It is likely the Treasury is going to have to issue more debt than planned to help the Reserve Bank (RBNZ) remove some of the “printed” money it’s injected into the financial system.
The RBNZ, in its Monetary Policy Statement released on Wednesday, confirmed that from July it will start selling $5 billion of New Zealand Government Bonds (debt) per year back to the Treasury.
The RBNZ bought $54 billion of New Zealand Government Bonds on the secondary market between March 2020 and July 2021 in order to put downward pressure on interest rates to boost inflation and employment, in line with its monetary policy mandate.
It also bought $1.8 billion of Local Government Funding Agency bonds, which it will leave to drop off its balance sheet as they mature.
While the Treasury is currently sitting on a lot of cash - $35.7 billion as at January - it may need to borrow more in the future to fund these bond buybacks.
It confirmed it will update its forecast debt issuance programme on May 19, when Budget 2022 is released.
The Treasury noted the RBNZ’s decision doesn’t influence its debt issuance plans for between now and June 30, when the current fiscal year ends.
Why this matters
Should the Treasury have to issue new bonds (as it probably will) to buy old bonds back from the RBNZ, New Zealand taxpayers will ultimately be indebted to investors (on and offshore) for Covid-related expenditure, rather than the RBNZ, as is currently the case.
More debt also equals more costs for the Treasury, particularly in a rising interest rate environment.
The other takeout is that the RBNZ selling bonds back to the Treasury could put upward pressure on interest rates.
This could mean the RBNZ might not have to increase the Official Cash Rate (OCR) by as much as would otherwise be the case. However, it is unclear at this stage how much of an impact the sell-down will have on rates.
Background
The RBNZ bought the bonds in the first place because the OCR was already very low. If the Bank cut it more, it would’ve gone into unchartered negative territory.
The RBNZ’s willingness to become a large player in the bond market was convenient for the Treasury, as it meant there was a buyer for the big wad of bonds it issued to pay for Covid-related expenses like the wage subsidy and vaccines.
Now that inflation has surpassed the RBNZ’s target range, it is trying to put upward pressure on interest rates.
The main way it is doing this is by increasing the OCR. On Wednesday, it forecast increasing the OCR by more than previously expected (to 3.4% by 2025), possibly lifting it in 50-point increments in the future, rather than the usual 25 points.
Now that the RBNZ is firmly in tightening territory, it considers it a good time to start clearing the decks/downsizing its bond holdings to make it easier for it to potentially use bond purchases again in a future downturn.
Details
The RBNZ plans to sell the bonds to the Treasury rather than other investors on the secondary market to avoid its sales distorting the market or getting in the way of the Treasury’s debt issuance plans. The Treasury has agreed to this.
When the Treasury buys the bonds back, its cash account with the RBNZ (a liability on the RBNZ’s balance sheet, known as the Crown Settlement Account), will be debited. This effectively removes the liquidity that was injected into the system when the RBNZ created money in 2020 and 2021 to buy the government bonds/credit the Treasury’s cash account.
To put the planned $5 billion per year of buybacks in perspective, pre-Covid, the Treasury expected to issue only $8 billion of New Zealand Government Bonds in the year to June 2023. In December its forecast issuance for the 2022/23 year sat at $18 billion.
Impact on interest rates unclear
While $5 billion of buybacks per year will make for notable transactions between two arms of government, the RBNZ does not want this to impact monetary conditions.
“The bond holdings will not be actively used to remove monetary stimulus,” it said in its Monetary Policy Statement.
“Bond holdings will be gradually reduced to minimise unnecessary volatility in interest rates.”
However, the RBNZ said some members of its Monetary Policy Committee “noted that some longer-term interest rates may change as the market analyses the net effect on bond supply”.
ANZ senior strategist David Croy believed the sales would put upward pressure on rates.
However, he couldn’t specify exactly what $5 billion of quantitative tightening per year equated to in terms of equivalent OCR hikes. He suspected the RBNZ didn’t know either.
He noted that while on the one hand the RBNZ said it didn’t expect its bond sales to influence monetary conditions, on the other hand it noted the sales could “put some upwards pressure on longer-term interest rates”. It said this was one of the reasons it only hiked the OCR by 25 points, not 50 points.
RBNZ’s LSAP bond holdings could hit zero by 2027
Digging further into the detail, Croy believed the RBNZ would sell its longer-dated bonds, leaving its shorter-dated ones to naturally drop off its balance sheet in the near-term.
Depending on which bonds the RBNZ sells, Croy said the LSAP programme could be fully unwound by 2027. The RBNZ alluded to this too, including the graph below in its Monetary Policy Statement. Without the sales, this point would only be reached in 2041.
All this said, the RBNZ made a disclaimer: “The Committee reserves the right to change the rate of sales or halt sales should conditions change, but do not foresee such changes to be common.”
