RBNZ quandary set to deepen

Bonds

Figures out this week may increase the perils of the central bank's juggling act between facing virtually no inflation now and the future risks of the rising housing market

12th Jul 13, 1:39pm by David Hargreaves

<a href="http://www.shutterstock.com/">Image sourced from Shutterstock.com</a>

New inflation figures out this week are likely to offer a perplexing challenge for our central bank the Reserve Bank of New Zealand.

Statistics New Zealand is due to release the Consumer Price Index (CPI) figures for the June quarter on Tuesday morning.

The figures are almost certain to show that for the fourth consecutive quarter annual inflation will have been actually running below the RBNZ's medium-term targeted rate of 1% to 3%. Next week's figure could turn out to be the lowest since 1999.

So, not a problem then?

Not right now. But the central bank sees trouble ahead.

It has been formulating a set of "macro-prudential tools" aimed at addressing the build-up of system-wide risks in the financial sector. In recent times the RBNZ has been leaning increasingly toward the use of so-called "speed limits" on the amount of lending banks might be able to do on loans that are in excess of 80% of the value of the house being bought (high LVR loans).

RBNZ deputy governor Grant Spencer in a speech late last month gave the clearest indication yet that the central bank was looking at applying these speed limits, both with the ambition of ensuring financial stability and in an attempt to take heat out of the housing market.

The RBNZ has been in consultation with the banks over the past month about potential implementation of speed limits on high LVR lending and might only be days away from some sort of announcement on the issue. The central bank has to give only two weeks notice of implementation of such limits.

A big problem it faces, however, is opposition from the Government, which wants to see first-time buyers excluded from such a policy and also reportedly wants to see homes under NZ$500,000 excluded. The RBNZ has already said it is against any sorts of exclusions from the policy.

The background to all this is the rapidly heating house market, particularly in Auckland. The most recent Real Estate Institute figures showed annual Auckland house price inflation was running at close to 20%. So, the housing market is providing twin threats to the RBNZ - through the potential risks to financial stability if there is a sudden sharp fall in house prices, and through the risks that the surge in house values will encourage consumer spending and thus spark inflationary pressures.

In front of the RBNZ

So, against this backdrop, the RBNZ will have put in front of it next week inflation figures that are apparently benign in the extreme. But it will know that the future inflationary path looks anything but benign.

The RBNZ has forecast that the CPI for the June quarter will show a rise of 0.3%, which will produce annual inflation of 0.8%, down from 0.9% after the March quarter. And while the "market" as a whole concurs with the RBNZ forecasts, some economists think the inflation figures will be even lower.

ASB chief economist Nick Tuffley and senior economist Jane Turner are picking a CPI rise of just 0.1% for the quarter, which would give annual inflation of a miniscule 0.6%.

"Should inflation come in closer to our expectation, it would further increase the existing tensions within the policy outlook," they said.

"Continued downside inflation surprises may reduce the RBNZ’s confidence of a lift in future inflation pressures. This additional uncertainty could keep the [Official Cash Rate] on hold slightly longer, despite growing pressure to lift the OCR coming from the housing market and the fall in the [New Zealand dollar]. We continue to expect the first increase in the OCR to occur in March 2014."

The RBNZ makes its next call on official interest rate on July 25.

Westpac pick

Westpac senior economist Michael Gordon is picking a 0.2% CPI rise in the quarter, for an annual inflation rate of 0.7%.

"With the New Zealand dollar index hitting a new post-float high during the June quarter of this year, another quarter of soft consumer price inflation was all but assured," he said.

Gordon' said the largest upward influence on the CPI figure would be electricity price rises, while the biggest minus would be private transport - with petrol prices hitting their lowest levels since December 2011 during the quarter.

"That will prove temporary – petrol prices have already established a new record high this month."

Gordon said the RBNZ, which had previously described its 'dilemma' in terms of low inflation today versus expected higher inflation in future years, "probably won’t be rattled by next week’s release" as another quarter of sub-1% inflation would be uncomfortable, but not unexpected.

