The Reserve Bank (RBNZ) is increasing its quantitative easing programme by committing to buying local government bonds on the secondary market to support liquidity and keep interest rates low.
Its Monetary Policy Committee (MPC) on Sunday decided to extend its Large Scale Asset Purchase programme, unveiled on March 23.
So, in addition to committing to buying up to $30 billion of New Zealand Government Bonds over the next 12 months, the RBNZ will buy up to $3 billion of Local Government Funding Agency (LGFA) bonds.
This represents about 30% of all the LGFA bonds on offer.
The RBNZ had previously signalled it would extend its programme to cover LGFA bonds, so the news isn't unexpected.
There was a delay between the MPC making this decision on Sunday, and the announcement being made on Tuesday because Finance Minister Grant Robertson had to agree to extend and increase the indemnity provided to the RBNZ to cover any losses it may incur.
The RBNZ on Monday made a “small scale offer” to buy LGFA bonds “until further notice”. This appears to have been a stop-gap measure, pending the MPC getting the necessary sign-offs to commit to buying a substantial amount of LGFA bonds under its Large Scale Asset Purchase programme.
ANZ strategist David Croy noted there was a decent uptake by investors, who sold the RBNZ $75 million of LGFA bonds on Monday under the "small scale offer" (which is distinct from the Large Scale Asset Purchase programme).
Investors selling the RBNZ bonds gives them cash to invest elsewhere, including in buying new New Zealand Government and LGFA bonds issued to pay for the COVID-19 crisis. Treasury's New Zealand Government Bond issuance is expected to hit a record $25 billion in the year to June.
The MPC said that the RBNZ's commitment to buying New Zealand Government Bonds has so far achieved its goal of reducing longer-term interest rates.
Yet it said: “The negative economic effects of the COVID-19 outbreak continue to evolve.
“The Committee agreed it was important that monetary policy operated as effectively as possible.
“The LGFA bonds also play an important role in determining interest rates faced by firms and households. As such, the Committee agreed that the purchase of LGFA bonds by the Bank will provide stability and retain confidence in New Zealand’s capital market.”
Going into further detail, RBNZ Governor Adrian Orr, in his letter to Robertson requesting an extension of indemnity, said: "Over recent weeks... the Bank has observed signs of significant dislocation in other New Zealand debt markets, caused by a combination of the near-closure of global credit markets, domestic intermediaries reducing risk due to increased market volatility, and fund managers liquidating their holdings in order to meet redemptions.
"There is particular concern about the dislocation and lack of liquidity in the market for New Zealand LGFA debt.
"LGFA debt provides a critical benchmark for non-government credit instruments in New Zealand, and in normal times is the most liquid part of this market.
"A persistent lack of liquidity would have a deep and lasting detrimental impact on the confidence in New Zealand’s debt capital markets, which will increase interest rates in New Zealand more broadly and inhibit the transmission of monetary policy.
"This presents a threat to the achievement of the MPC’s economic objectives."
The MPC is due to update its economic assessment and the size and scope of its Large Scale Asset Purchase programme at its next scheduled meeting on May 13.
Here’s the record of its meeting in full:
3-5 April 2020
On Friday 3 April MPC members were informed via email that while the Large Scale Asset Purchase programme (the ‘Programme’) had been successful to date in lowering government bond yields and improving the functioning of this market, there were growing signs of a lack of liquidity in the broader corporate bond market.
The Bank had observed signs of increasing illiquidity and dislocation in the Local Government Funding Agency (LGFA) market in particular in recent weeks. This could be largely attributed to a combination of the near-closure of global credit markets, domestic intermediaries reducing their participation due to recent volatility, and fund managers liquidating their holdings in order to meet redemptions.
The Committee was advised that the LGFA was a critical benchmark for non-government credit instruments in New Zealand, and was normally the most liquid part of this market. Reserve Bank staff advised the Committee that a lack of normal market functioning was posing a significant risk to the transmission of monetary policy in New Zealand, which would compromise the ability of the MPC to meet its economic objectives.
All members were made aware that steps were being taken to enable a decision whether to add LGFA debt purchases to the Programme. These steps included early engagement with the New Zealand Treasury on an extension of the indemnity provided by the Crown on 21 March 2020, and operational preparations.
On Saturday 4 April, the Chair of the Committee called for a decision to be made via conference call the following day. Committee members received papers on Saturday evening containing advice from staff on the expansion of the Programme to include LGFA.
The Committee’s discussion focussed on understanding the nature of the issue, the risk to market functioning, and on the implications for the availability of funding and interest rates faced by households and firms. The Committee noted staff advice that secondary market purchases of LGFA bonds of NZ$3 billion, representing about 30 percent of the LGFA debt market, would support the smooth functioning of this market and improve market liquidity.
The Committee noted that a full economic assessment was currently being prepared by staff and would underpin any decision at the scheduled meeting in May to review the total size and asset classes within the LSAP programme.
The Committee assessed the purchase of LGFA debt against its principles for alternative monetary policy:
- In the current context these purchases were likely to be effective in enabling the Committee to meet its economic objectives of medium-term price stability and supporting maximum sustainable employment. Although LGFA bond yields are not a direct benchmark for retail interest rates, they form an important component of the monetary policy transmission mechanism. A persistent lack of liquidity in this market would have a deep and lasting negative impact on the confidence in New Zealand’s debt capital markets. This would be likely to raise interest rates in New Zealand more broadly and thereby inhibit the transmission of monetary policy.
- The Committee noted that purchases of LGFA debt would also support financial market efficiency and stability, by increasing confidence in this part of the debt market. These purchases would provide liquidity, aid price discovery, and enable banks to shift their existing inventory of assets to alleviate credit limits and thereby support the efficient functioning of primary and secondary financial markets.
The Committee reached a consensus decision to:
- Purchase up to NZ$3 billion of LGFA debt on the secondary market within the next 12 months.
- Revisit the overall size and eligible assets of the Programme at the scheduled decision on 13 May 2020.
- Continue to delegate to staff the implementation decisions of the Programme.
- Communicate the Programme in terms of the total volume to be purchased.
Reserve Bank staff: Adrian Orr, Geoff Bascand, Christian Hawkesby, Yuong Ha
External: Bob Buckle, Peter Harris, Caroline Saunders
Observer: Caralee McLiesh
Secretary: Rebecca Williams