Roger J Kerr counters the arguments for lower interest rates and says the hurdle for a further OCR reduction is higher than most commentators are currently suggesting

Roger J Kerr counters the arguments for lower interest rates and says the hurdle for a further OCR reduction is higher than most commentators are currently suggesting

By Roger J Kerr

Central bankers around the globe are under the pump to get consumers spending again to stimulate economic growth.

Across many economies, zero or negative interest rates are not working as you would expect, to cause increased consumer demand.

A loss of confidence in political and economic leadership to improve the situation in places like Europe and Japan seems to be the reason why consumers are not spending.

We do not have that problem in New Zealand. We have record low interest rates (in our terms). And we have a strong economy (outside the dairy sector) delivering job security and rising residential property values. So, there is plenty of confidence to borrow and spend.

Despite the buoyant NZ economy, however, the pressure is mounting on the RBNZ to immediately cut interest rates further.

My view is that RBNZ Governor, Graeme Wheeler will be reluctant to cut interest rates at this time as it would fuel the over-heated housing market even more.

Those calling for immediate cuts cite four main reasons for the need to loosen monetary policy further:-

  • Annual inflation is just 0.1%, well below the 1% to 3% target band, thus the RBNZ must reflate the economy. That's the argument. Changing monetary policy settings today will have an impact on the economy in 12 to 18 months’ time, it cannot change historical inflation results. Inflation is so low due to lower oil and commodity prices over the last 12 months which are totally outside to influence of monetary policy in NZ. Governor Wheeler must wait for the March quarter’s CPI inflation numbers in mid-April to gauge how much of the NZ dollar currency depreciation will feed into higher prices of imported consumer goods.
  • As the Europeans and Japanese go into further negative interest rate territory the argument is that the differential to NZ interest rates widens and this pushes the NZ dollar higher (which is a tightening of monetary policy). Thus our rates must be cut to maintain the same differential. My counter argument would be that there is not a lot of evidence of new carry trades out of Yen and Euro and into the Kiwi dollar at this time. There is also very little connection or relationship between what is happening in the European and Japanese economies and what international forces impact on our economy. We are much more aligned with Australia, China and the US.
  • Global financial/investment market volatility in early 2016 is causing a lot of uncertainty in the world and we need lower interest rates to buffer those forces. We had the view in January that the sharemarket sell-off would not be long-lasting (i.e. reasonably short-lived as it was in August 2015) and not lead to anything like GFC2. Over recent weeks the markets have settled down as expected. Governor Wheeler should not overstate global market volatility in January as a risk to the NZ economy.
  • Some of the banks are arguing that as their own funding margins (credit spreads) have increased sharply over recent months for their own wholesale market funding sources, that the RBNZ should lower the underlying market interest rate to compensate and thus keep all-up interest cost the same for household and business borrowers. It looks to me that most of the corporate borrowers in NZ took the opportunity of low credit spreads last year to refinance and extend their debt facilities (we were strongly advising to do this). In contrast, it appears that some banks were not as prudent on their funding risk management and are now being forced to pay up to raise term money. Why should Mum and Pop retail investors suffer lower market interest rates to subsidise poor funding risk management by the banks?

Governor Wheeler will need to deliver a dovish statement on Thursday to get the Kiwi dollar back down.

However, the hurdle to actually do another OCR rate cut is a little higher than many commentators are currently suggesting.


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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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34 Comments

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Unless inflation goes negative I don't see anything happening other that the statement you've suggested. No point inflating a housing bubble to try to compete with the EU and Japan while they are flushing their economies down the toilet.

I'm relieved to find inflation is 0.1%, Here I was worrying we might be in/heading for a recession.

I feel more comfortable and relaxed now that I know prices have only increased under 1%.
I had foolishly thought my electricity, rates, insurance, rent and the price I am going to pay for my next house had actually gone up by more than 1%.
I will not have to ask the boss for a pay rise now!!

Not sure he should be citing residential property to substantiate his position that we have a strong economy. Commentary on this site has clearly and regularly talked about property being out of step with the economy.

Rising residential property values are just a side-effect of low interest rates combined with poor supply of housing. It's not worth including except for any new construction. Both commercial and residential new construction work is quite strong at the moment.

