ANZ economists say negative interest rates won't be without potential costs and they believe the Reserve Bank will have to weigh these against perceived benefits when deciding whether to drop the Official Cash Rate below zero

ANZ economists say negative interest rates won't be without potential costs and they believe the Reserve Bank will have to weigh these against perceived benefits when deciding whether to drop the Official Cash Rate below zero

There will be "winners and losers" from any Reserve Bank move to introduce negative interest rates, economists at the country's largest bank say. 

In its last Monetary Policy Review on August 12 the RBNZ gave clear indications that it is favouring taking the Official Cash Rate (currently at 0.25%) into the minus territory probably early next year. This move would be in conjunction with a 'Funding for Lending Programme' (FLP), which would involve directly funding retail banks at an interest rate near to the level of the OCR.

It is NOT expected that the move to negative interest rates would see deposit rates for bank customers become negative, but it is certainly expected that they would go even lower than they are now, as would lending rates such as on mortgages.

ANZ senior economist Liz Kendall and and senior strategist David Croy have produced an extensive NZ Insight publication, which takes a deep dive into the possible introduction of negative interest rates and the likely accompaniment of an FLP, and what this would all mean and entail. 

"A negative OCR would not be without potential costs," they say.

"And the RBNZ would have to weigh these against perceived benefits of the policy when deciding whether to deploy it. As with conventional monetary policy, there would be winners and losers."

Kendall and Croy say the key issue is ensuring the policy "is in fact net stimulatory".

"As with any OCR cut, deposit holders will be worse off. Those living off interest income, typically retirees, may have to reduce their spending," they say.

Getting no help

"Some younger savers may also conclude that they need to save more rather than less, as they get less (or no) help from cumulating interest in terms of hitting their saving targets, whether that is a house deposit or a retirement savings goal." 

The economists say that on balance, the RBNZ’s modelling "will no doubt" conclude that the stimulatory impacts on borrowers outweigh the contractionary impact on savers, "but the offset is real".

They also say the impact on the banking system needs to be considered carefully.

"Done in the wrong way, a negative OCR could be outright contractionary, with significant adverse effects."

Kendall and Croy also say there would be a risk that negative rates could "squeeze" bank margins. This could produce a tightening of credit availability, "particularly if global banks allocate their capital elsewhere because returns in New Zealand are lower".

"This could have significant contractionary effects on the economy, even if a negative OCR were stimulatory through other channels, and financial system functioning could be hampered."

They say this is a key reason why implementing "a well-designed" FLP alongside the negative interest rates is so important.

The FLP fillip

By itself, an FLP – as used by the Bank of England, Reserve Bank of Australia, and others – can be used to encourage lending as a monetary policy tool, they say. By offering lending at (or near) the policy rate, an FLP lowers bank funding costs and provides a direct injection of liquidity, encourages lending and lowers retail rates, increasing the money supply and providing stimulus to the economy.

"Additionally, when an FLP is implemented when the policy rate is negative – as done by the ECB and Bank of Japan – then in addition to having these benefits, the FLP can be targeted to mitigate the negative impacts of a negative policy rate on bank margins and credit supply."

The economists say that much of the cost of the policy is focused on impacts on the banking system, but they point out that other financial market participants would also be affected.

"One example is KiwiSaver funds and the like that invest in cash or bonds. A key question that many fund managers will have to tackle is whether or not they 'invest' at a negative interest rate, should wholesale term deposits fall below zero. Doing so is tantamount to guaranteeing their clients a loss. Many fund managers are likely to have guidelines preventing this, and some may view a guaranteed loss scenario as a breach of their fiduciary duty to invest responsibly. This could encourage risk taking as funds look to hold higher-yielding assets, but that could come with challenges in terms of managing risk."

So, those are some of the costs and risks. Benefits?

Kendall and Croy say the benefits could come "through a range of channels", including a lower exchange rate than would otherwise be the case.

Weighing on the currency

"We don’t expect dramatic outflows or a sudden currency adjustment, but we do think that a negative OCR would weigh significantly on the NZD, both in advance of the policy and once it was deployed, relative to a state of the world where the policy was not used at all. This would flow through into higher prices for imported goods, but also boost competitiveness of exporting and import-competing firms and contribute to higher net exports. The extent of the currency reaction will to some extent be out of the RBNZ’s control, depending on global developments, but its size would have significant implications for the effectiveness of the policy."

The economists say "a negative OCR and FLP combo" would also further lower mortgage rates, contributing to higher house prices and lower debt-servicing costs, spurring spending, building and confidence.

"If spare capacity in the economy is absorbed as a result and expectations are supported, then price pressures would increase and business investment would recover. All of this would contribute to higher inflation and lower unemployment in line with the RBNZ’s objectives. All of this assumes that credit is flowing freely."

However another potential cost of the policy is that lower interest rates could worsen wealth inequality via asset price inflation.

"That is indeed a valid concern, but we would note that there are bigger structural forces that have driven worsening wealth equality, quite separate from monetary policy, including falls in the neutral interest rate and constrained land supply, in the case of house prices. And, if the policy is stimulatory, then it will benefit overall incomes and wealth positions in aggregate."

