NZ Economic Update: Inflation targeting bending to financial stability

ASB Banner July 11

Key highlights:

  • RBNZ increasingly worried about housing risks, but appears to be in no hurry to take action on the financial stability front.
  • However, financial stability concerns are beginning to interfere with monetary policy decisions.
  • Not cutting the OCR will see the NZD move even higher, with exporters bearing the brunt of slow action on housing.

Inflation is going to sit below 1% for 2 years, the longest period outside the numerical inflation target range since inflation targeting began in NZ. But, with the Auckland housing market taking off again and the rest of the country following, the RBNZ appears very reluctant to cut the OCR much further. Instead, the RBNZ is putting the flexibility of the inflation target through moves that would hospitalise a circus contortionist, a stance reinforced in last week’s housing speech from Deputy Governor Grant Spencer.

It is clear that the RBNZ has been taken aback by how swiftly the Auckland housing market shook off both the Auckland investor LVR restrictions and the Government’s investor tax changes, and there is also greater wariness about what is happening beyond Auckland. The level of concern from the RBNZ has gone from noting back in March that Auckland house price growth was moderating to now having housing risks back at the top of the list and heavily influencing the stance of monetary policy.

We weren’t expecting the RBNZ to announce implementation of a fresh house-lending restriction in last Thursday evening’s speech from the Deputy Governor (we would like to believe that a communication-savvy central bank would not make such a market-sensitive announcement after NZ financial markets have closed for the day). But we were gobsmacked by the apparent lack of urgency in the speech to take macro-prudential action. The RBNZ is talking about a timeframe of putting into place new restrictions by the end of the year, and is “closely considering measures that could be progressed in the coming months”.

If the risks are large enough that they are holding back the RBNZ from cutting interest rates (as appeared to be the case in June), then the RBNZ needs to be acting to counter those risks sooner rather than later. Tightening up the Auckland investor restriction could be implemented very swiftly, for example, through a speech or media release (during NZ market hours). Meanwhile, if the NZD holds up or lifts even further, then exporters will further bear the brunt of slow action on housing.

If it wasn’t for the ever-higher NZ dollar, further OCR cuts would be off the table for the foreseeable future. But the NZD is much higher than the RBNZ has anticipated, and is trending up rather than down. And, if the RBNZ doesn’t cut the OCR any further, the NZD will likely end up even higher. Whether or not we see further OCR cuts very much depends on how the RBNZ chooses to view the long-term outlook for the NZD and on the extent to which it is prepared to tolerate a slow return to a normal inflation rate.

We are sticking to our view that the RBNZ will cut the OCR in August and November. But there is a lot of uncertainty now about whether any of those cuts eventuate, particularly if the RBNZ does indeed take its time introducing further housing restrictions.


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