In his first speech new RBNZ Governor Graeme Wheeler rules out quantitative easing but not currency markets intervention; Says NZ has 'tremendous' assets

New Reserve Bank Governor Graeme Wheeler says there's no need for the central bank to follow overseas counterparts and adopt quantitative easing, or money printing, but he isn't ruling out the possibility of intervening in the currency markets to try to weaken the New Zealand dollar.

Speaking at the Admirals’ Breakfast Club in Auckland In his first speech since succeeding Alan Bollard last month, Wheeler - who left the Official Cash Rate (OCR) unchanged at its record low of 2.5% yesterday - said pursuing price stability and using its prudential powers to promote financial system stability and efficiency, were the greatest contributions the Reserve Bank can make to New Zealand’s long-term economic growth.

"We do not see any reason to adopt quantitative easing in New Zealand," he said.

"Quantitative easing is being adopted by central banks that have little or no scope to lower interest rates in economies experiencing major deleveraging, and where deep concerns exist about generating and sustaining economic growth. It is a sign of desperate times for central banks, who in some instances are shouldering the burden of domestic policy paralysis over fiscal policy," Wheeler said.

"Since the onset of the global financial crisis, the Federal Reserve has expanded its balance sheet by 13 percent of GDP, the European Central Bank by 16 percent of GDP, the Bank of Japan by 10 percent of GDP, and the Bank of England by around 20 percent of GDP. In all four cases the official cash rate is 0.75 percent or less. In all four cases there is little evidence of any appreciable impact on economic growth. New Zealand is in a very different situation."

The New Zealand economy is growing at an annual rate of about 2% and the Reserve Bank has scope to lower interest rates if needed, he added.

"While annual Consumer Price Index (CPI) inflation has fallen to 0.8 percent, we expect inflation to head back towards the mid-point of the (1% to 3%) target range. We will continue to monitor inflation indicators, such as pricing intention and inflation expectation data, closely over the coming months as stronger residential investment gets into full swing," Wheeler said.

The Reserve Bank didn't see any scope for directing monetary policy to achieve target rates of economic growth, saying this was beyond monetary policy's capability.

"Trend rates of economic growth depend largely on the quantity and quality of human capital and the amount and productivity of the capital that labour has to work with. But, we do examine the state of the economy very closely when setting monetary policy. We study a range of economic indicators such as building and manufacturing activity, measures of capacity, conditions in the labour market, trends in competitiveness, and forward indicators of orders and investment intentions," Wheeler said.

"Doing so enables us to get a better feel for the pressures on resources and to assess whether there is scope to support stronger growth in demand while achieving our inflation objectives."

New Zealand dollar 'high'; RBNZ wants to see it lower

He noted considerable public debate on the exchange rate with external commentators, such as the International Monetary Fund (IMF), suggest the New Zealand dollar, at US81.60 cents this morning down from as high as US82.40c before Wheeler's speech, is over-valued in terms of New Zealand's economic fundamentals. Wheeler noted some of the strength in the Kiwi reflects the weakness of the US dollar.

"On a bilateral basis the New Zealand dollar is especially strong against the US dollar, Euro and Sterling. Against the Australian dollar, it has tracked slightly below average. Ultimately, it is the relative rates of return between New Zealand and the rest of the world that explains the strength of the New Zealand dollar. These returns reflect developments in the economy and international demand for our products and services. Over the longer haul the dollar is very strongly correlated with measures of the terms of trade or commodity prices, and much of the strength of the New Zealand dollar is due to our terms of trade being close to a 40 year high," said Wheeler.

He said exchange rate movements can also reflect differences in growth rates between economies, differences in interest rates, perceptions of safe havens, and fluctuations in investor risk appetite, with New Zealand not alone in experiencing upward pressure on its exchange rate.

"The appreciation in our exchange rate has affected the tradables sector of the economy. Manufactured export volumes, although growing at around 3 percent a year since the global financial crisis, are lower than they would otherwise be; investment in industries such as tourism has declined; and the profitability and output of import competing industries is reduced," said Wheeler.

"On the other hand, resources shifted to the more sheltered and less competitive non-tradables sector where producers find it easier to raise prices. The high exchange rate does however, generate some important benefits to the economy. Consumers and producers benefit from lower import prices, and interest rates are lower than would otherwise be the case."

The Reserve Bank did want to see a lower exchange rate, Wheeler added, provided this can be achieved without damaging price stability and financial stability.

"In the wake of the global financial crisis, institutions such as the IMF, are reviewing the scope for managing capital flows. Capital controls may be appropriate in some circumstances, perhaps to mitigate problems arising from temporary surges in capital inflows in economies with weak financial sectors. For a debtor country like New Zealand, an open capital account is essential. Introducing capital controls, instead of making the necessary adjustments, would damage the credibility and stability of New Zealand’s financial sector, and increase the real cost of capital for New Zealand," he said.