However, the RBNZ would need to carefully consider financial stability risks and the potential build-up of financial imbalances when deploying the policy.

Unintended consequences

"These could be particularly relevant if a negative OCR were employed for an extended period and encouraged excessive risk taking. It would be important to monitor the system for such risks and other unintended consequences, and potentially overlay macro-prudential policy to head off any rising risks on that front."

Kendall and Croy say the various risks reinforce the importance of designing an FLP to maximise the effectiveness of a negative OCR, so that benefits can be delivered and the policy reversed relatively promptly.

"If not enough stimulus is provided, then negative rates could become entrenched and coincide with potentially perverse structural changes, such as deflation, lower inflation expectations, low capital accumulation (and potential growth), and lower neutral interest rates.

"The other consideration is that we don’t know exactly how a negative OCR policy will go, and neither does the RBNZ.

"Although they have been employed in other countries, the New Zealand experience might be different. There could be costs or risks that are unforeseen, which may be colouring some of the reluctance from other central banks to consider the policy, including the Fed and the RBA.

"The RBNZ appears willing to give it a go, given the outlook, but we are in uncharted territory."

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36 Comments

Kendall and Croy also say there would be a risk that negative rates could "squeeze" bank margins.

Seems we have the argument in a nutshell.

Banks and savers are the losers, hence the moaning from ANZ, WBC and Kiwi. Westpac were valued at > 2x book 3 years ago, now they are .85x book. The party's well and truly over...

Won't they stop lending?

It's possible, but I doubt it. The NZ operations have been most of the 4's most profitable unit's. The RBNZ is also about to introduce schemes that will make new lending very profitable as well - Funding for Lending for example.

They will need to bolster capital to extend lending via retained earnings - has that been modeled in a negative interest rate environment? FLP will offset the negative OCR impost on the proposed $100 billion settlement cash received in exchange for QE surrendered bonds, but can extra margins be sought which will not prove prohibitive to borrowers?

They're not capital constrained and they were also prevented from paying a dividend so there is more capital there as well.

You don't need a lot of capital for resi lending either, around 3%.

How long can the Aussie parent banks suffer the indignity of no NZ sub dividend?

good question.

They are no longer the cash cow they were - are they worth the cost?

Lyndon B. Johnson Quote: "Making a speech on economics is a lot like pissing down your leg. It seems hot to you, but it never does to anyone else." That's all I think when I read economists statements. If the banks fired all their economists they would save a lot of money and achieve the same outcome.

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Yes, we are in uncharted territory.

So why ask economists, and particularly bank economists? Firstly, economics as-taught worked until it didn't. Just like the mole on my left cheek stopped me getting cancer - until I get it. Secondly, banks issue keystroke-created debt, 'charge' others (who do real things) a percentage of their real wealth for the privilege of borrowing the keystrokes. The bankers then buy real stuff with their computer tokens.

Worked until it didn't. Ran into physical limits. Rates of interest chargeable went flat, then negative; no surprise to us real-world studiers. The overhang is unrepayable - who blinks first?

"when an FLP is implemented when the policy rate is negative – as done by the ECB and Bank of Japan"
So the banks are pushing us down this path? Hope no one's relying on a V (or U or anything better than a L) recovery.
Who is meant protect us from this short sighted madness? We have a property buying frenzy going on can't we just wait and see before we get our own lost decade?

K is in vogue. Government workers, white collar, asset holders marching on up, not only unaffected but better off with billions sloshing to, well, them as it happens, the holder of the money bucket doling it out on the upper limb because one, quick as a flash, brandished a sign declaring the upper limb "the economy". None dares look down lest they see the peasants and the real economy far below their exalted realm. Interesting times...

"However another potential cost of the policy is that lower interest rates could worsen wealth inequality via asset price inflation. That is indeed a valid concern, but [that was happening anyway]. And, if the policy is stimulatory, then it will benefit overall incomes and wealth positions in aggregate."

Any French historians here? Willing to bet early 1789 an economist advised the monarch that the aristocracy was already rich and becoming richer would help the peasants. I'm pretty sure that turned out well...

Russian revolution along with lots if African ones and even the rise of dictators prior to WW2.

Indifference and stagnation create inequality, inequality the destruction required for systematic upheaval. Change is not typically a linear, gradual, managed, predictable process because the people who instigate change are typically revolutionary and outside the traditional political system.

"...However another potential cost of the policy is that lower interest rates could worsen wealth inequality via asset price inflation."
Allow me to to continue for you-
"Fortunately, the RBNZ has no mandate to give a damn about wealth inequality, and the potential government to take us into negative rate territory doesn't either. The blue shirts of course having the mandate to look after the wealthy, and the red shirts naturally feel quite comfortable in using welfare to keep the unwealthy just on the edge of poverty.

The question is why would we even try to go this way, negative rates have never been positive :) for any country that has tried using them.

Furthermore, more private debt is exactly what we must avoid at all costs since it's already off the charts and poses a significant risk for the economy already.