Higher inflation

"As for the prospect of higher future inflation, what happens to the New Zealand dollar is crucial. Even if it were to hold steady, it would be less of a disinflationary force from here on. And if it extended its recent decline, it could become a major cause of inflation in coming years."

Gordon said much of this was in the hands of the US Federal Reserve and the pace at which it draws back from its quantitative easing monetary policy measures.

"We think they will move more cautiously than the market is factoring in; if we’re right, the NZ dollar could claw back some of its recent losses.

"Either way though, we suspect that the NZD’s long-running uptrend has broken. A softer exchange rate, a strengthening economy, a hot housing market and massive pressure on the building industry would all point in the same direction for inflation.

"We think that by next year the RBNZ’s ‘dilemma’ could be looking distinctly one-sided."

No repeats

ASB's Tuffley and Turner said the RBNZ didn't want to repeat the experience of the 2004-2007 monetary policy tightening cycle, when inflation expectations rose on a sustained basis.

"However, the recent track record of economists’ inflation forecasts does highlight the danger of moving pre-emptively to head off the rise in inflation pressures that are widely expected," they said.

A weak result [in next week's CPI] would further emphasise the tricky situation the RBNZ is in: current inflation is very muted but housing is a growing concern from a financial stability point of view.

"Such an outcome would make use of macro-prudential tools more likely if recent housing and credit trends continue, even though their impact is questionable.

"The RBNZ faces a tricky balancing act between very muted current inflation on one hand, but expectations of rising inflation pressures and growing financial stability concerns over housing on the other."

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35 Comments

by steven | 12th Jul 13, 1:57pm 1373594261

but wewere NET low inflation (0.9%? in march) now its declining, so that should mean some sectors have deflation, are in recession and getting worse, as others like Power and councils are putting on 5%+ So putting up the OCR could send these sectors further into recession and they could bring the rest of us in as well.

regards

by Stephen Hulme | 12th Jul 13, 4:53pm 1373604831

Nah, raise rates and the solvent would reinvigorate the economy and raise growth expectations to such an extent that deflation would no longer be a factor.

by Happy123 | 15th Jul 13, 10:16am 1373840189

Huh? Are there two "steven"s posting on this site?? You've changed your tune...

by steven | 15th Jul 13, 10:32am 1373841151

not as far as I am aware....what tune have I changed?

regards

by bigblue | 12th Jul 13, 4:45pm 1373604358

House price rises are not included in CPI calculations - only rents and these are falling.

by splineman | 12th Jul 13, 4:59pm 1373605170

Big Blue...so renting is relatively a better deal no?

by iconoclast | 12th Jul 13, 5:19pm 1373606351

Rents can be coming down for any number of reasons:- residences being acquired and turned into rentals, the orignal owners are departing, or hanging on to the residence but renting it out - more likely the former - tennant city

from a Real Estate Agents July newsletter - Aucklanders are heading out or getting out

We are seeing a huge number of Aucklanders buying in the North at present. Not just baches, but people looking to sell in a strong market and buy in the North. 50% of last months deals in our Whangarei office have been to Aucklanders – the feedback is that the value for money and lifestyle on offer are second to none. Over 50% of the buyers for our Hibiscus Coast offices currently come from either the North Shore or greater Auckland also. There is no question there is a migration north and we are right in the middle of it. Who can blame them for wanting to move to the most beautiful and fast growing area in New Zealand though really?

by bigblue | 12th Jul 13, 5:28pm 1373606882

Renting in Auckland for the last 12 months would have seen the renter miss out on a 20% capital gain which equates to approximately $90.000. So in answer to your question better off owning.

by kiwimm | 12th Jul 13, 5:35pm 1373607342

So they should have bought for a year then sold it? How else do they get their hands on this mysterious gain? From a cash flow perspective renting is far cheaper for the equivalent house and no need to wait for a greater fool.

The better way to think about it is that renting got 20% cheaper.

by bigblue | 12th Jul 13, 5:38pm 1373607504

No - they should wait 3.6 years for prices to double and if cashflow is a problem just take on a couple more flatmates or put a cabin in the backyard - lease that off the cabin company for $50 per week and put a flatmate in there at $150 per week. Plenty of lateral thinkers out there.

by steven | 12th Jul 13, 6:52pm 1373611929

So a normal price income ratio is 3 to 1 in a normal market, right now in a bubble its 6 to 1.

