By Gareth Vaughan
The Reserve Bank of New Zealand (RBNZ) could cut the Official Cash Rate (OCR) to somewhere below 25 basis points but above zero while it waits for banks to be ready for negative interest rates, suggests Wigram Capital Advisors principal Rodney Jones.
Jones also told interest.co.nz he'd like to see more debate about the RBNZ response to the COVID-19 crisis, including around its large scale asset purchase program, or quantitative easing (QE). Jones said he personally prefers the Reserve Bank of Australia's response. And, having closely followed events in Japan for more than 20 years, Jones said the RBNZ could take a leaf out of the Bank of Japan's book.
"On March 16 the Reserve Bank made a commitment to keep rates unchanged [through] forward guidance. But that's not supposed to be a binding constraint. They can change that, the facts have changed. What did Keynes say? The facts change you change your mind, we expect that with central banks. We expect central banks to deal with what's in front of them. And the question to ask is why are New Zealand rates not at zero today? Why are they still at 30 basis points? The bank bill rate is up at 30 basis points, what drives lending rates?"
"Now we're talking about maybe negative rates will be on the agenda in 2021, and yet it's not clear why rates aren't zero today. So I think there are different things the Reserve Bank could be doing they're choosing not to do, and it's not clear to me why they're not doing that," Jones said.
"When I covered the Bank of Japan they cut from 25 [basis points], to 15 to 10 to five. And then eventually they went to zero, they actually went to one or two basis points. So there's nothing magical about 25 basis points. We could have had the remuneration rate set at zero, and the RBNZ lending rate set at 10 basis points, or five basis points, [there's] nothing to stop that."
The Reserve Bank of Australia has its cash rate at 0.25%. It's also buying government bonds in the secondary market in support of a target of 0.25% for the yield on three-year Australian Government bonds, and an interest rate of 10 basis points on exchange settlement balances held by financial institutions at the central bank.
The RBNZ's QE program, when announced in March, was to be worth up to $30 billion over 12 months. It has now increased to up to $100 billion by June 2022, with the RBNZ buying central and local government bonds on the secondary market. The aim is to ensure low retail interest rates in order to help meet its inflation and employment targets.
'We should be debating different policies'
Jones said he's not convinced a very large QE policy will be resilient once the COVID-19 pandemic passes, because the RBNZ may have to start selling the bonds it has bought at higher interest rates.
"Now sure you take a loss but in a sense the government is having to finance at a higher interest rate, whereas we could all be issuing 10, 20, 30 year bonds and funding at this very low rate. And so I think there needs to be more debate about QE, particularly with these very big numbers now," said Jones.
"As an emergency measure for this year it made complete sense, 10% of GDP, $30 billion, yeah we understand that. The Reserve Bank of Australia has done something similar. But what the Reserve Bank in Australia has done is rather than buying long term bonds, they've focused their buying in the three year and they've said 'we want yield curve control, we want to keep the three year rate at 25 basis points.' And because that is credible they haven't had to buy so many bonds."
"So I think we should be debating different policies. And I'm not convinced having the Reserve Bank buying $100 billion of bonds is the right policy from a medium-term basis, that it's resilient and I don't think we've had enough debate and discussion around this," Jones added.
"In New Zealand our Official Cash Rate's 25 basis points, but you [also] have something called the remuneration rate which is the rate that the central bank pays banks. Now in Australia that is 10 basis points. So while their cash rate is 25, it's 10 basis points [on exchange settlement balances] in Australia. They have lower rates than we do."
Meanwhile, Jones said that whilst a deflationary environment is the most likely one over the next couple of years, he's not ruling out a return to an inflationary environment.
"I just have in the back of my mind that in a world of deglobalisation, trade frictions, of the need to price carbon effectively, of supply chains being disrupted by geo-politics, we have China official papers threatening to invade Taiwan which is a critical part of the western supply chain, the world we're going into is much less certain than the world we've lived in for the last 30 years. And I can see paths where inflation is an outcome."
"I'm not predicting it, but I think the future is very two sided. Deflation is not guaranteed. People assume with [an] ageing population deflation is a given and I don't think we can be so sure. I think we have to be open minded [about] a return to inflation even if you don't necessarily forecast that. It's the sort of thing that may not be around one corner but could be around two," said Jones.
'I think a lot of the debate in New Zealand, and talk about Sweden, has missed the gains from [COVID-19] elimination'
Wigram Capital Advisors has been modelling the spread of COVID-19 since it emerged in Wuhan, with its modelling used by the New Zealand government earlier in the year. Jones said the firm's COVID modelling came about because he experienced SARS in Hong Kong in 2003 and kept a lot of data.
"I found an old spread sheet from 2003 that I hadn't opened in 17 years that had all the data in. So we got to work modelling SARS to start with, looking back at the Hong Kong experience of 2003, and then that allowed us to be analysing the Wuhan data. And then we were broadening it out across cities in China until they stopped publishing data around mid-February," Jones said.
"So once it started to spread we were able to take that modelling approach and apply it to Europe, the United States and then to New Zealand when it arrived here. It's not an epidemiological model, but it's based on models that were constructed after SARS by epidemiologists."
Jones said Wigram Capital Advisors is still modelling COVID-19 daily, out a little beyond 14 days into the future. This he describes as "a guide on the path of the virus."
With the recent re-emergence of COVID-19 in the Auckland community Jones said there has been lots of criticism, or "carping." In response he uses a rugby analogy pointing out after the 2011 Rugby World Cup New Zealanders didn't complain that the All Blacks had only won the final by the skin of their teeth.
"This is really about getting the job done. And in rugby terms sometimes you have to win ugly, it's not about perfect," said Jones.
"And I think there's a lot of demands for perfect in New Zealand. In reality no one has achieved perfection with this virus. It's very tricky, it's very dynamic, it moves in ways we don't understand, still."
"What we did right was once we realised we had community transmission...we went into regional lockdown straight away. That's the ideal policy. We've achieved elimination, we had 100 days free of COVID, then we had an outbreak...That regional lockdown was able to stop the virus spreading, we didn't have to apply lockdowns beyond Auckland," he said.
"Hopefully it's not long until we can get back to elimination. What we saw under level 1 is there's a big pay-off to elimination and that's what we see every day with the Chinese data, Taiwan data...You get back to elimination your economy normalises very fast. I think a lot of the debate in New Zealand, and talk about Sweden, has missed the gains from elimination, or the payoff from elimination."
And Jones believes New Zealand can get back to where we were just a couple of weeks ago.
"And with the improvements at the border we should be confident that we can do that. We hopefully will come out of this saying 'we know what to do, this is not about perfect, mistakes will be made, it's a very complex process.' But if we get an outbreak we don't need to panic. We have tools to contain it. We can do mass testing, we can contact trace, we can lockdown a region, and then we get back," said Jones.
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