The hurdle for further interest rate cuts just got higher says BNZ's head of research Stephen Toplis

The hurdle for further interest rate cuts just got higher says BNZ's head of research Stephen Toplis

The hurdle for more interest rate cuts just got higher and the Reserve Bank has admitted that it is getting "really nervous" about cutting interest rates much further, BNZ head of research Stephen Toplis says.

He says the crux of the argument put forward by RBNZ Governor Graeme Wheeler in a speech is that further rate cuts must be constrained by the fact that (a) there is little evidence that reducing rates further will boost growth and, in turn, inflation and (b) further rate cuts risk pouring more fuel on an "already blazing housing market". Toplis says BNZ economists agree with the thrust of that argument.

"Importantly, the RBNZ also reaffirmed its September MPS news that it is becoming more relaxed about getting CPI inflation within the target band and less focused on hitting the 2.0% mid-point.

"The combination of the above factors is critically important because it means the hurdle for further interest rate cuts has just got higher. This is not to say the Reserve Bank is likely to pause with a cash rate of 2.75%. To the contrary, the Governor also confirmed that further easing is still likely but he does suggest there will be a pause at 2.5% unless economic activity indicators deteriorate significantly in the interim."

Toplis says BNZ economists had argued that blindly targeting 2.0% inflation in the current environment was unwise and that there was a real risk the RBNZ might fire all its bullets too early and then have nothing left if growth started to wane worryingly, later on down the track.

"We also warned that there was no point in lowering interest rates further if doing so further inflamed the housing market while having little impact elsewhere in the economy. Again, the RBNZ seems to share these concerns."

Toplis says BNZ economists do think growth will slow and that the unemployment rate will rise steadily.

"We don’t see the unemployment rate peaking until 2017. Moreover, we doubt anything the Bank does now would change this outlook. So, if the RBNZ cut after each published increase in the unemployment rate it would have almost nothing left to play with at the time when the public demand for further rate cuts would be at its peak."

Toplis says there are some who contest that New Zealand’s real interest rates are too high both in an absolute and relative sense.

"There is some merit in this argument – at least in a theoretical sense. But we would also point out that, because the current interest rates do not appear to be adversely impacting investment activity, revealed preferences would suggest real interest rates are not too high. Moreover, the real rate that a householder is facing is actually highly negative if you use house price inflation as the deflator. And if all this wasn’t reason to overlook the real interest argument, for the time being, the fact that the RBNZ restates that 'it is unable to influence long term interest rates' suggests there is little to be gained in asking it to do so."

Toplis sees "very little chance" of the RBNZ hitting the 2% midpoint of its 1-3% inflation target range unless the Kiwi dollar falls significantly further or global spare capacity is absorbed and commodity prices rise.

"Trying to raise inflation by cutting interest rates in this environment is like pushing on a piece of string – highly unproductive. Consequently, and rightfully in our opinion, Governor Wheeler is now saying lets treat this target more flexibly both in terms of the levels we are aiming for and the time it might take to get there. With regard to timing, it notes there is no need to 'immediately' correct CPI deviations from target.

Toplis predicts that after one more rate cut this year, the RBNZ "will pause to survey the landscape".

"The balance of risks will still favour further interest reduction thereafter but the perceived hurdles to doing so have just got higher. Currently, the market prices a 2.46% low in the cash rate by mid next year. This looks about right to us."

Westpac chief economist Dominick Stephens says the Westpac economists have been expecting the RBNZ to keep the OCR on hold in October, but to signal that "some further easing" is coming. "And we have been forecasting a December 2015 OCR cut. We see no reason to alter either of those forecasts."

He also says the economists have been arguing that a 2.5% OCR will not be low enough to ensure that inflation returns to 2% on average over the medium term, and that "disappointingly" low inflation will eventually force the RBNZ to cut the OCR to 2.0%.

"We remain steadfast in that assessment, and continue to expect that the OCR will eventually reach 2.0%. But today's speech reiterated that the RBNZ does not share our view. Consequently, our forecast for further OCR cuts in early-2016 is now under review pending Friday's inflation data, with an eye to shifting towards forecasting OCR cuts below 2.5% at a later time."