'Prepared to intervene' in the currency markets

He noted that cutting interest rates can at times reduce pressure on the exchange rate. However, analysis of past OCR cuts in New Zealand shows on average minimal or no intra-day impact on the exchange rate, and even less impact on a weekly basis. Furthermore, analysis of "unexpected" OCR changes with Trade Weighted Index changes following a rate decision still doesn't show a strong relationship to subsequent New Zealand dollar movements.

"This reinforces the idea that the exchange rate primarily reflects returns in the broader economy rather than simply returns in the money market. We set the OCR such that the inflation outlook remains consistent with the Policy Targets Agreement (PTA) and the financial markets understand this. If we reduced the OCR without sound reasons the exchange rate might drop initially but rise later when the inflationary implications of the rate cut became clear, especially if the belief was formed in the meantime that the central bank’s commitment to price stability was wavering," Wheeler said.

"Foreign currency intervention is unlikely to have a sustained impact on the New Zealand dollar, but can have an impact in the short term if the Reserve Bank makes the right calls about the exchange rate departing from fundamentals."

He noted the Reserve Bank's four criteria to assess whether intervention should be undertaken;

1) Whether the exchange rate is exceptional relative to history;

2) Is the exchange rate justified;

3) Would intervention be consistent with the PTA;

4) Whether the market conditions exist to successfully shift the value of the currency.

"Even if the first three criteria are satisfied at a point in time, it makes little sense to risk incurring losses to taxpayers by intervening when currency flows supporting the New Zealand dollar are particularly strong."

"But we will remain vigilant on these criteria and will be prepared to intervene if all conditions are met," said Wheeler.

However, to achieve a sustained reduction in the New Zealand dollar he suggested it would be necessary to alter the overall level and pattern of saving and investment in the domestic economy. This would especially require tackling "our addiction of depending on foreign savings to finance our consumption and investment." Wheeler said this dependency means New Zealand has consistently needed interest rates above those in most developed economies to maintain inflation at target levels similar to those being followed elsewhere.

"Policies that increase domestic savings, including reducing the government’s fiscal deficit, and to reduce the flow of resources into the public sector and other non-tradables sectors, would help to achieve a sustainable reduction in the exchange rate."

Under his watch Wheeler said the Reserve Bank will be consistent, open, and flexible in reflecting on new information and data. Its focus will stay on meeting the PTA objectives and maintaining New Zealand’s reputation for "credible monetary policy outcomes and financial stability."

"This is the best contribution we can make to help bolster New Zealand’s rate of economic growth and serve New Zealanders."

Working with Bill English and Treasury on macro-prudential tools including housing loan-to-value ratio limits

Meanwhile, Wheeler said a Memorandum of Understanding between Minister of Finance Bill English and himself was being discussed with the Treasury.

"It will confirm the guidelines under which the (Reserve) Bank should operate macro-prudential instruments in 'promoting the maintenance of a sound and efficient financial system'. It will also outline the consultation processes with the Minister and the Treasury if macro-prudential intervention is under consideration, and prior to any decision to deploy macro-prudential policy instruments," Wheeler added.

The macro-prudential tools the Reserve Bank is focusing on include the core funding ratio, a counter-cyclical capital buffer, adjustments to sectoral risk weights, and housing loan-to-value ratio limits.

"These instruments are expected to reinforce the overall tougher approach to prudential regulation and supervision under the new Basel III (bank regulation) regime. We need to ensure that we have well governed and well capitalised financial institutions, with strong funding and liquidity buffers, and sound risk management practices," Wheeler said.

Although New Zealand was vulnerable to global economic shocks, Wheeler noted the country faces the world with 'tremendous" assets.

"The World Bank suggests that on a per capita basis, New Zealand is ranked eighth for natural capital (pastoral and crop land, forest resources and subsoil etc) with only oil producing countries ahead of it. We lead the world in renewable natural resource related capital. OECD comparisons of high school student attainment place us seventh among 71 countries," said Wheeler.

"Transparency International considers New Zealand the least corrupt country in the world, and the World Economic Forum ranks New Zealand among the best for the quality of its institutions, and the efficiency of its product markets and its financial markets. With these assets we should be capable of stronger economic growth. Internationally, and particularly in smaller economies, economic growth is driven by the private sector and its ability to compete on global markets."

"We need to reverse the slowdown in multifactor productivity growth since 2005 and the decline in value added in our tradables sector. And we need to reverse the shift of resources into the public sector and other non-traded activities," he said.

See Wheeler's full speech here on the RBNZ's website.

Economists' reaction

ANZ's Economists

The Governor confirmed previous RBNZ signals that macro-prudential tools are coming. A Memorandum of Understanding is to be signed with the Minister of Finance, an important step forward. · We see such tools as eventually supporting and complementing monetary policy.

Such tools will have long lead times and will never displace the OCR. · In other regards, Governor Wheeler reiterated that it is business as usual:

– The existing inflation-targeting monetary policy framework is best practice.

– He sees no reason to introduce quantitative easing.