The economic effect of the new construction work will start showing up in the next 3-6 months.

yes, and they don't generally reflect the price of new builds.

...it appears that some banks were not as prudent on their funding risk management and are now being forced to pay up to raise term money. Why should Mum and Pop retail investors suffer lower market interest rates to subsidise poor funding risk.

Exactly, one year USD Libor has risen ~51 bps from 68.71 basis points on 3/3/2015 to 120.045 basis points on 3/3/2016. Financial stability risks are not reflected in the returns offered to domestic bank depositors. This is one cohort in dire need of a professional guild to publicly barrack on their behalf beyond the fickle choices offered by professional financial advisors.

Hey, on this article basis, Why not deliver a 50 point hike?!
After all, that would generate some inflation, shock the housing market, confuse the financial markets.

Without doubt, a much overdue, but nonetheless equitable outcome.

I thought the financial markets were already confused.

Increasing the OCR will bring even more foreign Money into NZ looking for a decent return. This money then has to be lent out by the banks (that's how they make money) so it will increase borrowing substantially, which of course will fuel real estate prices further

It doesn't quite work that way. The banks lend first thereby creating an asset for themselves which needs to be balanced by a liability in the form of a deposit or their own borrowing to balance the credit they have issued. Sounds arse about but that is what happens.
We need to continue to borrow from, or sell assets to foreigners to balance our current account deficit to the tune of (currently) about $10,000,000,000 per year. We've been doing this for 45 years but (in the words of Michael Cullen) it doesn't matter - till it does. That is, when we're in debt to the eyeballs and/or have nothing left to sell.
The money coming in is a result of years of consuming more than we produce not the cause of future borrowing.

That is what I used to think. Now, I'm not so sure. Do we in fact export NZD by running a trade deficit that then has to flow back to NZ in the form of cheap debt or land purchases? This modern money is really slippery stuff.

Cheers Roger, good question. The way I think it works is that we need to borrow/sell assets to balance the outflows of interest payments, trade deficits and profits to our foreign creditors/overlords. That's right, borrowing to pay the interest bill. I suspect that Bill and John are not entirely unhappy with the inflows into housing and to hell with Kiwi FHBs.
We are just damn lucky that interest rates are low or we would quickly be back up to the 8 and 9% of GDP current account deficits of a few years ago.
The theory was that your trade deficits would result in a lower dollar = more competitive exports = balanced trade and (eventually) CA close to balanced. It would appear that this was wrong in practice and the correction won't occur until there is a complete lack of faith in the economy and currency as per Argentina etc. Good luck finding a cheap mortgage in that scenario.

Yes, that is how we are told money works and I think sometimes it does so. This guy offers an alternative view http://moslereconomics.com/ see 7 Frauds of Economic Policy. Crucially he is a trader and therefore has tested his ideas in real life.

http://www.amazon.com/Warren-Mosler-Innocent-Economic-Hardcover/dp/B00JZ...

One point he makes is that if you issue your own currency you need never default on your own government debt as you can always issue more. You don't even have to sterilise it by selling bonds, that is optional (it is inflationary not to issue bonds but that is not necessarily a problem). Interestingly Russia did in fact choose to default on their own ruble bonds in 1998, maybe they misunderstood how modern money works. Most people have no idea, he recounts an incident where he built up a large postion in Italian debt and then explained how their money worked to the Italian Finance Ministry in pre Euro days. Well worth a read if you have time.

We have control of our interest rates and thus some measure of control of their impact on the domestic economy. We have no real control over the currency value or the flow of capital into or out of the country (which may be another way of saying the same thing).

KiwiDave, you say: "The money coming in is a result of years of consuming"
This is absolutely wrong, the money coming in, is due to vasts sums of cash worldwide looking for a decent (read 3%) yield in a 1st world country with reasonably stable governance... i.e. NZ. That's why a high OCR (compared to most developed countries) fills the coffers of NZ banks, what do they do with that money ? well the banks have to lend it out, that's their business

What is saving us now is all this speculative money from money laundering coming in from China and inflating house prices. This is why the Government will sit on its backside and not control Chinese raping our housing stock.

