price of, other sources of funding. This would in turn help to lower the cost of loans for households and businesses. Internationally, term lending programmes have also sought to directly encourage the supply of credit via including incentives for banks utilising the programme to expand their lending, providing additional stimulus to the economy.” (RBNZ Aug MPS)
We were surprised, however, to see the idea of a “package” deal with a negative OCR. “Combining a negative interest rate with lower lending rates to banks… to lower all retail rates” Christian Hawkesby. The MPS positioned a negative OCR alongside term lending to banks as a package to fight downside risks. At face value, a negative OCR (say -25bps or -50bps) could see a term (wholesale) funding rate for banks below 0% from the RBNZ. In such a world, retail rates would NOT fall negative, but closer to 0%. We could conceivably see retail deposit rates well below 1% (and closer to 0%), and mortgage rates closer to 1%.
In the process to smashing interest rates expectations to, and now through, 0%, the Kiwi currency took a welcome hit. But the Kiwi dollar is still too strong. Commodity prices for Kiwi exports remain strong, but our exporters are reaping little benefit. Because of the recent uptrend in the Kiwi dollar. A lower exchange rate should help our exporters take advantage of the higher prices. Pumping the FX market with more, freshly printed Kiwi currency is one way to place downward pressure on the exchange rate. Easier said than done. It’s not hard to understand why the NZD is performing the way that has been. Coupled with general US dollar weakness, NZ’s Covid-19 situation is envied by many. And if global investors are piling into Kiwi dollars, because the rest of the world looks a lot worse, it’s difficult to stop. But if conditions deteriorate further and the level of the exchange rate becomes unjustified, the option of purchasing foreign assets may become a serious one. But we’re not there yet. It is an option.
Fiscal policy will continue to play an important role in supporting NZ’s economic recovery. Next Thursday the Government’s books will be opened ahead of the general election. The Government had set aside around $14bn from the Covid-19 recovery fund to tackle further Covid outbreaks. Like the one we are facing now. This morning the Minister of Finance, Grant Robertson, signalled that the Government is open to a regional wage subsidy for Auckland should the region go into an extended lockdown. The PREFU will take on a little more importance as a result.
Forecasts reflect the high level of Covid-19 uncertainty
The RBNZ latest baseline forecasts, finalised August 5, talk to the heightened level of uncertainty in the Covid-19 era. The trajectory of the Bank’s forecasts looks broadly unchanged. And that’s despite NZ coming out of our initial lockdown sooner and domestic spending data bounced back much faster than the Bank had expected. The risks clearly remain to the downside. A point highlighted by the events of the last 24hrs.
Looking at the forecasts, the level of GDP is still not expected to recover back to pre-Covid levels until early 2022. To get there, the RBNZ lessened the depth of the trough in GDP growth in the June quarter to a 14.5% drop. But the Bank has reduced the punch of the recovery on the other side. Since the May MPS, the global outlook has deteriorated with the Covid-19 pandemic gaining momentum. The NZD has stayed stubbornly high. And the RBNZ has pushed out its assumption on closed borders from the end of the March quarter 2021 to the end of next year.
Inflation remains below the RBNZ’s 2% target midpoint for almost all the forecast period, taking an extra quarter to reach 2%. And the bank will fall short of the full-employment mandate too. The unemployment rate track has a smaller peak, but a fatter tail compared to the May MPS. The RBNZ has lowered the peak rate to 8.1% (from 9%) by the end of 2020. But the unemployment rate only reaches 5.8% by Q3 of 2023.
Lockdown (again)
Auckland is in lockdown, level 3. The rest of the nation is in level 2 but feels like level 2.5. As economists, we spend a fair amount of time presenting at conferences. Unfortunately, the Build NZ conference was immediately affected, and other conferences over the next few weeks have also been postponed or converted into webinars. We’re all erring on the side of caution. We’ve also heard of conferences and events being canned in the capital. Anecdotes from restaurants and bars, outside of Auckland, have customers cancelling bookings. Resorts and tourism operators in the regions next to Auckland (Northland, Waikato, BoP, Gisborne), have told us they’re losing bookings for this weekend (and next week). It seems Aucklanders are preparing for a few weeks of level 3. And all of this on day 1.
