RBNZ holds OCR at 2.5%, but warns of imbalances (Update 5)

The Reserve Bank of New Zealand has held the Official Cash Rate (OCR) at a record low of 2.5% and has renewed its pledge to keep it at or below that level until the latter part of 2010. (Update 5 with comments from Bollard at Parliament's Finance and Expenditure Committee hearing in Wellington). But Reserve Bank Governor Alan Bollard took the unusual step of warning any economic recovery was likely to be patchy and unsustainable if the exchange rate kept appreciating and the housing market recovery undermined any improvement in household savings. Click here to see a replay of the press conference held at the Reserve bank this morning. "For growth to be sustained in the medium term there is a need for improved competitiveness in the export sector and a continued recovery in household savings," Bollard said in a statement with the RBNZ's September quarter Monetary Policy Statement. "This rebalancing is required to stabilise New Zealand's external payments position," Bollard said. "If the exchange rate were to continue its recent appreciation and/or the recovery in house prices were to undermine the improvement in household savings, then the sustainability of the present recovery will be brought into question," he said.

Meanwhile the RBNZ said in its quarterly update of economic forecasts there was more evidence the decline in economic activity was coming to an end "and that the patchy recovery is underway." This was partly due to a recovery in New Zealand's trading partner economies in the June quarter, which was likely to continue in the short term, it said. "Domestically, retail spending appears to have stopped falling, following a rise in net immigration and a pickup in the housing market in recent months," Bollard said, noting however that the medium term growth outlook looked weak. "We expect household spending to grow only modestly given weak income growth and a reduced appetite to take on debt," he said. "Business profits are under pressure because of the low level of activity and the elevated New Zealand dollar; this limits the scope for employment and investment to rebound quickly." Bollard said annual inflation was well within the 1-3% target band and was expected to track comfortably within the band over the medium term. "As we have said previously, the forecast recovery in economic activity is based on monetary policy continuing to provide substantial support to the economy. We expect such support will be needed for some time. As a result, we continue to expect to keep the OCR at or below the current level through the latter part of 2010." What I think Alan Bollard has rightly warned about the economy's imbalances threatening any recovery in the long term, but he has done nothing about it.  New Zealand's property obsessed populace are making the same mistakes all over again, aided and abetted by banks scared of lending to business. New Zealand's banks lent over NZ$6 billion to farmers and homebuyers in the first eight months of 2009, yet reduced lending to businesses by NZ$3 billion. New Zealand's current account deficit is still rising and the nation is still sucking in foreign debt to pump up property prices. Sound familiar? This nation has learnt nothing despite all the tellings off by our headmasters at the Reserve Bank, Treasury and the ratings agencies. Yet Bollard still appears to be doing nothing. He could fire a shot across the bows of the housing market by warning of rate rises to come sooner rather than later. He could have stopped it in its tracks by putting up interest rates. Instead he is holding the Official Cash Rate at a record low of 2.5% and promising to keep it there for another 12 months. He is adding fuel to the fire. Critics would argue any hike in the OCR would simply push the New Zealand dollar higher and make the imbalances worse. I doubt that. The currency markets are utterly focused on US dollar weakness and the overall global outlook. They have already priced in tighter Australian monetary policy and we're just along for the ride. Markets already believe Bollard will have to hike the OCR by early next year, not the latter part of 2010 that he has pledged. Bollard could also suggest a tightening of rules about capital adequacy for banks to discourage them from lending so heavily to farmers and home buyers, but he has given no indication he will do that. Bollard appears to be comfortable as a spectator to a slow motion action replay of an economic car crash that he has seen before. Why won't he do something about it? It is clear since the June Monetary Policy Statement that the housing market is firing up again. Auctions are full and clearance rates are down. Open homes are chocka-block with eager buyers brandishing their mortgage approvals at 5.5% interest rates. It's amazing what you think you can afford when you believe interest rates will stay low for the foreseeable future (which for most people is about 2 years). Inaction by the Reserve Bank simply invites the inevitable sovereign credit rating downgrades and a loss of international investor confidence that will provoke a much harder landing in years to come. Is that our only hope? Perhaps Bollard should simply ask for the ratings agency to hit the fast forward button and downgrade us sooner rather than later. That seems to be the only way this version of economic "˜deja-vu' will end. Bollard seems intent on doing nothing himself. ASB economist Jane Turner Turner said a key change in Bollard's statement was "walking away from the beefed up easing bias of July."

