Governor defends flexible inflation targeting regime; sticks with MPS view of another 35 bps of OCR cuts; says holding OCR would push up NZ$; but says more aggressive cuts would not lower NZ$ much and would worsen housing imbalances

Governor defends flexible inflation targeting regime; sticks with MPS view of another 35 bps of OCR cuts; says holding OCR would push up NZ$; but says more aggressive cuts would not lower NZ$ much and would worsen housing imbalances

By Bernard Hickey

Reserve Bank Governor Graeme Wheeler has used a speech on monetary policy to push back at those suggesting the central bank should either abandon inflation targeting or cut the Official Cash Rate more aggressively to lower the New Zealand dollar and get CPI inflation back up into the bank's 1-3% target band.

The Governor, who is under pressure to lift CPI inflation from its current 0.4% level to his 2% midpoint target, said more aggressive cuts would worsen imbalances in the economy and housing market, while not cutting again would lift the New Zealand dollar and risked creating a downward spiral in inflation expectations.

Wheeler said flexible inflation targeting remained the most appropriate framework, as long as the bank retained flexibility.

He said the scope and influence of monetary policy in small open economies was heavily constrained by developments outside their borders.

“Nearly 10 years on from the Global Financial Crisis, economies face a difficult global economic and financial climate, with below-trend growth despite unprecedented monetary stimulus, declining merchandise trade and rising protectionism, very low inflation and interest rates, and high asset prices presenting financial stability risks," Wheeler said in the speech he wrote.

"Many of these issues have complex structural elements that are unlikely to fully self-correct as global growth recovers," he said.

Wheeler said there was a "range of views" about what monetary policy could achieve and how it should be operated.

"In New Zealand, these include a view that flexible inflation targeting is no longer an appropriate framework for conducting monetary policy," he said.

Wheeler said flexible inflation targeting remained the most appropriate framework for conducting monetary policy in New Zealand, "provided sufficient flexibility is allowed to accommodate the frequent and often severe impact of external shocks, the most important contribution monetary policy can make to promoting efficiency and the long-run growth of incomes, output and employment is the pursuit of price stability."

'Changing target would damage credibility'

“There is nothing sacrosanct about what particular inflation band or target should be adopted as a measure of price stability. However, changing a target when times become tougher reduces the incentives on central banks to achieve earlier agreed goals. It could damage the central bank’s credibility – particularly if a perception develops that the central bank will continually seek to respecify goals," Wheeler said.

"The Bank also encounters a view that it should not lower interest rates, because current strong economic growth makes interest rate cuts unwarranted and undesirable. However, if financial markets believe that the Bank is content with below-target inflation, they would conclude that the easing process is over and proceed to bid the exchange rate up, perhaps substantially," he said.

“The TWI exchange rate is already at a high level based on the Bank’s models. A sizeable appreciation would further squeeze incomes in the tradables sector, and drive tradables inflation lower for longer, thereby lowering overall headline inflation.”

'Risk of self-perpetuating spiral of falling inflation expectations'

Wheeler said low headline inflation could also bring down inflation expectations in a self-perpetuating spiral.

“If inflation expectations fall too far, it can be very difficult to raise them back up. In such a situation, even further cuts in interest rates would be needed to stimulate economic activity and increase inflationary pressures," he said.

Wheeler said there was a third view that the Bank should rapidly lower interest rates to bring inflation quickly back to the 2% mid-point of the inflation band.

"However, an aggressive monetary policy that is seen as exacerbating imbalances in the economy would not be regarded as sustainable, and would not deliver the exchange rate relief being sought. Rapid ongoing decreases in interest rates would likely result in an unsustainable surge in growth, capacity bottlenecks, and further inflame an already seriously overheating property market," he said.

"It would use up much of the Bank’s capacity to respond to the likely boom/bust situation that would follow, and place the Reserve Bank in a situation similar to many other central banks of having limited room to respond to future economic or financial shocks."