What you are saying is hang on 3.5 years to get to 12 to 1. Can you maybe show a city in the world at 12 to 1 and stayed there? Sydney was 9 to 1 and regarded as seriously over-heated and a danger to lend into....

At 12 :1 where next? double again? in 3.5years 24 to 1?

Personally I wonder if there is another 20% in the market....ie 1 more year growth but anything is possible with human behaviour it seems.

regards

by steven | 15th Jul 13, 10:42am 1373841749

I think in-arguably ppl are buying into potential, the tulip mania was such a potential until it disappeared, then it was real losses.

PS Infratil is a great example of ppl buying into "potential" of Shell's NZ busines and then seeing it never happen.

regards

by Happy123 | 15th Jul 13, 12:00pm 1373846438

I'm starting to think that you just make this up as you go, Infratril is up 20% in the last 12 months...

by Vera Fayed | 15th Jul 13, 12:14pm 1373847269

steven - If you seriously consider a speculative boom in tulip bulbs that occurred briefly 4 centuries ago is a valid comparison to the New Zealand housing market rising slightly above the level of general inflation over the last 6 years you are even more foolish than I previously thought.

How about just for one day you give the commentors on this site a break from your inane dribblings. Just one day. Not too much to ask.

by Happy123 | 15th Jul 13, 11:58am 1373846319

Another tech company example from the NZX is SLI, up 20% in the last two days.

by Happy123 | 15th Jul 13, 10:25am 1373840706

Hi Steven, still using your antiquated price to income ratios... Other posters have already made some good points:

flatmates,

converted garages; &

couples sharing.

I want to add:

Buyers not starting from $0 (i.e. deposit from parents, equity in last home, earnings from OE);

the unitary plan offering cheaper types of houses; &

Auckland eventually including apartments in the house price statistics (like most other countries).

More than enough reason for you to finally accept that the measure is antiquated. But if you insist on using it you should factor apartment prices into the average price.

by steven | 15th Jul 13, 10:40am 1373841658

Thats right, interestingly even HughP sees above 3 to 1 as too high. It seems some see want the wish to see.

Just remember this time is different............

Just how many couples want to share btw? mostly a couple is very keen to get a place by themselves. They would only share as there is no other way. So Ok lets say they do, whats next? convert the garage to get another couple? frankly thats desperate IMHO....whats left after that BTW? its not really a single home then is it?

regards

by steven | 15th Jul 13, 10:44am 1373841869

PS we differ, you seem happy to buy into this market, I do not. If you are happy with your justifications why worry about what I and others say? better not to read maybe....

regards

by splineman | 12th Jul 13, 5:34pm 1373607294

Yes I agree in a cash market. Add interest payments, risk....not as simple and if you have an eyewatering mortgage and no disposable income.

by bigblue | 12th Jul 13, 5:32pm 1373607179

Suspect that this is why rents have fallen - lets say a 3 bedroom house in Auckland was rented for $600 per week. In the past maybe three people living in it or $200 per week each whereas now three couples are living there or $100 per week each. Therefore less rental homes needed as more people living in each house so rents then come down for the remaining stock. A net migration gain will soon fix the problem though.

by steven | 12th Jul 13, 6:43pm 1373611430

It would be interesting to see if there is any indication that renters are moving more frequently and where to? ie if there is more of a turnover and to lower cost rentals then that would explain the -1% ppl simply cant afford increases. I think there is an vacancy rate? 6%? is it increasing? I'd certainly like to know why we have -1% when houses prices are supposedly rising 20%. If there was a migration effect I'd expect both to rise and vacancy rates to drop, yet not....a conundrum.

regards

by Alex13 | 12th Jul 13, 5:36pm 1373607386

I often wonder: why are house prices not part of inflation rate calculation?

by steven | 12th Jul 13, 6:00pm 1373608852

A house is an investment and not a cost hence its not in the inflation calc. What else would you include? gold? shares? look at the massive specualtion thats now exiting fast from gold.

