By Roger J Kerr
RBNZ Alan Bollard delivered a monetary policy statement bank in line with expectations - that is, downbeat, cautious and dovish on the economic outlook.
The pessimistic RBNZ forecast for the economy over the next six to nine months is a bit hard to reconcile with strong and improving business and consumer confidence at this time.
However, the Governor is keen to get to the NZ dollar value lower and in some ways I do not blame him for a tactically and deliberately dovish prognosis of the economy.
The Kiwi dollar did weaken marginally in response.
There was very little reaction by the interest rate markets as the long-end of the yield curve was being pushed higher by rising long-term US Treasury Bond yields (up from 2.90% to 3.28%). The RBNZ were far too optimistic on economic growth with their forecasts for 2010 at the start of the year.
Now as the year draws to an end, the RBNZ seem to be reacting negatively to their own woeful forecasting performance with a forward projection for the whole economy seemingly entirely based on the flat domestic retail and housing sectors.
Anecdotal evidence is that the Christmas retail spend will be stronger than the doomsayers predict and house construction activity has picked up with old consents now being actioned. It may be dangerous to conclude the decrease in building consents is a sign the home construction sector is going backwards.
In terms of the track of short-term interest rates in 2011, the RBNZ are now adopting a strategy of waiting to see real evidence of increased activity in the economy before adjusting the OCR up from its current stimulatory level.
I see this as a dangerous and ill-advised management of monetary policy, which requires a bit of “art” as well as science to read the mood and pre-empt increased economic growth that technically drives increased inflation risks.
If they wait until June 2011 before increasing the OCR the RBNZ run the real risk of being well behind the 8-ball and being forced to raise rates very rapidly in response. We all know that such a knee-jerk response to stronger actual data leads to a sharply rising NZ dollar and exporters being slammed once again.
The RBNZ forecast muted GDP growth of 0.4%/0.5% per quarter over the next three quarters and then a sudden gear-shift higher in activity to over 1.00% per quarter for the next three quarters. It is very difficult to fathom just what will prompt the step change in mid-2011, other than the re-build in Christchurch that will add +0.5% to next year’s GDP growth.
The RBNZ also see consumer spending and business investment continuing to be cautious and flat. I think they are under-estimating the positive knock-on impact of export commodity prices being at 30-year highs has on the wider NZ economy. Some industry sectors like forestry and log exports are booming right now, not that the local financial media have realised this yet.
In my opinion the first half of 2011 will be stronger than RBNZ forecasts.
As expected, a good part of the RBNZ monetary policy statement was devoted to the housing market as the most important driver of the economy. The residential property market has been subdued by tax changes, tighter lending criteria and job insecurity. The latter factor is no longer a negative as the export-led recovery starts growing employment.
The RBNZ’s continuing pre-occupation with the housing market is a worry for the conduct of monetary policy.
The Export NZ survey last week reported that 44% of export firms are going to be increasing their staff numbers over the next year. That is considerably more positive than the official RBNZ view of business investment/expansion.
The other surprising aspect of the MPS was the RBNZ view that the “low” interest rates are having a less stimulatory effect than in the past.
The RBNZ should realise that even though the OCR may be “low” at 3.00%, true market interest rates were lenders are meeting borrowers on price are quite a bit higher at 5.00%. Banks have been paying 5.00% for one to 12 month retail deposits for some now, lending the money on at 7.00%.
The core funding ratio regulation and wider credit/lending margins has caused this situation.
I have always contended that maintaining the OCR so far below the true market price for money is imprudent and will eventually cause the Governor a problem i.e. he will lift the OCR from 3.00% to 5.00% and it will have no impact on the economy or the banks’ cost of funds. So why not make that adjustment sooner rather than later?
Clearly, I see considerable risk in believing that the forecast RBNZ track of 90-day rates in 2011 will be close to actual outcomes. Come March/April the RBNZ will be forced to change their tune on the economy.
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* Roger J Kerr runs Asia Pacific Risk Management. 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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