'We still see another 35 bps of cuts'

Wheeler referred to the bank's August 11 Monetary Policy Statement in the speech, which included forecasts for another 35 basis points of cuts in the Official Cash Rate on top of the 25 basis point cut to 2.0% on August 11.

“The key rationale for cutting the OCR in August was to lower the risk of a further decline in short-term inflation expectations. Our present judgement is that the current interest rate track, involving an expected 35 basis points of further interest rate cuts, balances a number of risks weighing on the economy, while generating an increase in CPI inflation back towards the mid-point of the 1 to 3 percent target range," he said.

“We remain committed to the inflation goals in the Policy Targets Agreement. We do not believe that the outlook and balance of risks warrants a position of no policy change, nor a position of rapid easings. If the emerging information and risks unfold in a manner that warrants a change in our judgements, we will modify our policy settings and outlook.”

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

We welcome your comments below. If you are not already registered, please register to comment.

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.

35 Comments

Comment Filter

Highlight new comments in the last hr(s).

Graham doing his best to push NZD higher. AUD/NZD looks set for parity, a call I was too early with before.

The world economy is still taking a beating with the value of manufactured goods in a deflationary cycle , and commodity prices falling..... again .

I see AFP have reported overnight :-

London - World oil prices slid on Monday on resurfacing supply glut concerns, slamming the brakes on last week's rally.

If there is precious little that a reserve bank governor can do to achieve inflation targets because of external factors then should we not make the position redundant? Seems an awful waste of taxpayers money.

We should be hammering the commercial banks , the floating mortgage rate is 5,5% while depositors get 2% from ASB and as little as 3/4 of 1 % from BNZ .

After tax and inflation , the BNZ is actually charging YOU to keep your savings there .

It borders on an unfair business practice

I just don't see what you are complaining about here..
If you want a better return, increase your risk profile.
If you want to borrow lower, take a fixed rate - fixed rates in NZ are subsidised by the floating rate, for obvious reasons.

I'm sorry, but this in no way comes close to "unfair business practice".
What it is is prudent business practice.

If you want a better return, increase your risk profile.

Hmmmmm...irrational exuberance has redefined the profile.

It reminds me of the great Victorian English journalist Walter Bagehot. He once said that John Law can stand anything but he can’t stand 2%, meaning that very low interest rates induced speculation and reckless investing and misallocation of capital. So I think Bagehot’s epigraph is very timely today.

Obviously, the financial markets like this cautious mindset of the Fed. Earlier this week, US stocks climbed to another record high.

Isn’t that a funny thing? The stock market is at record highs and the bond market is acting as if this were the Great Depression. Meanwhile, the Swiss National Bank is buying a great deal of American equity.

Indeed, according to the latest SEC filings the SNB’s portfolio of US stocks has grown to more than $60 billion.

Yes, they own a lot of everything. Let us consider how they get the money for that: They create Swiss francs from the thin alpine air where the Swiss money grows. Then they buy Euros and translate them into Dollars. So far nobody’s raised a sweat. All this is done with a tab of a computer key. And then the SNB calls its friendly broker – I guess UBS – and buys the ears off of the US stock exchange. All of it with money that didn’t exist. That too, is something a little bit new.

Other central banks, too, have become big buyers in the global securities markets. Basically, it all started with the QE-programs of the Federal Reserve.

It is a truism that central banks do this. They’ve done this of course for generations. But there is something especially vivid about the Swiss National Bank’s purchases of billions of Dollars of American equity. These are actual profit making, substantial corporations in the S&P 500. So the SNB is piling up big positions in them with money that really comes from nothing. That’s a little bit of an existential head scratcher, isn’t? Read more

"The stock market is at record highs and the bond market is acting as if this were the Great Depression."

There is no free market - only manipulation. The central banks understand they have to do whatever it takes to prop things up because a financial system reset isnt feasible.