So if we'd included gold in the last two years from the effects of the gold bugs we'd think we had inflation and we'd maybe raise rates while actual manufacturing ie health of the economy was doing poor;y and we'd then make it worse. In the last few months we'd see a 30% loss in gold....so drop the OCR?

Rent is included I think as an equvalent and maintenance costs?

How would you derive a number to add in?

What are you seeking to measure? and get from the calculation? if its health of the economy then you dont want specualtive inputs masking the real economy.

There is of course nothing stopping you running your own index to suit yourself.

Besides which, how would you know if housing say was a good investment if its in the CPI? If the CPI is the baseline at say 3% and houses are rising at 5% then its an easy judgement housing is rising faster, buy houses IMHO.

regards

by billsay | 12th Jul 13, 8:55pm 1373619329

and hence the so called 'cost of living' is misleading when many actual costs of living are not properly included because they are an 'investment'. e.g. a house, or a 'tax' e.g. rates or EQC levy, etc.

The actual cost of living inflation is higher than what gets quoted since rates, insurance, EQC levies, etc are not included nor are decreases in various services as Councils move to charge for services previously included in rates.

My personal living cost inflation certainly exceeds 0.9%.

by steven | 15th Jul 13, 11:00am 1373842818

Ok, so lets say you earn $100 or rather say there are 100000 ppl all earning the same. When power goes up say 5% they are all still earning $100, or maybe if they are lucky they now earn $102. That means they spend $3 less somewhere else, the effect overall on the economy is very little NET.

So what we see are some sectors, say energy taking income from others....say food...the point is the overall effect on the economy is 0.9% inflation not 5 or 6% seen in some sectors so others are deflating to cope.

Now in terms of personal, yeah sure 1 person might see a bigger impact, say a OAP as they spend more on essentials like food and power than say myself. The point is the inflation number is an overall impact hence why I said 100000 ppl and not 1.

The EQ levy increase to meet chch's bills is a one off increase possibly over several years, like the GST increase its not a permanent increasing affect. Lets say its 20% in one year, next year however there isnt another 20%...certainly that is how my ECQ levey cost went.

"Councils move to charge for services previously included in rates." the calculation isnt exact...somethigns may well get missed. Also when you take 100000 ppl as a sample some, maybe most never used the service in the first place so see no change and in effect their rates bill doesnt increase as much, they actually save.

regards

by Wolly | 14th Jul 13, 6:17am 1373739449

How long before this media report is about NZ!

"With a fragile coalition that is barely hanging on by a thread, a new battle over tax hikes and a stick it to the rich mentality is about to set in.

Italy's Finance Undersecretary Says Budget Crunch May Require More From Rich.

http://globaleconomicanalysis.blogspot.com/2013/07/problems-in-italy-go-on-and-on-and-on.html#sMrwxTzduggxcXXJ.99

by Stephen Hulme | 14th Jul 13, 9:52am 1373752327

stick it to the rich mentality is about to set in.

A myth in the making that avoids the hard decisions while appearing to appeal to the needs of the poor. Read more

PMorgan suffered a $3.1 billion decline in accumulated other comprehensive income, a measure of shareholder equity, in the second quarter while Wells Fargo reported a $3.35 billion hit, according to results released yesterday. The equity figure includes unrealized security gains, which fell to $5.1 billion at Wells Fargo from $11.2 billion at the end of March.

And the "rich" avoided this inconvenience? - I think not.

Somehow the Fed has succeeded in making unstable global markets even more so. Read more

by steven | 15th Jul 13, 11:05am 1373843126

Yep....its coming I think, when the top 1% have more assets and cash than the bottom 50%, things will change.

regards

by Stephen Hulme | 14th Jul 13, 9:52am 1373752368

by splineman | 14th Jul 13, 10:20am 1373754000

"Somehow the Fed has succeeded in making unstable global markets even more so. Read more"

Good read.

