Roger J Kerr says the RBNZ has invited global financial markets awash with cash to buy more NZ dollars to gain a higher yield return

 By Roger J Kerr

Managing monetary policy is about finely made judgment calls.

In delivering last week’s Monetary Policy Statement the Reserve Bank of New Zealand took the decision that there was more risk associated with inflationary pressures in the domestic economy than there was a risk of sending the NZ dollar higher and damaging export sector jobs and investment.

Backed by updated economic forecasts, what their econometric model is saying and observations of financial markets/bank lending behavior, the RBNZ concluded that there was greater risk of inflation going above their 3.00% upper limit, than there was of the annual inflation rate returning to below 1.00%.

The decision to tighten monetary conditions through higher interest rates, which also sent the NZ dollar higher, was more aggressive than what the markets and economic analysts were expecting beforehand.

It appears to me that the RBNZ was “spooked” into a more aggressive monetary policy stance at this time by two developments:-

• Very strong net migration numbers potentially adding to housing demand, even higher house prices and thus “demand-push” inflation from the wealth effect on consumer spending.
   
• Fixed rate mortgage interest rates for two and three year terms actually going down from March to June, despite the RBNZ lifting the OCR 0.50% and forcing higher variable mortgage interest rates. Strong competition between banks for the fixed mortgage borrower, consistently reducing bank credit margins and lower swap market interest rates due to market expectation of a lower interest rate forecast for 2015 from the RBNZ, all combined to drive the two and three year mortgage rates lower over the last three months.

RBNZ worries about the immigration numbers may well prove to be misplaced as the increase in the net inflow of immigrants is all about fewer New Zealanders leaving permanently for jobs in Australia and beyond, and less about massive numbers of new immigrants arriving in New Zealand and needing to buy a house in Auckland (as that is where the jobs are). There are far less pressures on the housing market from a 23-year old deciding to stay at home and work here than departing for the big bucks in the mines in Western Australia. The 23-year old was not going to be buying a house in any case.

As expected, the RBNZ did revise downwards their 2014/2015 GDP growth and inflation forecasts from their March prognosis. However, they surprisingly left their 90-day interest rate forecasts unchanged from March. They clearly did not want to give the message or signal to mortgage borrowers that interest rates may increase at a  slower rate and not as far as previously indicated. The more stringent monetary stance may well prove to be the correct one; however the collateral damage to the export sector of prolonging the elevated exchange rate may well reduce business activity and thus GDP growth more than what the RBNZ expect.

Time will tell on that front. What is a worry is the inconsistency of the RBNZ messaging to the markets and business community. Just four weeks ago the RBNZ Governor sent a warning shot that “it would be opportune to intervene” in the foreign exchange markets to sell the NZ dollar if the divergence between the NZD/USD exchange rate (or TWI) and economic fundamentals (i.e. export commodity prices) continued. Since that time milk powder prices have dropped another 10% and the NZD has remained elevated above 0.8600.

The opportunity to generate a lower NZ dollar was available to the RBNZ last week by revising down their 2015/2016 interest rate forecasts.

In choosing not to do that they may have missed a trick to get the dollar down.

Whether intentionally or not, they have instead invited global financial/investment markets awash with cash to buy more NZ dollars to gain a higher yield return. 

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Roger J Kerr is a partner at PwC. 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