Uh, a reset will happen, its just a Q of how long it can be delayed, and which event pushes it over, ie when Peak oil occurs? finally financial wizardry fails? etc etc.

trouble is any reset involves big write offs of wealth and debt obligations which are spread across borders - try sorting that mess out without military force coming into play.
And debt is what gets Oil out of the ground and commodities at viable levels.

Stephen, re the Swiss printing money to buy up the sharemarkets of the world. The fact this has been going on now for some years, matched only by the Japanese, and in a slightly different way, the Chinese and Germans, makes me scratch my head not so much that they are doing it, but that either the rest of the world doesn't kick up a stink, or doesn't start joining them. Instead what have we done in New Zealand? Sold our power companies, while fretting that the NZD is too highly valued. Bill English's excuse was that he needed some money to do other things, as though as a sovereign nation with an overvalued currency, he had some limits. If your currency is too highly valued then acquire like crazy, by buying up offshore assets, building your own infrastructure, or at the very least not selling off your own crown jewels.
In case anyone wonders the Swiss are not stupid about finance- the friendly Gnomes know probably more about it than anyone. We could do well to learn from them.

Are you claiming depositors are not risk? Guess that OBR option was just for laughs then!
Honestly mate. Your tunnel vision on these matters is astounding. Did you ever play Monopoly as a child?

When did I ever say that depositors face no risk?

Investors should always be aware of the risk of loss. So depositors were always at risk, just now with the OBR its totally clear.

Central banks must make finely balanced judgements when setting monetary policy, based on evidence, research, scenario analysis, and continual review of their policy record and international experience,” he said.

“If inflation expectations fall too far, it can be very difficult to raise them back up. In such a situation, even further cuts in interest rates would be needed to stimulate economic activity and increase inflationary pressures.”

When? 150 bps of cuts and counting and there is not a shred of evidence to support this claim.

From yield curves all around the world to things like eurodollar futures and swap spreads, the verdict is far simpler than groping in the dark for some magic number of just the “right” amount of inflation. If there is a lack of inflation even though central banks are and have been massively engaged, it is much consistent that central banks just aren’t so central. Read more and more

What else can he do , other than defend it, its his Tina* ?

TINA :- There Is No Alternative

For a start he could threaten to resign unless........
And then he could do it.
It all strikes me that it is the Blind (Wheeler) leading the Blind( JK, BE) and none of them getting anywhere.

12
up

"At the end of the day" does JK want to get anywhere?

I believe he thinks that by remaining with the status quo on the Housing and Immigration Ponzi he can successfully drift up to the next election trumpeting a rise in GDP as evidence of a successful economic plan.
He believes no notice will be taken by the dumb electorate of the current and future pain to FHBs, traffic chaos, crowded schools, hospitals, increase in drug and race based crime, destruction of water supplies all over the country. The economy - check out the static GDP/capita.

Lets face it the future is being stuffed up for short term gain - do we expect better from our leaders?

100 Children

Today this is your world, tomorrow it's ours
Leave us pure water and forest uncut
Think of tomorrow, leave something for us

20% gains a year in house prices in auckland over the last few years. Prices up 80% in 4 years or so.

This is what happens when the Reserve Bank and the government are both asleep on the job.
- 500k increase in the average Auckland price under Nationals watch
- yet the average wage increased by approx 15k tops maybe 20k at a stretch.

500k / 20k = so house prices increased by 25 times more than the increase in the average wage

25 times...

Reserve Bank should have brought in the Loan to income when it saw investors were buying 46% of properties. Why the delay ?

Government should apply a stamp duty to all foreign buyers and investors (15% like Vancouver)

Well specifically target property and drop interest rates. That is his job. RBNZ is becoming like the weatherman......say and do anything regardless of whether it is correct or not yet still have a job at the end of it. What is Wheelers job? And what is he doing to address his core function? He should not be doing the Govt's job, he should be concerned with his....

"The Governor, who is under pressure to lift CPI inflation from its current 0.4% level to his 2% midpoint target, said more aggressive cuts would worsen imbalances in the economy and housing market, while not cutting again would lift the New Zealand dollar and risked creating a downward spiral in inflation expectations."