Of course Bernanke has been burned once and won't let it happen again on his watch. Hence the 180 degree U turn within a month of threatening to tighten monetary policy. $85 billion a month on for the forseeable future.....and we think we can make informed decisions on huge financial commitments like million dollar homes.

Interest rates are at the mercy of the Eccles building and policy is set politically. New Zealand is collateral damage....

I don't believe there is any rational way to predict interest rates, they are political in nature.

by Plan B | 14th Jul 13, 8:07pm 1373789278

Inflation. Somehow the RB has managed to convince itself that there is CPI and House price inflation are unconnected. Inflation is not a measure of the price of stuff. The price of stuff is a measure of inflation.

If inflation was a measure of the price of stuff then measurement of it could be administered by the retail merchants association .

Inflation is about money. NZD, it is about how much there is out there chasing goods and services.

It is our way of determining if the value of our dollars is being maintained or not. That is why measurement of it is supposed to administered by the RB.

The RB has unfortunately gotten into the habbit of saying it is doing a good job when people in China start making flat screen TVs etc for very little wages. in meg factories.

Meanwhile it stands back while Aus banks debase our currency through massive amounts of debt via the housing market. The idea is that the money is sequestered in housing and the massive inflation does not leak out so much as to matter.

What a mess of a result. The NZD is worth less and less. We have ened up with wage rates in the middle and lower plummeting. House prices doing something or other . The only way to really see how the value/purchasing power of the NZD has plummeted is to see it through the lense of NZs richest. Take a look at CEO pay packets and that will give you a better answer as to what has happened to the NZD. - It is not worth much.

by Happy123 | 15th Jul 13, 10:14am 1373840083

How do we stimulate the economy and calm the housing market... start building houses. Either government funded or take away the hurdles for developers. Increase supply and create economic activity, so simple.

by steven | 15th Jul 13, 11:09am 1373843360

bugger the idea of starting more exporting businesses eh? lets just plant more tulips and sell them to each other, yes that will work.

regards

by Happy123 | 15th Jul 13, 11:54am 1373846094

You need to pay more attention, Steven. I run a export business, one a started myself, I sell a NZ manufactured dry food product to China and elsewhere. You were asked in another post what you do and I note there's no response...

Increase supply will reduce the cost of houses and hence improve affordability, fact. The extra building work will create jobs and stimulate the economy, fact. Who said anything about speculation?

by iconoclast | 15th Jul 13, 1:24pm 1373851482

Happy123: happiness is: Increase supply .. build more houses .. so simple

If it was simple it would be happening .. increasing supply is such an ill-considered, sweep it all away statement that defies logic ..

Where? How? Who?

If you have followed Kumbel's explanations you would understand the fallacy of that. If you followed David Chaston's article last week on "strangled supply" you would wonder where you would locate and achieve all this magic supply .. Chaston's tome conjured up images of 70 story apartment buildings (Hong Kong style) occupying the entire length of the eastern side of Jervois Road, Herne Bay .. overlooking St Marys Bay .. and then Kumbel comes along and says, whoa, hold on a bit .. it's going to take us at least 10 years to expand and "gold plate" the water supply and sewerage sytems that we "gold plated" just last decade .. and by the way we are going to increase your property rates from $4,000 pa to $10,000 pa for every property owner in Ponsonby and Herne Bay and Freemans Bay. Not just the additional, incremental supply. Brilliant. Genius.

Alternatively, if you believe in the user pays principle, the incremental costs should be borne by the occupiers of the incremental supply, then each new resident of each new apartment along Jervois Road will be paying $70,000 pa in rates. Is that your intention, or would you prefer to spread the burden over the existing residents?

Which introduces the principle of dis-economies of scale which are reached at a point beyond which the cost of each increment is greater than the standard unit cost - it becomes prohibitive - defined as the increase in long-term average cost as the scale of operations increases beyond a certain level. This anomaly can be caused by factors such as (1) over-crowding where the additional increments get in each other's way, (2) greater wastage due to lack of coordination, or (3) a mismatch between the optimum outputs of different operations. See also economies of scale.

And your solution is .. ?