Reserve Bank Chief Economist Yuong Ha says the emergence of the Omicron variant of Covid-19 hasn’t changed the central bank’s outlook when it comes to the way it sets monetary policy.
“It hasn’t fundamentally changed our picture. It’s just reinforced that there are still huge uncertainties and big risks on both sides to our employment and inflation outlook,” Ha told interest.co.nz.
“There is still a lot of uncertainty that we see, but we are starting from a position where the economy by and large has weathered the worst of the Covid storm and is in a pretty resilient position in terms of both the inflation outlook and the employment outlook.”
Asked how effective higher interest rates can be in suppressing inflation, when much of this pressure is coming from supply chain blockages, which might be exacerbated by Omicron, Ha said: “The global shortages are simply adding to a domestic economy that’s already running above potential.”
Ha recognised Omicron will add volatility to market interest rates, but questioned whether it will be enough to “unseat” upward pressure on rates stemming from higher inflation expectations.
Ha’s comments follow the RBNZ last week lifting the Official Cash Rate (OCR) by 25 points to 0.75%, and signalling its intention to keep lifting the rate in small increments for now.
Ha said the RBNZ is “pretty comfortable with where monetary conditions are sitting”.
He noted market rates had increased “quite significantly” between the RBNZ releasing its August and November Monetary Policy Statements, and said this was “broadly in line” with how the RBNZ’s outlook for the economy had evolved.
RBNZ can only sell its NZ Govt Bonds back to the Government
Ha reiterated what the RBNZ said in its Monetary Policy Statement - that the RBNZ intends to reduce the size of its New Zealand Government Bond holdings.
The RBNZ bought $53.5 billion of New Zealand Government Bonds between March 2020 and July 2021 via its Large-Scale Asset Purchase (LSAP) programme, otherwise known as quantitative easing.
It bought these bonds via the secondary market to lower interest rates and support smooth market functioning at a time Treasury’s Debt Management Office was issuing a lot of debt to fund the Covid-19 recovery.
The RBNZ now plans to gradually manage down its bond holdings, all the while using the OCR as its main lever to adjust monetary policy.
It can do so by selling its bonds and/or letting them roll off its portfolio when they mature. It can also reinvest some of the proceeds when the bonds mature to smooth the downsizing of its portfolio.
However, Ha made the little-discussed point that under the indemnity provided to the RBNZ by the finance minister when it launched its LSAP programme, the RBNZ is required to sell any New Zealand Government Bonds back to Treasury’s Debt Management Office.
If the RBNZ chooses to sell its government bonds, it can’t sell them on the open market to the banks and fund managers it bought them from.
Ha explained the reasoning behind this is to ensure the market functions smoothly.
The market could become distorted if Debt Management was issuing new bonds while the RBNZ was trying to offload its massive portfolio.
“It’s about being co-ordinated and understanding our impact on market functioning,” Ha said.
“The idea of whether we actively sell the bonds - we haven’t actually discussed what that would look like yet.”
He said the fact the RBNZ is still working through the logistics of how it could sell the bonds isn’t a sign that it isn’t keen on this option. It isn’t ruling active bond sales in or out at this stage.
QE hard to unwind
ANZ senior strategist David Croy, in a recent research note, said there’s no urgency for the RBNZ to detail its plans for reducing its bond portfolio, as the next major tranche of bonds (worth $7.7 billion) doesn’t mature until 2023.
He said it will be more difficult for the RBNZ to pull off quantitative tightening (QT) than it was to embark on quantitative easing (QE).
“QE was only supposed to be temporary and as it morphs into QT, that will bring with it a reduction in liquidity… It is akin to the “printed money” being “burnt”,” Croy said.
“It is not clear what impact QT will have on the economy, but historic international experience and logic suggest that it will have a negative impact on growth, and that could temper the need (or the ability) for the OCR to go higher.
“In essence, QT could see longer-term interest rates rise (which affect business and the government more), leaving less room for short-term interest rates (which affect households more) to rise.”
Detail on how the RBNZ and Debt Management need to co-ordinate
Coming back to the logistics that Debt Management and the RBNZ need to work through, Croy said, “If the RBNZ decides to go down the road of allowing its bonds to simply roll off, this will have little bearing on NZDM’s [NZ Debt Management] funding needs into the future. That’s because NZDM’s issuance projections already incorporate the need to repay all maturing bonds, whether they are held by the public or by the RBNZ.
“But if the RBNZ does elect to partially or fully roll over its holdings at each maturity date, it will reduce the refinancing burden that would otherwise fall on the market.
“Similarly, the impact that unwinding QE will have on the Settlement Cash Level [the Government’s cash account with the RBNZ] will depend not just on how many bonds the RBNZ elects to roll off or sell, but also on how much cash the Treasury is sitting on, how much it wants to keep on reserve as a buffer, and how much needs to be funded via taxes or borrowing.”
Interest.co.nz also asked Ha about his upcoming departure from the RBNZ, and how the organisation has changed over the 25 years he has been there. Listen to his response towards the end of the video interview.