Another is that, despite substantially tighter monetary conditions, the inflation outlook has not fallen - in other words the RBNZ's assessment of underlying inflation pressures has been lifted substantially. We expect the RBNZ will hike by June next year (previously July). However, the risks are skewed to an earlier start. The main implication of today's MPS is that the RBNZ is very unlikely to stand in the way of any further climbs in the NZD and wholesale interest rates. In the absence of a circuit breaker we expect those rates to continue trending up. The door to relatively low fixed-term rates will steadily close up, though short-term rates will remain low for 6 months or so. The RBNZ's next policy challenge will then be backing away from the expectation that it won't lift the OCR until the latter part of 2010. Doing so will be interpreted (rightly or wrongly) as a signal the start of the tightening cycle is only a few meetings away.

JP Morgan economist Helen Kevans Kevans said a key argument not to lower the OCR any further would be if consumers reverted to their old 'borrow and spend habits'.

While the RBNZ will likely maintain its current dovish tone in the statements accompanying the upcoming October and December OCR announcements, we do expect that Bollard will shift away from the current easing bias in early 2010. The RBNZ said today that "until the risks and uncertainties about the outlook have acceptably reduced we anticipate keeping the OCR low." By year-end, though, we believe the synchronized global economic recovery will be gathering steam, and the domestic economy would have begun to expand; thus, we maintain our forecast that the first OCR rate hike will be delivered in July next year. The RBNZ maintained its forecast that a recovery will get underway in New Zealand toward year end. This is in line with our forecast which calls for positive GDP growth in 4Q09, following seven straight quarters of decline. The RBNZ said, though, that the forecast economic recovery is based on an easing in monetary conditions, which have tightened considerably thanks to NZD appreciation (chart). If monetary conditions fail to ease, the recovery forecast to get underway later this year will be "put at risk" and the RBNZ would need to "reassess policy settings." Indeed, stronger NZD is the main risk to an imminent recovery. NZD has gained more than 4% against USD since the last OCR decision, so it was no surprise that Bollard again today voiced his anxiety about continued NZD strength. The high currency is hampering a prospective export-led recovery and the much-needed rebalancing of growth away from debt-fuelled household spending, a rebalancing needed to promote a sustainable recovery. In recent months, the Governor has oft voiced his concerns that, amid signs that the prolonged downturn in the economy has bottomed, consumers may revert to their old "borrow to spend" habits; this, we believe is a key argument not to lower interest rates any further.

Bollard talks at FEC Reserve Bank Governor Alan Bollard appeared before Parliament's Finance and Expenditure Committee later on Thursday. He made the following comments. These are repeats of Tweets and I will fill out with fuller quotes later. RBNZ's Bollard tells parliamentary committee that he didn't want to cut the OCR again as wanted to avoid fueling housing market bubble RBNZ's Bollard says he looked at cutting the OCR but decided it wouldn't have much impact on dragging the NZ dollar lower RBNZ's  Bollard says would like to see flattening of tax structure around housing investment RBNZ's Bollard says most obvious part of tax structure to look at is property investors 'flicking on' properties for tax reasons RBNZ's Bollard says not keen on using capital adequacy rules to slow bank lending into housing market RBNZ's Bollard says capital adequacy rules not very sophisticated tool RBNZ's Bollard says will watch the outcome of Government's Tax Working Group closely RBNZ's Bollard says disappointed global financial reform won't include freeing up of currencies 'hiding behind US$'