RBNZ flip flop?

Bonds

Roger J Kerr says high and rising inflation favour borrowers over savers and that is not what the economy needs

1st Feb 16, 8:31am by Roger J Kerr

That the Reserve Bank of New Zealand should rely entirely on macro-prudential debt lending regulations on the banks and other Government initiatives to control/rectify the runaway Auckland residential property market and not use monetary policy tools (i.e. raising interest rates) could prove to be the correct approach, or end in tears!

We will know the answer as to whether it was the correct policy formulation or not in about 12 months’ time.

If the housing boom caries on and consumer demand ramps higher, we could potentially experience demand-driven inflation and supply side inflation at the same time if commodity/oil prices reverse globally. Just painting one potential risk scenario! The Auckland housing market can still be more of a risk to the economy than just a financial stability issue for the banks and the RBNZ.

With global inflation non-existent and the tumble in oil prices the RBNZ find themselves in yet another dilemma with our annual inflation well below their 1.00% target minimum. Hence the renewed pressure on the RBNZ to cut interest again to below 2.50%.

The OCR review statement last week from the RBNZ to return to an “easing bias” with monetary policy runs the risk of flip-flopping too often on their future guidance based solely on historical economic data. Under their inflation control mandate the RBNZ are supposed to “look through” one-off price changes that are outside their control (i.e. the collapse in global oil and commodity prices).

The RBNZ did highlight last week that their own measure of annual core inflation the “sectoral factor model”, which strips out volatile food and energy prices, was tracking at +1.6% pa and thus inside the 1% to 3% target band.

The problem is the target band is on the official CPI inflation measure from Statistics NZ which is at +0.1%, not their own core measure. Years ago there were several strong cases made for the RBNZ’s inflation target band to be cross-referenced to the average inflation rate of our trading partners, not a rigid numerical 1% to 3%. The 1% to 3% band does not cater too well with the current global record low inflationary environment and the RBNZ come under pressure to cut interest rates, when such action could prove to be damaging to the overall economy through a boom/bust housing cycle.

On an international trade competitiveness basis the linkage to trading partner’s inflation rates may have some merit. However, it does not necessarily protect the purchasing power of domestic savers if NZ inflation increases significantly but is still in line with trading partners.

High and rising inflation favour borrowers over savers and that is not what the economy needs.

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Source: NZFMA

Roger J Kerr is a partner at PwC. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com

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10 Comments

by waymad | 1st Feb 16, 11:10am 1454278211

A new variation of a very old virus has hit Auckland. It is being dubbed the NZika. It manifests by a curious shrinking, or indeed complete atrophy, of the financial brain, but seems confined only to property owners, real estate agents, and the assorted other parasites which inhabit the property ecosystem.

It results in frenzied bidding at property auctions, seemingly without regard to income, yield or cash-flow considerations - in effect, an instant lowering of financial inhibitions. The virus has rapidly accelerated through the property-owning class in Auckland, but as the transmission mechanisms (still apparently unknown) mature, it seems to be gaining a foothold in adjacent areas, thus giving rise to speculation that it is in fact spread by intimate financial transactions.

The Reserve Bank of New Zealand has made several attempts at controlling the spread of NZika.

It has tried an inoculation campaign, by temporarily raising interest rates so as to inject some financial reality into the afflicted subjects. However, before the results could be ascertained, it was forced to drop rates yet again on the advice of the Combined US-China Plunge Protection Team, leaving the results indeterminate.
It has tried a Financial Prophylactic Device, being an IRD-registered and surgically inserted Cap on certain parts of the Financial property Anatomy. Early results were promising, but as with many medical and social experiments, the potential for unintended consequences is large and there are too many uncontrolled variables (not to say, Financial body parts) to be able to say with certainty that NZika has been contained, let alone diminished.
It has been confounded by the fact that NZika seems also to have an intimate link with the land-use, zoning, consenting and other policies of local authorities. These institutions are staffed by people with zero financial brain capacity as a condition of employment, and thus are completely immune to the financial effects of whatever policy fad they embrace, and indeed, to NZika itself.
Having regard to the foregoing, financial medical researchers suggest that local authorities and NZika form a symbiosis - a mutually beneficial relationship between two otherwise completely unrelated species.

Under these circumstances, the Reserve Bank is, apparently, considering compulsory genetic modification to local authority staffers, to confer a heightened (rather than an absent) quotient of financial intelligence.

