Borrowers and savers can expect interest rates to fall further this year without an Official Cash Rate (OCR) cut.
The Reserve Bank (RBNZ) on Wednesday strongly signalled to banks that it was preparing to introduce a programme to enable them to cut interest rates, without worrying about deterring depositors, and thus losing some of their funding.
The RBNZ’s Monetary Policy Committee directed the central bank to get ready to deploy a Funding for Lending Programme (FLP) before the end of the calendar year.
Bank economists believe the FLP could be launched as early as November 11 when the Committee releases its next Monetary Policy Statement.
This would see the RBNZ provide banks with low-cost, secured, long-term loans.
Westpac chief economist Dominick Stephens explained: “Currently, banks source their funds from a mix of transactional deposits (at zero interest), term deposits (currently approximately 1.2%), and wholesale funds (currently about 1%).
“Under an FLP, the RBNZ would offer funding to banks at a low interest rate - perhaps close to the OCR, which is currently 0.25%, or close to current swap rates which are zero.
“If banks can bring in money more cheaply, they can subsequently lend it out more cheaply while maintaining the same bank margin.
“So by providing these cheap loans to banks, the RBNZ will engineer a decrease in mortgage rates.
“There will also be an indirect effect - banks will compete less vigorously for term deposits and wholesale funds, so the interest rates on these will also fall, further reducing banks’ funding costs.”
Cost of funding, not supply of funding the issue
ASB chief economist Nick Tuffley stressed the aim of the programme would be to lower bank funding costs, and thus interest rates, in a bid to boost inflation and employment in line with the RBNZ’s monetary policy mandate.
Unlike at the 2008 Global Financial Crisis, the RBNZ isn’t trying to increase banks’ access to funding. There is currently ample liquidity.
Both Tuffley and Stephens believed the RBNZ wouldn’t put too many conditions on the FLP, by saying banks have to use it to lend to businesses, for example.
This would see the FLP lose its effectiveness. If banks don’t make much use of the programme, their funding costs won’t fall enough for them to warrant lowering interest rates.
Bank economists happy
Tuffley said the RBNZ’s statement gives banks certainty and allows them to start planning for how they’ll use the greater flexibility around funding given to them.
ANZ chief economist Sharon Zollner agreed, saying introducing the FLP before an OCR cut means deposit rates can “safely” be cut, paving the way for lower lending rates.
Zollner said a negative OCR without a FLP could’ve been “highly detrimental” to credit supply.
The reason the RBNZ is looking to implement a FLP rather than simply cut the OCR is that in March it said it would keep the OCR at 0.25% for at least a year. It wanted to give banks time to ready their systems for a negative OCR.
In August it announced that its preference was for a negative OCR and FLP to be deployed at the same time.
But it appears that further to talking to banks about this, and also adopting a more downbeat view of the economy, the RBNZ is keen to decouple the two and provide more stimulus as soon as possible.
FLP reduces urgency of an OCR cut… technically
Kiwibank chief economist Jarrod Kerr said: “The FLP will have an immediate, and lasting impact on retail rates.
“The market took the separation of the FLP from a negative OCR as reducing the probability of negative rates. In theory, yes. An effective FLP reduces the need for a negative OCR. But, we still think a negative OCR will be deployed.”
However Kerr believed the RBNZ would go back on its word and cut the OCR at the scheduled release of its Monetary Policy Statement in February.
“If the Bank follows its forward guidance to the letter, then the earliest timing would be its pre-scheduled meeting in mid-April,” he explained.
“But the best bang for buck would be to cut in February 2021, just a few weeks before the Bank’s self-imposed guide. February is a full Monetary Policy Statement, enabling the RBNZ to ram home the bold move with a dovish statement, full of forecasts and special boxes, and press conference.
“Of all the criticism the RBNZ will get for going negative in February, we don’t think it would be the “breaking” of their 12-month guidance made in mid-March by a few weeks.”
Zollner, Tuffley and Stephens believed the RBNZ would wait until April.
Stephens said: “Assuming that the FLP interest rate is close to the OCR, then the OCR cut would reduce the interest rate at which the RBNZ lends to banks under the FLP.
“That would certainly increase the potency of the FLP, and arguably could increase the effectiveness of the OCR cut.”
QE still going full steam
The RBNZ is still continuing to use its quantitative easing (QE) or Large-Scale Asset Purchase (LSAP) programme to lower interest rates.
The thinking behind this is that if the RBNZ is a large enough player in the New Zealand Government Bond market, it will drive up the prices of these bonds, in turn lowering the interest rate on them.
Because the rates on these bonds have a strong bearing on the retail bank rates, the aim of this is likewise to encourage more borrowing, investing and spending.
The RBNZ remains committed to buying up to $100 billion of mostly New Zealand Government Bonds by June 2022.
It is continuing to front-load these purchases, to put a lot of pressure on lowering interest rates.
Zollner explained: “The pace of next week’s LSAP purchases of NZGBs is almost twice the rate of issuance, and the delta of next week’s QE is almost 2.5x that of issuance ($1.1 million vs $448,000).
"The fact that the tactical approach to purchases will continue to be aggressive gives scope for more purchases at the longer end of the curve. That in turn speaks to continued vigilance and pressure on the curve to flatten.”
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