Chris Green responds to the RBNZ's criticism of 'some commentators advocating mechanistic rate cuts'; says RBNZ seeing inflationary ghosts and has systematic upward bias; ignoring rise in real interest rates and tightening relative to other central banks

Chris Green responds to the RBNZ's criticism of 'some commentators advocating mechanistic rate cuts'; says RBNZ seeing inflationary ghosts and has systematic upward bias; ignoring rise in real interest rates and tightening relative to other central banks

By Chris Green*

In response to the Bank’s suggestion that some critics of the RBNZ have an inappropriate mechanistic fixation on headline inflation, I would suggest that they have:

  1. an inappropriate fixation on persistently seeing domestic inflationary ghosts & an inability to acknowledge a systematic upside bias in their historical inflation forecasts,
  2. issues in not accepting any responsibility for contributing to lower tradables inflation through a higher NZD – on the back of an inappropriate 100bps rate rise back in 2014,
  3. an excessive attribution of weak domestic headline inflation to lower oil prices,
  4. an apparent inability to acknowledge and respond to headline CPI inflation below the 2% target since Sep-2011 quarter & below the bottom of the 1-3% target range for 5 consecutive quarters,
  5. a reluctance to accept the current downside risks to global inflation,
  6. the absence of recognising a rise in real interest rate settings with lower inflation outturns,
  7. an apparent inability to assess the balance of risks surrounding a potential monetary policy mistake,
  8. together with ignoring a relative tightening in domestic monetary conditions as other major central banks undertake additional easings and/or reverse proposed tightenings.

Perhaps if the Bank was solely focused on domestic activity developments, their apparent reluctance in the undertaking of additional interest rate cuts may possibly be understandable.

But against the international backdrop of financial market volatility, downward revisions to global growth forecasts & noted heightened downside risks, it makes little sense to adopt their current approach – particularly when it places a floor under the NZD.

In addition, following recent global developments, muted domestic inflationary pressures, subdued inflation expectations, together with the inherent uncertainties surrounding the forecasting of inflation, it seems reasonably clear that the policy approach that minimise the risks of regret is one of an additional easing in NZ’s current interest rate settings.

From my perspective there appears little risk of a near-term spike in “underlying” domestic inflation, combined with an unlimited ability for the RBNZ to react to such a remote development through interest rate increases.

The perception that they give of a reasonably high hurdle before cutting rates would be more consistent with CPI out-turns around the top of the band, not having been below the mid-point for more than 5 years & not projected to get back their until the December quarter of 2017 -- at the earliest.

Here's Bernard Hickey's report on Graeme Wheeler's "mechanistic" speech this week.

'Yet more defensiveness'

My sense is that the Governor is far more focused on defending his current position than objectively attempting to assess the optimal risk-adjusted monetary policy response.

The defensiveness has continued, with the RBNZ Chief Economist John McDermott’s latest speech making the almost comical suggestion that the significant changes in their 90-day interest rate projection between their Mar-14 MPS and their Dec-15 MPS, should be view as a positive because it “illustrates how flexible inflation targeting operates in practice” – further reinforcing the Governor’s perspective that there wasn’t any “mistake”, or that there is anything of significance that the Bank can learn from the experience. Here's David Hargreaves' report on McDermott's speech.

Furthermore, Dr McDermott’s recent speech also attempts to suggest that since the beginning of 2014 “unforeseen economic events led to weaker-than-expected inflationary pressures in the economy”, apparently completely ignoring both the Bank’s potential mis-read of the domestic inflation linkages, together with denying that any of the Bank’s own (misguided) policy actions were contributing factors.


* Chris Green is the director economics and strategy at brokerage and investment bank First NZ Capital.

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It is obvious that the RBNZ does have a tightening bias, in all circumstances, and in all parts of every cycle.
Is this a historic heritage from the NZ Brash era of tough inflation fighting, or is it an external influence pressure from the World Bank/IMF etc?

Only when the RBNZ's hand is completely forced, e.g. The large Christchurch earthquake, or the GFC1, or completely dominant deflation data will they cut rates.

Making steeply rising debt level service costs cheaper has not raised post GFC economic growth. In fact redefining inflation to affect a redistribution of wealth to the asset owning classes has been a miserable failure in terms of collective national consumer demand, if the US can be cited as a low interest rate regime of long standing?

December’s trade figures released by the Census Bureau today confirm still further what the Chinese had figured out years ago. Imports from China declined by an alarming 6.2% year-over-year in December – there is no oil or commodities in those trade routes, just pure and unadulterated consumerism, or rather its conspicuous absence. That was the second worst monthly contraction of this cycle, though in reality it was the worst when factoring the two-month process of February and March 2013 (Feb. 2013 was +16.4% followed by the convergence the next month of -13.1%). Read more

Are you not rather forgetting Governor Bollard, who kept interest rates far too low for far too long causing a leap in houshold indebtedness to previously unheard of levels? Which caused the collapse in 2008/2009.