If they know it doesn't work for the stated intention, the goal must be something else? Just inflate asset portfolios more?

They indeed know this would be the result but it would be a criminal decision since they would be destroying the future of the whole country for the profit of the wealthy few.

When the word 'stimulus' is used, it means only that the property market and to a lesser extent, the stockmarket, should at all costs be propped-up. It does not mean that money will be funnelled to businesses, few of whom right now are in expansionary mode.
A contact in one of the big 4 banks told me that companies are, like many households, paying off debt rather than taking on more.
As a beneficiary of this policy with both property and stockmarket holdings, perhaps I should be grateful, but Ithe ever growing disconnect between house prices, incomes and the economy can only end badly, though I have no idea when.

More and more debt, regardless of its price will eventually prove Hemmingway's prescient comment:

“How did you go bankrupt?"
Two ways. Gradually, then suddenly.”

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Save NZ - Fire Adrian Orr before its too late.

Negative interest rates have not worked in the Europe or Japan. It will only kick the can down the road and shaft anyone who has saved money but it will boost house prices for a while. So RBNZ decides LETS DO THIS. Once the debt fueled get use to free money taking it away will be like trying to get a P addict off meth.....

Hope they go negative. Even at 2.5% our rates are much higher than most countries. My brother's mortgage rate has been about 1.5% for many years in Sweden, as has my in laws in Japan.

I am hoping employment numbers go really negative so house prices can reset at least 30% and stay that way. My brother's house in London is cheaper than most in Auckland and my cousins house in Texas is much cheaper than Auckland!

That wouldn't be good. House prices would be lower but the jobs to pay for them wouldn't exist.

The market will sort it out it always does....House prices would be much lower but that would be a good thing. The memory of the massive fall of house prices will be imprinted in the memory of the next few generations and perhaps it will stop them speculating on them like we have had for the last 20 plus years and instead get them to invest that money in productive businesses directly or via the stock market in NZ or offshore.

Or, more likely, the thousands of people who have bought first homes in the last few years would be left in negative equity and effectively completely stuffed financially. The boomers who drove prices up will just cash out and those coming through get cheaper houses - so I'm sure it's a 'good thing' for some, but it would be financially ruinous for others who committed the crime of buying their first home - unless they are just acceptable collateral damage?

Personal responsibility. If you cant come up with 25% plus deposit don't buy. Getting saved by creating artificial interest rates of zero or negative interest rates is BS. All the emotion of first home buyers is just that. Emotion. How are is your first home different to your tenth home?

We don't talk about even protecting elderly who have saved a little cash for their retirement with a bank deposit guarantee. All the while they are greatly put at risk their bank deposits at near zero rates and an OBR event with continued reckless lending by banks to people who cant save a sufficient deposit.

We encourage debt fueled living and now that it doesn't work and cant be paid for we must save the debt fueled by making them pay no interest for their non-conservative ways. PS I am not a boomer as you put it but I just find it a stupid term to use that gets bandied around. I actually don't know what generation I am but I don't actually care (in my 40s! Should probably talk about financially illiterate young people more.

Giving a few thousand cushy government jobs that'll pay their mortgage until inflation catches up would probably cost far less in QE or government debt than the current madness - and perpetuating the current madness. Why advocate putting more into the same risky situation to eventuate in even more collateral damage?

Yep, & current settings are financially ruinous for another group. You're right, one group will be worse off if the mandarins pull lever one way or the other. But rather than let things settle with gentle tweaks to cushion the impact a little for all, they're determined to pull the lever all the way over. And we have Fed, RBNZ, RBA, Govt playing God, deciding to save one group while crushing another. Curiously, the favoured group is the one the mandarins are in... (The tragedy is the super bubble created from the lurch to crush one group to save their own risks more carnage for all).

Why does being in negative equity really matter to someone who has a house and a job? If they had to sell and move, they would be buying and selling in the same market, and a house is a long term investment, so over a very long period house prices do tend to rise. Shares also go up and down, but smart people don't tend to sell when share prices drop, they buy those shares that drop to a good price. If anyone is worried about going into negative equity, it is the banks.

Wishing for interest rates to go down is also wishing for it to be the case that the jobs to pay for the houses wouldn't exist, because it means the vast majority of people with jobs who don't already have houses won't be able to get them. Unless you think that's a good thing, seeing as (I'm assuming) you personally will be better off?

Nothing good will will come out of a negative OCR. The rbnz is floundering. Im not sure of a solution, but it will get uglier before it gets better

I think Kiwisaver investors could be hit really hard in the next few years. Especially if they are in conservative and cash funds, that mainly invest in cash accounts. Potentially the kiwisaver fees could be more than any earnings from the account. Investing in higher risk funds also could be rocky, based on the world situation over the next few years. It isn't looking pretty.

Interest rates are now so low for savers that there is no point worrying about it, just spend and enjoy your money . Really not worried until the banks try and take rates negative for savers, which is unlikely to happen because everyone will start pulling their money out of the banks.