All our forecast assumptions had excluded another lockdown. Another prolonged lockdown is clearly a downside scenario. A 3-day lockdown would have a limited impact on Auckland, and therefore National, activity. But another lockdown of 2-4 weeks is likely to have a significant economic impact. The need (ability) to adapt, work from home or move online, will again be thrust upon businesses.
Markets jumped into action
The reaction in our financial markets was immediate. The wholesale swap curve has been appropriately flattened by the extension to the RBNZ’s LSAP programme and expectations of additional stimulus. The pivotal 2-year swap rate was trading around ~19bps before the MPS. The dovish nature of the RBNZ has seen swap rates fall, with the 2-year now down 4bps to ~15bps. Longer-dated rates fell by a similar magnitude; the 5-year is down around ~4bps at 24bps.
The Kiwi dollar continued its glidepath lower against the greenback. The PM’s announcement last night on the revised travel restrictions within NZ was the first blow. And the Kiwi dropped to an overnight low of 65.72c. Today’s MPS statement was the second blow, and was more lethal than the first. In the lead-up to the announcement, the Kiwi was cautiously trading around the 65.70 range. Bang on 2pm, the Kiwi dropped to 65.28c. The statement read dovish, and the other tools remain firmly on the table, including the infamous negative rates. The NZD fell against the other G-10 currencies too. Against the Aussie dollar, the NZD fell from 92.08c to 91.66c – a two-month low.
RBNZ Statement
The Monetary Policy Committee agreed to expand the Large Scale Asset Purchase (LSAP) programme up to $100 billion so as to further lower retail interest rates in order to achieve its remit. The eligible assets remain the same and the Official Cash Rate (OCR) is being held at 0.25 percent in accordance with the guidance issued on 16 March.
Reflecting a possible need for further monetary stimulus, the Committee also agreed that a package of additional monetary instruments must remain in active preparation. The deployment of such tools will depend on the outlook for inflation and employment. The package of further instruments includes a negative OCR supported by funding retail banks directly at near-OCR (a Funding for Lending Programme). Purchases of foreign assets also remain an option.
Over recent months New Zealand had contained the spread of COVID-19 locally, allowing a relaxation of social restrictions and a recovery in economic activity. Recent indicators highlight that the faster return to social norms and a higher proportion of employees working from home has seen output and employment recover sooner than projected in our May Monetary Policy Statement. Recent spending also reflected pent up demand resulting from the lockdown period.
However, the severe global economic disruption caused by the pandemic is persisting. Any significant change in the global and domestic economic outlook remains dependent on the containment of the virus, which is highly uncertain as evidenced today by the return to social restrictions in New Zealand. Such uncertainty is stifling household and business spending appetites, as highlighted in confidence surveys. Given the ongoing health uncertainty, there remains a downside risk to our baseline economic scenario.
International border restrictions will continue to significantly curtail migration and tourism, and lead to the activity outlook being uneven across industries and regions. Commodity prices for New Zealand’s exports remain robust, but this has been partly offset by a rise in the New Zealand dollar exchange rate moderating the return to local export producers.
Ongoing support for domestic economic activity is being provided through significant government spending on business assistance and household income support. This will be supported by a rising level of government investment. However, there will be a transition of policies in the near-term, with the announced end of the Wage Subsidy likely to coincide with a decline in employment.
Monetary policy will continue to provide important economic support in the period ahead. Its effectiveness is evidenced by retail banks’ lower funding costs and lending rates, which are benefiting businesses and households. It remains in the long-term interest of banks to fully pass on the benefits of lower funding costs to their customers.
The Monetary Policy Committee will provide additional stimulus as necessary to meet its remit.