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Actions speak louder than words.

Fed talking up a rate rise (and blinking) is the same as the RBNZ (and banks) talking down a rate cut (and blinking).

Bring on 29 October.

I recall arguing at the time of Wheeler's appointment that the RBNZ Act should have been changed then. (Marginally more important than my opinion, Parker of Labour, Winston Peters, and Russell Norman all argued for change). Bill English was having none of it.
In my view there should be current account, unemployment, and inflation targets out of both monetary and fiscal policy. Wheeler appears to be trying to say the same thing, but is hamstrung by the Act and English's pigheadedness.
The likely ideal mix of policies over the next 1-2 years are interest rates no lower than now, and potentially even higher to help get house prices affordable; but a much looser fiscal position, either spent on infrastructure, general expenditure or tax cuts. This looser fiscal position should be funded by the RBNZ to an amount at Wheeler's (and not Treasury or English's) discretion, to keep unemployment lowish, the exchange rate competitive, and economic activity robust.
To help English get over his previous conservatism, he could plausibly suggest that ZIRP forever and deflation had somehow not occurred to him, and that circumstances have changed.
Am not holding my breath though. In the meantime Wheeler appears to be ignoring the Act, as he probably should.

Wheeler needs to go, he had one target (2% inflation) which he has blatantly ignored and therefore failed to achieve. He focused on Auckland property prices which was a political not monetary consideration. He must now accept responsibility for the state of the economy.

Your suggestion of quantitative easing combined with increasing the OCR is counter intuitive and would result in an offset and therefore have little impact on house prices.

Sounds like you'd like a run on the NZD...

National need to accept responsibility for the state of the economy, meanwhile some countries would love to have someone of Wheeler's competence:
http://www.macrobusiness.com.au/2015/10/can-we-poach-graeme-wheeler-for-...

To increase inflation (or to keep unemployment down, and incomes up in a global recession, they being more important to me, than hitting 2% inflation) we need to increase domestic consumption and or exports. Current world orthodoxy is to get interest rates down to zero to achieve these things. That method has been proven to blow asset bubbles, and to stimulate investment in more capacity, but not spending, hence global deflation. Increasing exports will be a challenge into global surplus capacity, especially with our half pregnant low for us but globally high interest rates leading to an always too high exchange rate. (See the jump in the NZD today, post Wheeler signalling fewer cuts).
The Japanese, Germans and Swiss have been very active currency war players, explaining their ultra low unemployment. Their policy mix is not materially different to what I would advocate.
So in world orthodoxy, we would get interest rates lower still, but Wheeler is rightly choking on house prices. If we don't, and Bill English continues his obsession with a fiscal balance, then recession here we come. Or we sell off the kitchen sink. National's only real economic policy. Rising unemployment would be a clear signal of government ineptitude, but on current settings, that is probably where we are heading.
I sense by the way that other countries including the US and UK are heading towards looser fiscal policies.

The RBNZ's mandate is price stability. If it needs to lower interest rates to achieve the 2% target it should do so.

The RBNZ should not be the scapegoat for the government which has failed to manage the inbound migration rate to something which NZ can sustainably handle and doesn't push the Auckland house prices through the roof.

The Governments role is to increase gdp per capitia not total gdp.

GIven the Government's inaction the 12 month rolling migration rate should be given to the RBNZ as a macroprudential tool. A manageable migration rate would allow real interest rates & the dollar to drop.

While we're at it, we need a land tax and comprehensive capital tax.

It's really simple - we have an asset bubble, there is risk in an overheated proprty sector, Auckland specific. Raise the risk weighing of assets (housing) in Auckland. This will force the banks to hold more capital. They will have to do a number of things, raise capital, increase interest rates specific to Auckland housing, pay better yields to investors to compensate for the risk.. This will not penalise the rest of the country, will stabilize the bubble. aucklanders should have a better income to absorb the rise, and a larger population base to pick up the pieces, ie mortgagee sales if they were to increase. Inflation is a red herring. It has been for 5-10 years. Businesses can't put up prices, whilst wages remain so low, relative to housing. The only cost increases over this period have been council charges. Wheeler needs to pull finger. He reminds me of a possum caught in headlights