28 Comments
Still not super sure the RBNZ actually likes lifting interest rates. We heard that the FX rate was the key driver for years and the dollar was 'overvalued' despite it sitting at the same price for about five years; at some point that's not overvalued, it's a new normal. Now that it's walking back, we're seeing big chunks of imported inflation hitting when we can least afford to, but that doesn't seem to be panicking anyone.
So I'm guessing there's still a sense the dollar is too high for their liking and they think that particular flow-on effect of big hikes is still a negative - otherwise I suspect they would be a lot bolder than they already have been. Hopefully the lower dollar is at least working out well for the rural community, even if they are going to be socked with higher input costs.
HM, I'm surprised you haven't changed your stance given the RBNZ's expectations of a much higher OCR and their tardiness to hike the OCR in meaningful ways (i.e. in 0.5% increments). You know we think alike about interest rates falling back down but yesterday's announcement delays this happening. Maybe you are commenting out of what you'd like to happen more than what reason suggests?
IO I agree, their forecast track is very unlikely to be delivered. My expectation is demand will drop away quickly as real and disposable income falls. It wasn't that long ago the RBNZ were asking banks to prepare for negative rates and then hey presto with huge monetary stimulus, shutting borders and greenflation here we are with inflation. I really think the RBNZ have lost the plot.
Te Kooti,
I would pay as much attention to the RB's forecasts as I would to a tarot reading. Orr has been a great disappointment.
By the time the OCR hits 2%, I agree with you that consumer spending will have fallen significantly. However, you cannot blame the RB for some aspects of inflation. Tradable goods inflation has risen very sharply and that is outwith their control.
This is just Mirrors and Smoke designed to confuse isnt it? First the rbnz issued loans to the govt at zero percent which the rbnz now wants to have repaid so govts treasury issues fresh debt to repay the former debt. This lot is well versed in changing the model but actually not changing anything
Man this guy at the helm of RBNZ has no idea what is he doing to the next Kiwi generation. I don't want not my kids to be indebted to the stupidity of these people.
We just need to get rid of incompetent people at the RBNZ. Do we not have any smart people left who can guide us to a better future?
They can do whatever they want, they can borrow as much as they want to violate the integrity of independence of central bank. But in the end, what really matters is:
Are we capable to pay off these debts? Do we have a robust economy to support government to service its debts so there wont be any risk for a sovereign default when the next crisis hit?
If not, then people will lose their confidence in NZD, this will result in big sellouts to push the value down, inflation up.
Indeed, Jenee. As Treasury issues new bonds to pay for the old ones, we're finally going to get price discovery on NZGBs. Markets will once again get to determine where rates should be, rather than the NZ government setting them according to political objectives.
I don't buy Orr's response to you yesterday that the OCR will do most of the heavy lifting with regards to raising interest rates, while LSAP being unwound is mostly just symbolic. If the government has to borrow in order to pay these bonds back, they will be borrowing at much higher rates.
Should the Treasury have to issue new bonds (as it probably will) to buy old bonds back from the RBNZ, New Zealand taxpayers will ultimately be indebted to investors (on and offshore) for Covid-related expenditure, rather than the RBNZ, as is currently the case.
First, Treasury redeems and extinguishes existing bonds currently lodged on the RBNZ's asset ledger when they purchase them.
Second, the Crown Settlement Account store of bank IOUs (deposits) used to purchase them are netted against the floating rate assets (RBNZ IOU liability - reserves/monetary base) owed to banks, both foreign and domestic. They are also simultaneously extinguished together with the bank IOUs.
The issuance of new bonds monetised by banks means they have been a party to an asset swap. They now own publicly tradeable coupon bearing government assets rather than inert floating rate government cash assets previously lodged at the RBNZ.
A question. Michael Reddell amongst others has stated that if marked to market, the LSAP purchases currently result in a $5-6 billion loss.
If the proposed unwinding does take place, is part of this loss crystallized, and if so, given 10% or so of holdings are involved , by how much?
And, because it hurts my aging brain cells to even think about all this, does any of it actually matter? Does it pass the 'So what?' test?
Should the Treasury have to issue new bonds (as it probably will) to buy old bonds back from the RBNZ, New Zealand taxpayers will ultimately be indebted to investors (on and offshore) for Covid-related expenditure, rather than the RBNZ, as is currently the case.
This is incorrect. The change in who holds the Govt debt will ultimately be between the holders of new bonds and commercial banks (mostly) who have settlement accounts at RBNZ. For example, $10bn of unwinding would see:
- RBNZ assets (bonds) and liabilities (settlement account deposits) decrease by $10bn (so neutral for RBNZ)
- The Crown would see an additional $10bn worth of bonds (liabilities) being held by the private sector and a $10bn decrease in liabilities to the private sector (settlement account deposits). So, again, no change in overall debt
So, ultimately the change in who owns Govt debt will be between commercial banks with deposits at RBNZ and investors who purchase bonds. Indeed, if one of those commercial banks buys and holds the newly issued bonds, then there will no change in who owns the Govt debt at all.
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