Westpac economists believe the prospect of banks being required to hold more capital will see the Reserve Bank (RBNZ) raise interest rates at a slightly slower pace than previously expected.
They still see the RBNZ hiking the Official Cash Rate (OCR) from 1.75% to 2.00% in December next year.
However, they now only expect it to make two 25-point hikes in 2021, rather than three.
The RBNZ last month released a consultation paper, detailing its proposal to require banks to hold about 40% more capital. This represents about 70% of the banking sector's expected profits over a five-year transition period.
While this contributed to ANZ chief economist Sharon Zollner grabbing headlines with her forecast that the OCR would plummet to 1.00% next year, Westpac chief economist Dominick Stephens is towing a more moderate line.
He says higher capital requirements will see banks charge borrowers more, and pay depositors less.
Higher lending rates could negatively affect asset prices (IE house prices), restrict bank lending and dampen economic growth more generally, prompting the RBNZ to try to stimulate the economy by hiking interest rates more slowly than would otherwise be the case.
However, unlike Zollner’s bold forecast (which also takes other factors slowing both global and local growth into account) Stephens’ updated forecast is only 25 points different from his old one.
He says: “Minimum capital ratios are proposed to rise slowly over a period of five years, starting this year and finishing in 2023. This makes it difficult to pin down when the OCR will be impacted, but as a placeholder we have shifted from forecasting three OCR hikes in 2021 to two.”
Stephens goes on to say: “Higher bank capital ratios will not affect the long-run neutral OCR, so our forecast that the OCR will reach 3.5% in the very long run has not changed.”
While Zollner says the proposed funding requirements imply a lower long-run neutral OCR, Stephens says they’re a “genuine change to the economy’s fundamentals that cannot simply be “wished away” by a lower neutral OCR.”
“Requiring banks to hold more capital amounts to a real increase in the cost of banking services that must be paid somewhere in the system,” he says.
“The “lower neutral OCR” idea implies that the entire cost will be borne by savers in the form of lower interest rates on deposits. That seems unrealistic.
“Our view is that the costs will be borne widely – by banks themselves, by borrowers in the form of higher borrowing rates, by savers in the form of lower interest rates, and by the economy in the form of lower GDP.
“The Reserve Bank appears to agree, since they estimate that higher bank capital requirements will lead to slightly lower GDP during normal times.
“The idea that higher bank capital requirements can be “offset” with a lower neutral OCR violates the principle that monetary policy is neutral in the long run.”
Stephens also says that while Fitch dubbed the RBNZ’s capital proposals “highly conservative relative to international peers,” banks were always going to be required to hold more capital in line with global trends, so the RBNZ’s consultation paper shouldn’t come as a complete surprise to markets.
What’s more, he notes there’s still a lot of water to go under the bridge before a firm stance can be made on how capital requirements will affect the OCR.
The RBNZ is only expected to confirm the final form of these requirements in June and there are a number of other factors that could have a greater effect on the OCR outlook than capital requirements.
RBNZ Governor Adrian Orr in November said he expected the OCR to remain at 1.75% "through 2019 and into 2020,” nothing “both upside and downside risks to our growth and inflation projections”.