Opinion: The RBNZ could do itself favours with a trade-off between a higher OCR and removal of LVR 'speed limits'

By David Hargreaves

As we have already been amply reminded, this is an election year.

That means there will be promises and trade-offs and trade-offs and promises and then some more promises and trade-offs. 

I have a fair amount of sympathy for our central bank, the Reserve Bank, which is cast into the middle of all this with a brief to maintain control over inflation - whatever ridiculous economic policies and spending patterns might be promised by those eying three years in Government.

The words of Rudyard Kipling come readily to mind: "If you can keep your head when all about you are losing theirs and blaming it on you..."

Well, nobody's really seriously blaming the RBNZ for anything yet. But they might. The fact is the bank could find itself stuck in the middle and treated as some sort of pantomime villain this year if it is not careful.

Remember, it has already ruffled feathers with the October 2013 implementation of its so-called speed limits on high loan-to-value lending.

This policy can be viewed either as: A totally mean-spirited idea that will rob young New Zealanders of a right to have their own bricks and mortar, or, As a necessary step to dampen irrational exuberance on the part of the banks and ensure that financial stability is preserved.

In the febrile environment of an election campaign, I rather suspect that the first line of thinking is going to gain more prevalence.

So, that's a problem for the RBNZ. The Government's already made it very clear it opposed the LVR limits being applied on first home buyers, which means the central bank has no ally there. And opposition parties - because they don't have to work with the RBNZ - can say virtually what they like, until they are in Government.

If the RBNZ had only the unpopularity of the LVRs to deal with this year then that might be okay.

The biggie on the horizon

But of course there's another biggie on the very near horizon: Yes, rising interest rates.

The RBNZ is going to hike the OCR either on January 30, or when the subsequent OCR review occurs on March 13. Personally I'm still picking March 13.

But regardless, the rates are going to increase and they will probably be increased further as the year goes on.

So, not only are the nation's young and pure being given almighty (LVR) hurdles to jump simply to get a mortgage, but now even if they clear the hurdle, they are going to be invited to pay more for the pleasure.

In the early weeks of election year the de rigueur political promises have centred on increasing the pay of teachers, improving the lot of schools generally and encouraging people to have more babies. But you have to suspect that home ownership by New Zealanders is set to be a big theme as the year progresses. And that's where the RBNZ could really find itself in the firing line.

No popularity contest

Now, nobody ever said central banks have to be popular. Indeed, it might be argued that if a central bank was popular you possibly should be worried about just what sort of job it is actually doing. Keeping the banks in line and controlling inflation should not be activities guaranteed to win popularity contests.

But equally, there could be a problem if the RBNZ ends up being too much of a centre of attention this year. It would be a huge backward step for the country in my opinion, if we were to see populist political policies that promise a shrinking of the independence of the bank gaining broad support.

An independent central bank with a clear monetary policy mandate should be treasured. But personally, I do fear the worst on this. Meddling may be just around the corner.

I think the RBNZ could do something to help itself.

Yes, get rid of the LVR limits.

A good time to go

Logic would suggest  that a good time to do this would be either just before or in conjunction with the first increase in OCR, assuming that this doesn't take place till March.

Now, the RBNZ might have some difficulty with this, because it doesn't like to mix its monetary policy (IE interest rate) announcements with its prudential supervision work - under which the LVR policy falls.

But what about an early March announcement, days before the OCR review, to the effect that the LVR limits will be lifted in June? 

That would mean the limits would have been in place for nine-to-10 months before being lift. That's a reasonable period of time. The RBNZ's first detailed evaluation of our banks' lending ratios was to be done on a six-month rolling average of figures, which would mean at the end of March. So, detailed information would be available prior to the actual lifting of the limits.

We have already seen from the figures available so far that the banks have very much moved into line with the LVR policy. The RBNZ said "jump" and they did.

In that respect then the policy could be termed a success. The central bank introduced the policy and the banks immediately responded in the manner required. An efficient market.

The good news then is that if the RBNZ now withdraws the policy it could claim it a success and of course it can always reintroduce it at very short notice later.

If the RBNZ insists on keeping the LVR limits in place then as interest rates go up, expect the policy to come under more attack and face more dilution.

Backtracking

Already we've seen the RBNZ partially backtrack on the LVR policy to allow exemptions for new builds. And just before Christmas the central bank put out documents showing a complete u-turn on plans to have all banks forced to include credit card and personal lending in LVR calculations. 

If the RBNZ insists on keeping the LVR policy in place, at the same time as raising interest rates, then it is just inviting trouble upon itself.

Now, it might be argued that removing the LVR policy is in effect a defeat. I don't think so.

Remember, there were two publicly stated objectives for the LVR policy. The principal reason was to preserve financial stability with a  secondary motivation being to take some heat out of the housing market.

A good handle

It can be argued that by getting the banks to jump into line as quickly as it did, the RBNZ has got a good handle on the financial stability picture. As discussed, it can always slam the limits back on again later if it starts to see the same loosening of attitudes and policies that was creeping in among the banks last year.

Secondly, the falling volumes of house sales suggest that some steam is coming out of the housing market.

The third point to consider is that most economists would say that the only real way the RBNZ is going to dampen the housing market is to raise interest rates, which of course is now what is about to happen.

There's no doubt that a decent dose of higher mortgage rates is likely to slow the housing market at some stage, so why doggedly stick with the LVR limits too?

Some might say this suggested course of action would be a cop-out for the Reserve Bank.

But we are going to see all sorts of political party trade-offs this year.

And for the Reserve Bank to undertake its own kind of trade-off just might help to keep unwanted attention off it and allow it to keep doing the best job it can for the country - without unwelcome interference.

It's all food for thought anyway...