News and Opinion, sponsored by RaboPlus

By Mike Jones

After hitting 5-week week highs on Wednesday, NZD/USD has crashed back to Earth over the past 24 hours. A steady stream of NZD-negative news has knocked NZD/USD back to 0.7000.

Yesterday’s RBNZ Statement proved a tad more dovish than market expectations, as we suspected. Growth appears to be turning out much as the RBNZ expected and inflationary pressures look contained. This being so, it was little surprise the Bank maintained its expectation to “begin removing policy stimulus around the middle of 2010”.

But markets were more interested in the bank’s assertion higher bank funding costs will “reduce the work that monetary policy might otherwise need to do”. OCR tightening expectations were trimmed back accordingly (2-year swap rates fell around 6bps), knocking some of the wind out of NZD/USD.
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By Bernard Hickey in Wellington

Watch Bernard Hickey deliver a report on YouTube here

Watch RBNZ Governor Dr Alan Bollard talk about the economy, interest rates and the housing market.

The Reserve Bank has left the Official Cash Rate (OCR) on hold at 2.5% and has repeated that it won’t be increasing the OCR until the “middle of 2010”. The Reserve Bank is scheduled to make OCR announcements on June 10 and July 29. The OCR has been on hold since April 30 last year.

Governor Alan Bollard said the economy was recovering broadly as expected and growth was expected to pick-up further through 2010. However, consumer spending and business investment was more subdued than in previous recoveries as indebted households and corporate increased saving and reduced debt, he said.

Some concern about decisions on property taxation in the May 20 budget budget also appeared to have slowed activity in the market for existing homes, the Reserve Bank said. It forecast stagnant real house prices over the next couple of years.

The Reserve Bank also pointed in its Monetary Policy Statement to likely one-off increases in prices later this year to come from increases in ACC levies and the Emissions Trading Scheme (ETS). It did not refer to an expected GST increase to 15% from 12.5%, but said it would “look through” the impact of the ETS as long as it did not change inflation expectations.

Here is the rest of the Governor’s statement below.

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By Roger J Kerr

It appears to me that there is more to the recent rally downwards in two to five year wholesale swap interest rates than the market just re-assessing and recalibrating of when the RBNZ will lift the OCR this year.

Since early January the three-year swap interest rate has declined from 5.15% to 4.50%.

The extent of this pull-back is telling us that more market participants (large investors and borrowers; not the banks as they are mere intermediaries) are perhaps buying into our view that there will be a paradigm shift downwards in the RBNZ “monetary policy neutral” interest rate from 6.50% to 5.00%.

The comment about the banks being mere intermediaries is not strictly accurate however – these days they are large buyers and holders of liquid securities (e.g. NZ Government Bonds) as they comply with new RBNZ funding ratio regulations.

What this also tells you is that the banks are doing very little new household and business lending; the cash is just piling up on their balance sheets.

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Watch on our video page here.

Watch on YouTube here.

Bernard Hickey delivers an economic weather report in association with BNZ that looks at the ‘new neutral’ for the Reserve Bank’s Official Cash Rate (OCR) ahead of its March Monetary Policy Statement and OCR announcement this coming Thursday.

Economists say the Reserve Bank will not have to lift the OCR as high as in previous recoveries because of new regulations and a change in the funding costs for banks. ASB has forecast the ‘new neutral’ for the OCR is likely to be around 5%, down around 1.25% to 1.5% from the previous ‘neutral’. The OCR has averaged 6% since it was set up in 1999.

Bank funding costs are now around 1.5% higher because it’s more expensive for them to raise money on international markets and they’re having to compete much harder on local term deposit markets. New Reserve Bank liquidity rules are intensifying this search for longer term and more stable funding, but it is helping to increase these funding costs.

This all means that longer term interest rates for fixed mortgages and term deposits are likely to be higher than at the equivalent points in previous cycles relative to the OCR. However, the net effect is for similar longer term rates in absolute terms. The one wrinkle is that variable mortgage rates and short term deposit rates are likely to be relatively lower than longer term fixed rate mortgages and deposits than at previous points in the economic cycle.

In other words, the yield curve is now sloping upwards rather than downwards. That in turn is likely to give the Reserve Bank more traction whenever it tries to slow and speed up the economy because more borrowers will choose variable rates.

By Roger J Kerr

Market swap interest rates have rallied lower over recent weeks, reflecting the belated re-assessment by the markets about the timing of OCR increases in 2010 from the RBNZ.

Swap yields may struggle to move a great deal lower from here, but do not expect any lift up for several months either.

The market outlook therefore appears very stable over coming months. Therefore, we have some time available to think about wider relationships between economic growth, inflation and short-term interest rates.

These two charts below support the view that 90-day interest rates may not travel much above 5.00% over coming years:-
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BNZ has gone looking for money overseas and succeeded, raising EUR 750 million through a seven year eurobond. At current exchange rates, this is equivalent to more than NZ$1.5 billion.

This issue is expected to cost the bank bank-bills-plus-150 bps, which it will probably feel satisfied with, given the seven year term.

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