Incredible. The RB Governor of a tiny country at the bottom of the world actually caused the GFC! NZ certainly punches above it weight.

Roger is in fact correct here. The RBNZ was following the 'Greenspan Plan' like all the rest of the foolish RB's. The RBNZ in fact admitted they kept the OCR way too low for too long but....as usual this admission came way after the 2008 GFC and the excuse (as usual) was "no one could of known what was coming".
Infact many were warning the RBNZ in writing as early as late 2003, myself included, and we just got fobbed off! Funny how many have very short term memories around the GFC and what was being said and blatantly ignored at great 'continuing' peril to us all. The only thing saving our banks was the a very secret 2008 $9 Billion US FED default swap made with the RBNZ

The GFC was actually triggered by US merchant banks, Lehman, ML, BoA, etc unable to meet obligations to each other, combined with complex CDOs coming to roost, & a lax mortgage lending policy. Then the US Fed & Govt deciding to let Lehmans fail with no bailout.
Sure low interest rates and a housing bubble was also in there & NZ was following a low interest rate trend ( though the OCR at 8.25 was not really making much of a dent on the housing boom here in 2008.
But it's a bit of a stretch to blame Bollard! NZ was really mainly a receiver of global conditions

Actually, on the contrary once the RBNZ did start lifting the OCR there was a significant reduction in new loan applications and speculation . But due to the catch 22 effect on the NZD at that time(the carry trade market which the RBNZ profits itself from with the advantage of being a player and.....manipulator) it also erodes our exporters bottom line. So the RBNZ actually screwed everyone over under the guise of needing to meet its inflation target. Presently we are way outside those targets and what are the RBNZ doing again? Making rules and excuses to suit themselves and their bank cronies. I guess you dont recall the Bollard RBNZ announcements during the GFC where the media were told in no uncertain terms what questions would be answered and what questions would not be permitted? The RBNZ have no willingness to correct their mistakes or take ownership. To try and blame other institutions outside this country for what predicament we are now in is the real stretch

I think you make the same mistake of not viewing history from a global perspective.
There was a global credit crunch. NZ & borrowers were affected by that, - the RBNZ had little influence on that event. Yes, they had some influence on the NZ financial scene - but GFC1 was a global event.

I prefer the oil at $148USD triggered it

Steven,
High oil prices as a cause of the GFC was a popular theory among the peak oil brigade but if it is correct why hasnt $30 oil fixed the global economy
I would vote for securitised mortgages as the last straw..

Correct Roger, many forget, or just plain didn't know, that we were well in trouble by 2008 through higher interest rates that were attempting to combat the 2003-05 failure of the RBNZ to recognise the inflation that had developed and was getting out of control. The GFC just permitted the rest of the world to join us in our demise.

if you consider wheelers fixation with a potential housing collapse, and his background having seen first hand how the USA faired during the subprime debarclle - i think it would be fair to say we know where his psyche is at.

to my mind he is jeopardising the economy by not making the hard decisions, and that would be to raise interest rates.

I am a net borrower and although this would cause pain to me it would have done a number of things.

1. increased fixed income to those that need it - retired and elderly
2. controlled borrowing into the heated housing market, thereby putting a dampener on price escalation
3. most plant and equipment post gfc that had been run into the ground has now been replaced. zirp has already run its course.

wheeler now has a major problem as the horse has bolted. he has in my opinion totally misread the recovery.

he has no more levers to pull.

The PTA and the purpose of monetary policy is inflation not asset prices. House prices are only a small driver of inflation. If there is a risk to banks from asset prices these should be addressed through prudential policy not monetary policy. The RBNZ is wrong to risk deflation and all that flow from it for prudential policy reasons.

Investors are starting to worry about more than just profit declines at the biggest banks. They're increasingly concerned about their ability to repay their debt. Read More

Higher risk demands higher rates of return. Bank depositors are nothing if not investors

the author does not address the misallocation of extra money going into inflating asset prices and not into consumer spend.
we only need to look at the dairy industry to see how farms prices shot up, debt was taken on to expand production and grow supply but then demand fell away. maybe if the interest rates had been HIGHER farmers would not have taken on the debt and been more prudent with their plans.
ZIRP has distorted the markets by removing risk and reward, now its all reward borrow and invest in assets because CB are falling over each over to see who can create the most cheap credit

m3 money supply growth is at a very healthy 8%..
Our economy is NOT in a recession...

I think mr Wheeler knows what he is doing..... he's doing ok.
There is far more to governing NZs' money supply and Monetary stability than a mechanical fixation on the CPI..... in regards to the Policy Targets Agreement.