In the crimes act you will find a crime, which is a crime against the good order of society, called Using a Document (Section 228 of the Crimes Act 1961). They key part of frauds is the pecuniary advantage.

I have been skimming through a bit of Mosler. I have not come across him before, but am not yet impressed. He is just another economist that doesn't understand the nature of interest, or human nature. He certainly doesn't understand the connection between money, or credit as he calls it, and fraud.

Mortgage belt 50 point rate hike will deliver inflation? . Possibly if all other Central Banks deliver 75. The Central Banks have now reached a point of dog eat dog , global domestic conditions( namely asset bubbles that have been created) and monetary policy are now so far out of whack that a coordinated central bank policy no longer stacks up .Each is concerned by their own local conditions that it has become beggar thy neighbour. Some central banks may decide to push the can , others might decide to take it on the chin sooner. For Graham Wheeler to come out and attempt to jawbone the currency lower in these conditions as suggested by Kerr is gooblygook but obviously Kerr continues to piss into the wind

I was being facetious and/or ironic - given Roger is always keen to keep the OCR high, or hike etc.
Another commenter some time ago recommended hiking then cutting in a randomised manner to upset the carry trade & drop the NZD!

I'm a property investor, I want the OCR to remain high so that foreign capital keeps flowing into NZ, which will keep Banks falling over each other to lend cheap money

You're something alright, just not a property investor.

The housing market should be part of the inflation figures (is it? anyone?).

Rents, construction cost ,service industries related to the real estate sector all show up in inflation data, rising house prices or the cost to purchase a home are not .

Discussed last year some time, new house costs yes, existing house price No.

Why are existing house prices not included ?

I guess the Rothschilds should know, since they've been playing the money game for about 250 years:

"We're In The Eye Of The Storm" Rothschild Fears "Daunting Litany" Of Problems Ahead

As central bank policy-makers' forecasts have become more pessimistic (i.e. more realistic), Lord Rothschild is unsurprised at the current malaise: "not surprisingly, market conditions have deteriorated further...So much so that the wind is certainly not behind us; indeed we may well be in the eye of a storm." On this basis, Rothschild highlights a "daunting litany of problems," warning those who are optimistically sanguine about the US economy that "2016 is likely to turn out to be more difficult than the second half of 2015."

http://www.zerohedge.com/news/2016-03-06/were-eye-storm-rothschild-fears...

The sector price inflation figures for the last quarter were
Food -2.1%
Alcohol -1%
Housing +0.5%
House contents -0.2%
Health +0.6%
Transport -1.2%
Communications -0.8%
Recreation and culture -0.1%
Education +0.1%
Misc +0.5%

Total for all Groups -0.5% Compared with the previous quarter
Total for all groups +0.1% year on year

The large weightings are in Housing, Food and Transport
Have either housing, food or transport gone up in the last quarter.
I would not be surprised if the next quarter is significantly negative AGAIN. And similarly for the year on year.
Granted that the housing bubble considerations are very significant and probably far more significant than half or quarter of a percent in the OCR at these levels. But his job description is focused very much at inflation, so he has quite a dilemma.

I'll be interested to see what the next figures say. If inflation has gone negative year to year then Wheeler has cocked up.

So Roger, are you saying that if the gov were to lower the OCR by say 1% (as he should IMO), that our exchange rate wouldn't drop? I don't believe that I'm afraid...

The governor is driving the economy slower than he could because he can see a spec of inflation way further down the road. I think he needs new bifocals.

Should go to SpeculatorSavers and halve the OCR you reckon?

Who expected falling interest rates to increase consumer spending? Or did you mean consumer borrowing?

In fact Hamish, the very opposite for many I know. Retirees, or worse I'm seeing, those in their 50's worried to hell about what moderately safe investments returns they may receive in retirement, admit that they've started to spend less and have stepped up their savings. Add to that problem, many over 65's who just don't feel they can afford to retire now, are occupying top jobs for longer that 45-55yr olds in their prime earning years aren't actually getting those roles as early as before - yet the RBNZ will cut further, achieve nothing in the way of increased inflation that would have happened anyway, and perpetuate the problem

OCR cut or not is not going to solve any economic problem, period.