However, and at this writing fatally, the Die Grünen Collective have barred the necessary preliminary research. They aver that local authority planning staff, like the fabled Stockton Snails, are a rare and endangered species, and that the Precautionary Principle should Prevail. Preservation of said planners, no matter, it seems, how disastrous for the millions outside the Property Ecosystem, trumps any possibility of combating NZika.

Truly, some Ecosystems are more Equal than Others....

by Roger Witherspoon | 1st Feb 16, 1:18pm 1454285890

Another curious effect is the desire for downward social mobilty to achieve the status of Indebted Serf to Aussie MegaBank Corp. This is seen by the sufferers as a higher social status than Freeman.

There is no academic consensus on why this delusion occurs, but there is a speculative theory put forward that it may be due to the genetic condition colloquially known as "Cultural Cringe". According to Professor Veryclever of the Notvery Scientific Institute, this causes a desire to imitate all things Australian and be outwardly as Australian as possible. Brought out to New Zealand with the early settlers, it's origins are unkown but it does bear similarities with similar conditions that affect the primitive regions of the brain that deal with emotions associated with fashion and comformity to group norms.

by MortgageBelt | 1st Feb 16, 12:37pm 1454283425

Borrowers are doing quite well from the current deflation and declining interest rates.
Home-owners Paying 4.3% on their mortgage is surely more favourable than paying 7% as the penalty for the Govt causing the Rising Auckland housing market due to immigration and open foreign purchasing.
With the OCR heading for 2% and mortgage interest rates heading to 3.9% then borrowers will benefit further.

by Roger Witherspoon | 1st Feb 16, 1:30pm 1454286651

Arguably the banks are doing better. Lower interest rates means a given income stream can support a larger loan. As the value of bank loans to NZ goes up the interest payments take a larger share of the societal surplus. Wealth flows to those who would relend it, rather than to those who would spend it or those who would build productive capacity with it.

Total bank claims on New Zealand now total $404,356,000,000,000.
http://www.rbnz.govt.nz/statistics/tables/s7/

This is a road to nowhere.

by Takere | 1st Feb 16, 4:41pm 1454298087

But Roger. On the RBNZ Household Balance Sheet ...NZ'ders are Wealthy, $1trillion dollars and change! http://www.rbnz.govt.nz/statistics/tables/c22/

by Roger Witherspoon | 1st Feb 16, 6:52pm 1454305926

It is a flimsy argument. When times are good we can easily afford to service our loans, so we increase them. When times are bad we cannot. Then an argument ensues as to who will take the loss. Will it be the mortgaged home "owners" through bankruptcy and repossession? Will it be the bank shareholders, bondholders and depositors? Will it be all taxpayers and residents of the entire country, as happened to Greece, Ireland, Latvia, Portugal and Spain, with foreign creditors taking their pound of flesh; demanding cuts in pensions and funding for hospitals plus the sale of government assets at fire sale prices to their mates? There are no happy endings to overindebtedness, "mortgage" is literally the "hand of death". The debt remains long after the good times are forgotten.

by Uninterested | 1st Feb 16, 7:27pm 1454308033

Before that point is reached, those who have been on table mortgages could be converted to interest only. Or pushed out on a longer term.
Of course those already on interest only/ long term are fook'd.

by Roger Witherspoon | 1st Feb 16, 7:42pm 1454308956

It's not really about the effect on the individuals, it's the unseen effect on society as a whole that is a worry. For example, the reason we have student loans is because NZ essentially went bankrupt in the late eighties due to overindebtedness.

by linklater01 | 2nd Feb 16, 9:02am 1454356963

Roger wonders whether the RBNZ should be Raising interest rates to help cool the Auckland house market. As he well knows,while overall financial stability is part of their remit,their primary remit is to maintain inflation within the 1%-3% band,over the medium term.
With current inflation well below the bottom end of that scale,what does he think would happen if rates were raised? Well,our currency might just appreciate sharply,which might not be a good thing and certainly not what the Reserve Bank wants.How would that affect the already hard-pressed dairy industry,both in terms of exports and debt repayment?
The last thing NZ needs right now is higher interest rates and their are other ways to cool the house market,such as loan to income restrictions,higher deposit requirements,stamp duties,etc.

by Roger Witherspoon | 2nd Feb 16, 9:25am 1454358330

The most effective way to cool the housing market is to let the bubble blow itself up and burst, by lowering interest rates . It's also the most disruptive.