My view is that Wheeler and the reserve bank have learnt from the GFC and now have one eye on the credit aggregates... ( They don't want the 16% growth in money supply/credit that we had in 2006).

If you read about the history of Banking.... the current system of having central Banks grew out of the desire to mitigate the boom bust cycle of excessive credit creation by banks , and the consequences of that which was/is credit destruction, bank failures , economic depressions ...etc..

Maybe wheeler sees the unintended consequences of ultra low interest rates and does not want to go there until we have our own banking crisis...????

I think it is Chris Green who has the fixation...

Quite. The author is a very interested party - his remuneration is amplified by increased asset prices.
Chris Green is the director economics and strategy at brokerage and investment bank First NZ Capital

The strategy is presumably to profit from the asset transfer fees generated by a credit boom.

We have been sold a pup somewhere along the line and have bought into a bunch of subtley destructive ideas that do not enhance our society but cause us to focus our energies on wealth transfer rather than its creation.

This article is typical of the self serving distraction that the finance sector puts out.

Years of zirp has distorted world markets, making money supply growth a meaningless figure. Everyone should pay back their debts and show us the money.

It will take 30 years until the US achieves 2% inflation again, apparently. Maybe more for NZ?!
http://www.bloomberg.com/news/articles/2016-02-01/bond-market-inflationi...

The governor needs to meet his targets regardless of whether they are the correct targets to have. He has the tools to be able to keep the financial system secure (e.g. loan to value ratios) and to keep inflation within the target band (lower interest rates).
If the governor continues to miss his targets because he keeps predicting inflation that never materialises then he is failing at his job.

or adjust the targets to match the environment he is working in.
with high immigration there will be no wage inflation to speak of
with fuel being so cheap that has lowered transport costs and feeds through as deflation
with suppliers over producing that have kept prices in check
on the other side
rents are rising faster than wages
house expenses are rising mostly a feed on from high house prices.
and now most people 35 and under are spending over half their income on housing themselves
I have said for ages change the CPI basket to reflect where most spend, it is outdated and reflects spending of 20 + years ago
if that happened he would be outside his window

So you are arguing he should be putting interest rates up and taking more money out of people's pockets? If wages aren't going up, interest rates should be going down not up.

out of whose pockets, there are more rentiers than home owners in Auckland now so the effect on them is rent not interest rates.
the days of 70+ of home ownership and lowering interest rates so people spent are long gone, now all that happens with low interest rates it allows investors to leverage up get more housing stock, and where do they spend that extra money, it goes to the big four banks

Its worth remembering Jimbo that a huge amount of money has been taken out of the pockets of savers and investors (i.e. the majority of NZers as only the minority have mortgages) to accommodate borrowers ability to escalate housing prices in a never ending spiral (well in truth it will end, possibly badly because of it).

Only in the western world, if you are a Chinese or a japanese "saved" then you have for decades got little return.

So the Q is why should the "western" saved enjoy high interest rates when there is no investment to give the return with?

The second Q and Ive yet to see a decent answer off the likes of you is, if we put up interest rates and the economy collapses and that causes an OBR, then what?

unlikely a interest rise would cause an OBR, with the amount in savings in the banks would more likely led to increased consumer spending in the economy and that is the goal
as for those over leveraged on home loans sorry but that's free market and risk and reward, if you want to load up on debt in the search of GC and you don't plan your fault.
banks will cull the weakest which would strengthen their balance sheets

So a small rise has indeed caused a relapse of recession in every country that had tried it since 2009. We are also taking 0.25~1% as enough to do so. Now consider the gains in some parts of Auckland are significant, just how high do you think the OCR would have to go to cool it? 6? 7%?

On top of that the tradeables sectors are already -2%, dairy looks set for 3 to 5 years of <$5.

Then consider just how much of a rise the saved would want, I hardly think a 4% OCR would satisfy them, I doubt 7% would.

"in savings in the banks would more likely led to increased consumer spending" of course you are guessing here on the NET benefit. So the saved would have a bit more cash, but an even bigger % of people would with 7% OCR meaning 10% mortgage have a lot less to spend.

In terms of a rising rate causing an OBR, it would to me mind be the straw that breaks the camel's back. So yes indeed I do think putting up the OCR to 4%+ would lead to an OBR.

You are right it is indeed a free market so go and out your money elsewhere if you dont like the return you are getting.