Well take off the House price handcuffs by
- bringing in the Loan to Income ratios (4 to 1) you have been talking about for well over a year
- encourage Mr Key to bring in a 15% stamp duty on investors & foreign buyers (offshore, stud + temp)buy existing homes

Correct. That would be the rational policy move of an independent central bank.

Insanity: doing the same thing over and over again and expecting different results. - Albert Einstein

The world has had 8 years of this approach (in Japan a lot longer ) with little real change other than asset bubbles and increasing wealth disparity. All he is offering is even looser monetary policy. This pretty much fits the above definition of insanity. Wheeler has a very limited range of tools. Clearly fresh thinking is required and the government needs to shoulder a lot more responsibility instead of hiding behind Wheelers skirt like a scared infant.

Inflation targeting is that what he calls it? While there is hyperinflation in housing costs? His inflation index doesn’t contain an adequate housing weighting. And his Interest rate tool mostly effects mortgages? That’s called Open-loop feedback, very unstable.

But what to do when the big countries are debasing their currency? So Interest rates are now also supposed to be used to set a currency peg? Which needs interest rates low at the moment to combat.

He should be keeping a stable local dollar value by setting interest rates against a more accurate inflation index, which the cost of housing would now dominate (in the current situation). That would make it in the interests of the government to keep housing inflation low, to keep interest rates low.

CPI is bunkum. Interest rates are too low.

The flood of cheap foreign money & goods needs some protective measures. Maybe removing the tax advantages and speculative gains from the property market may remove that hot money also.

The debasing of foreign countries is extremely visible in our housing prices. Our houses are worth about the same amount of gold as they were at the GFC. Money printing is the thing that is killing NZ. The killer crunch is that once the dust settles we have to pay interest for all this damn paper.

The central bankers are on the path to destroying all paper currencies.

"Many of these issues have complex structural elements that are unlikely to fully self-correct as global growth recovers," he said.

I'd like to know how they possibly think global growth is going to EVER recover, but I suspect they are becoming well aware it can't. Overcapacity everywhere, weak demand and ever rising energy costs (of production) but ever lower energy affordability. If you cant get growth on low priced Oil, you wont get it when it has to rise in price to keep the Oil co's solvent.

Well said Mr Wheeler (and I don't agree with you that often)

35bps is an odd number, different from the 25 increments they've used so far.
I wonder, then, I they will lower the OCR by 35bps in one go, in November, or if they will do it as 20 and 15, or 25 and 10?

He is right cutting interest rates further would have zero impact on the exchange rate. Now dairy prices appear to have turned we are seen(rightly or wrongly) as a goldilocks economy internationally. Only if out debt to GDP were to rise to 50% would it have much of an effect on the exchange rate.

We shouldn't be putting ourselves down. Yes we have the housing supply issue in Auckland but apart from that our economy is in great shape.

Apart from that unfortunate issue Mrs Lincoln did you enjoy the show?

Actually its not a supply issue but a demand issue caused by JKs rampant immigration but no one seems to want to recognise that elephant in the room.

I dont think our economy is in "great shape" If you removed housing and immigration from the equation, we would be going backwards.

Unless he takes to managing the currency and implements exchange controls . That way he can set interest rates at whatever rate he likes

yes manage the currency, he could raise and lower the dollar by allowing X amount of dollars in circulation, I am going back to when you needed physical money and countries could effect inflation and their currency by issuing or taking out of circulation dollars.
other countries now do the same in a modern way and it is known as printing (hmmm)
so why are we late to the party

If in fact we are borrowing in NZ$ and paying the interest in NZ$ the obvious way to pay back less of them is to make them of lower value by printing lots and lots of them.
Use the printed ones to build infrastructure and hope the funny money ( dirty money in the main) heads offshore.
Surely the mind of TraderJohn can understand that one. After all he is the master trader of them all.

I sure wish I lived in the same world as Wheeler, then I might be able to understand his warped sense of logic.