– Any assault on the exchange rate, through cutting the OCR or direct intervention, would be short-lived in its impact, and is thus highly unlikely. ·

We concur. A timely reminder of the Reserve Bank’s role was appropriate, given some of the hubris in the political arena surrounding what monetary policy could or should be doing. ·

The “Reserve Bank has scope to lower interest rates if needed” (the global scene and transmission from a higher currency via inflation expectations and unemployment are key to watch in our view), though it is clear that rebuild-related support to growth has the RBNZ watchful: “we will continue to monitor inflation indicators, such as pricing intentions and inflation expectation data, closely over the coming months as stronger residential investment gets into full swing.” ·

The outlook for monetary policy still looks veiled in uncertainty, and we reflect such uncertainties by playing down the spectre of the OCR moving for some time.

Westpac's Economists

The speech set out Mr Wheeler's approach to central banking in today's world. We would describe the speech as fairly standard macroeconomics. The speech explained clearly what it is that a central bank can achieve, and what it can't. The points Mr Wheeler made were things that most macroeconomists and central bankers would agree with:

•  The best contributions central banks can make to society's well-being are to keep inflation low and stable and maintain a sound financial system.
•  Monetary policy cannot be used to achieve target rates of economic growth.
• Quantitative easing makes no sense for NZ because we still have room to reduce the OCR if needed, and because our economic situation is less dire than that of countries that been forced down the path of QE.
• The high exchange rate is undesirable, but monetary policy cannot affect the exchange rate without damaging price stability and financial stability. OCR reductions have minimal or no impact on the exchange rate, because markets understand that reducing the OCR today would only necessitate more OCR increases later, once the inflationary consequences of the OCR cut becomes clear.
• Much of the strength in the exchange rate is to do with New Zealand's terms of trade being at a 40-year high, although some may have to do with our savings and investment choices. Mr Wheeler suggested that a sustained reduction in the exchange rate might be achieved by policies that increase domestic savings.
• Intervening in the exchange rate is unlikely to have a sustained impact on the New Zealand dollar.
• The Reserve Bank's macroprudential tools (core funding ratio, counter-cyclical capital buffer, adjustments to sectoral risk weights, housing-to-loan value limits) will be used infrequently and for the purpose of maintaining a sound and efficient financial system, rather than as a replacement for the OCR (although the use of macroprudential tools would normally support monetary policy).

Market implications - Mr Wheeler seems to be adopting a straightforward approach to monetary policy. Based on this speech, it seems that Mr Wheeler's view on the appropriate OCR will depend on the medium-term outlook for inflation. That outlook currently sits close to 2%, so the outlook for the OCR at this stage is "on hold."

First NZ's Chris Green

   Graeme Wheeler’s first speech as RBNZ Governor outlined three key points surrounding (i) NZ’s Vulnerability in International Markets, (ii) The Importance of Price Stability and an Efficient and Stable Financial System, and (iii) Quantitative Easing, Targeting Growth and the Exchange Rate.

·         On the whole, the key message of this speech is a broad defence of the RBNZ’s price stability and financial stability objectives as providing the best framework for achieving stronger growth in output and employment over the longer term.

·         In terms of market implications, the speech provides a strong counter response to the suggestion that the RBNZ should look towards undertaking a quantitative easing program. In particular, Governor Wheeler suggests that such a policy response is not required as;

o    The NZ economy is growing at an annual rate of around 2 percent, and

o    the Reserve Bank has scope to lower interest rates if needed. 

·         Governor Wheeler’s speech also further reinforces our perspective that a near-term currency intervention to weaken the NZD is unlikely. In particular, while he notes that a number of metrics suggest that the NZD remains overvalued, some of the strength is a reflection of US dollar weakness. Moreover, he also comments that much of the NZD appreciation is due to our terms of trade being close to a 40-year high and that several other commodity currencies have similarly experienced substantial currency appreciations.

·         While the Governor readily acknowledges the negative impact that the appreciating NZD has had on the tradables sector and also encourages substitution toward imported goods and services, he points out some important benefits in the form of lower import prices and interest rates lower than would otherwise be the case with a lower currency.

·         These comments together reinforce our perspective that the RBNZ does not currently assess the NZD to be “exceptionally” overvalued. Moreover, Governor Wheeler even raises concerns that the use of the more orthodox policy option of cutting interest rates to weaken the NZD has historically had little sustained impact on reducing exchange rate pressures.

·         From a fundamental perspective, Governor Wheeler notes that “in order to achieve a sustained reduction in the New Zealand dollar, it would be necessary to alter the overall level and pattern of saving and investment in the economy.  In particular, it will be necessary to tackle our addiction of depending on foreign savings to finance our consumption and investment.”

·         On the whole, the tone of these comments underline the new Governors comfort with the current “orthodox” monetary policy tools at his disposable and suggests little likelihood of any near-term intervention to attempt to weaken the NZ dollar. Moreover, while not as explicit as the comments regarding the NZ dollar, the underlying tone reinforces that of the October OCR Review, suggesting broad comfort with current OCR settings and little near-term pressure to look to cut rates.

(Updated with detail from the speech, reaction from economists).