In terms of "load up with debt" there is no difference between a property speculator and a FHB in what you propose. The FHB wants a house of their own, no real wish to make $s just own their home. These 30 somethings already probably have education debt, want a house and with a biological clock ticking want to have kids. You however want to decimate them to benefit the saved, many of whom are to lazy and incompetent to look after their own money, yeah right.

big difference in a FHB which numbers have dropped to shadow of what they were, and a investor.
for a FHB they are buying a home and will do what it takes to make payments right up to the last minute good risk for a bank
an investor is in it to make money, the smart ones concentrate on yield and make sure cashflow covers expenses they are positively geared these are normally long term and have been through ups and down and are a good risk for the banks.
the rest leverage up on CG and are requiring low interest rates. rent increases and tax return to trend water until they break even (most tip in) these are bad risk for the banks in case of a rate rise or slowdown.
it is interesting reading property talk some savy old hands warning about neg gearing and getting your portfolio ready for a downturn against the spruikers advising to take advantage of lower interest rates to leverage up(some bankrupted) and at it again

The purpose of lowering the ocr is to stimulate spending and investment, high interest rates encourage people to hang on to their money.
Auckland house prices are solely a result of supply being restricted by councils and demand being fueled by government. If high house prices were due to low interest rates we would see increases all round the country not just Auckland.

I think interest rates follow the economy not lead.

Umm, you are seeing sigificant increases and pressure on opening up land elsewhere, but Auckland just so happens to be the main fly in hub. Maybe not places like the West Coast for obvious reasons. Migration increases are the main factor keeping the CG's afloat as many NZders have little idea how cash poor they are compared to many overseas individuals coming here to live and invest. Met a couple from Singapore the other day in their late 20's who are already retired and looking to cash buy a million dollar home in Nelson. In singapore that barely gets them an average apartment. If you feel the record low OCR and bank IR's are having no effect then lets see the RBNZ raise it just 100 basis points. You would hear the screaming from bluff to the cape. Being on a fixed rate does not make one immune from the effects either

correct.

Very much so.

Yes but youre talking about people who actually do have a wage JimboJones, people with an income coming in, but ignoring what that would mean for those without one and living on fixed interest - I guess so long as I'm ok Jack all is well

dont agree.

The Auckland housing market is almost unique in the world insofar as it is driven by the stampede of immigrants attempting to escape the increasing awful conditions (economic, social and environmental) that now apply throughout most of the rest of the world.

Interest rates are largely irrelevant when people who have cashed-up overseas are arriving by the tens of thousands annually.

The government dare not restrict immigration because house construction and associated activities (construction of roads, sewers, shopping malls, offices etc.) are the last leg standing of the faltering NZ economy, which is now the most indebted it has ever been.

Contrary to the perception of some commenters, Peak Oil is not 'dead'. The peak of extraction of conventional oil occurred between 2005 and 2008, and since then the global economic system has been increasingly propped up by unconventional oil obtained by fracking, extraction from tar sands and deep-water drilling etc. All of those are expensive, and are failing under the current low oil price regime. However, nations and companies desperate to maintain cash flow continue to extract oil even though the profitability has largely vanished, just as dairy farmers keep going in the hope that dairy prices will soon bounce back to where they were 2 years ago. The crunch will come between 2016 and 2020, when the fracking bubble bursts and reduced expenditure on exploration and new extraction hits hard.

The imposition of negative interest rates in several nations -most notably Japan- is indicative of where things are generally headed.

Isn't that like arguing that we hit peak electricity before wind, solar and nuclear became feasable?

I think we need to face the music. What could happen is that credit could tighten as banks recognize that there is real risk of them losing money? Tightening the conditions by which they lend without interest rate changes could happen as they realise that the world economy is at risk of implosion. Could the game change when the banks start losing money? It's simple, there's now far too much debt out there for falling world markets. If prices start to fall and you are cashed up why jump in to buy? The debt ponzi will not operate on falling markets. How low could prices go that are largely propped up by debt?

I think credit tightening has already started going by some comments I see posted
"The banks seem to be a lot pickier right now. I'm refinancing, and its going OK but they now want a lot more detail than they did in 2015."

would love to see this here JK this idea is a winner
Longstanding tax breaks for investment properties are in the frame as the Turnbull government scrambles for alternative revenue sources to fund vote-winning income tax cuts in the next election.

Raising 100bps was a huge f...up but still no accountability. Compromising growth over inflation is an old way of thinking n playing too safe. If RBNZ was a private entity, then the chances of current Governer surviving was very limited or none!

I agree, there was no sound basis to raise. Note however in the 1970s UK Labour tried to reduce un-employment/get growth with quasi-Keynesian religion, it didnt work. I agree on the "old way of thinking" as well we are post peak oil / growth. Few really see that energy and cheap energy at that plus using more and more of it was the reason for our growth for 100years.

Not sure I agree with that. GDP was +10% higher in March 2015 than it was in March 2013. Over that period the OCR went from 2.5% to 3.5%. Hardly 'compromising growth'. In fact, our economy was growing faster than could be sustained in that period.

Your view is a hindsight judgment a luxury the RBNZ does not have. If they had not acted then the armchair analysts would have bagged them with the opposite opinion to your 2016 one.