By Bernard Hickey
Reserve Bank Governor Graeme Wheeler has mounted a strong argument against calls to cut interest rates any time soon, saying the economy remained strong and there were still risks to financial stability and the wider economy from Auckland's resurgent housing market.
Calls for the Reserve Bank to cut its Official Cash Rate from 3.5% have grown in recent weeks as headline inflation has turned to deflation and other central banks eased monetary policy, including the Reserve Bank of Australia yesterday. Financial markets have also begun pricing in an OCR cut as early as March.
Wheeler used his first full speech of 2015 to push back against the calls and to warn again about the financial risks of high house price inflation.
However, he stopped short of suggesting new high LVR-style Macro-Prudential controls to slow the housing market, but he said the central bank was monitoring the role of the banking system in the housing market.
Housing over-valued
Wheeler spent some time looking at the housing market and how over-valued it was.
"Our concern about house price inflation is based on the risk it poses to financial stability and the broader economy," Wheeler said.
He pointed to IMF research from 2013 showing New Zealand having the second largest deviation from its historic average in the world behind Norway.
"Although it has not been a major factor in recent years, high rates of house price inflation can spill over into stronger spending and pressure on consumer price inflation. And the more that house prices get out of line with historic relativities, the greater the risk of a sharp correction, leading to financial instability," he said.
He said the bank would talk more about housing over the next few months.
Rate cut calls addressed
Wheeler directly addressed the rate cut calls in his speech.
"Some commentators have suggested that a cut in interest rates would be appropriate at this stage," said, noting that a major supply side shock such as lower oil prices could be an appropriate reason for a cut, as could a deterioration of domestic demand.
“However, in our current situation there are important considerations why a period of OCR stability is the most prudent option," Wheeler said.
“Commodity price declines reduce headline inflation for a period, but do not deliver a sustained decline in inflation. Weak or negative headline inflation is not reflective of underlying cost pressure in the non-tradables sector of the economy, and our medium-term forecasts and measures of core inflation are well within the target band," he said.
“New Zealand is the only country among the advanced economies that has had a positive output gap in the past two years, our unemployment rate is low and falling, net inward migration and labour force participation is at record levels, and business and consumer confidence surveys remain strong," he said.
"In addition, we have already seen some effective easing of credit conditions with declines in fixed-rate mortgages, at a time when we have financial stability concerns about accelerating house prices in Auckland." On the other side of the coin, Wheeler said the bank would need to be confident that capacity utilisation and labour market pressures were generating, or about to generate, a substantial increase in inflation before it could consider a rate hike.
The New Zealand dollar rose around half a US cent to 73.8 USc immediately after the speech, which appeared to hose down growing speculation about an imminent cut.
House price warning
Wheeler said the bank’s concern about house price inflation was based on the risk it posed to financial stability and the broader economy.
"Its focus is mainly on the Auckland and Christchurch markets, where the housing shortages are greatest and where market pressures are the most intense," he said, noting house price inflation appeared to be increasing again in Auckland.
“Resolving the housing shortages is key. In Christchurch, this issue is expected to be resolved, although with longer delays. But in Auckland, much more needs to be done, especially in creating opportunities for residential construction in Auckland," he said.
“We will continue to monitor housing developments carefully, and the role that the banking system may be playing in contributing to pricing pressures in the housing market.”
Exchange rate warning
Wheeler repeated his comments in multiple recent OCR statements and MPS statements that the New Zealand dollar was unjustifiably and unsustainably high.
"We believe that, over time, New Zealand’s growth differentials will narrow vis a vis the advanced economies, making the New Zealand dollar more likely to undergo a significant downward adjustment," he said.
Economist reaction
ASB Chief Economist Nick Tuffley said there were no details in the speech to show the Reserve Bank was seriously considering a rate cut in March.
"In verbal comments the Governor noted that non-tradable inflation and house prices are shaping the Bank’s thinking," Wheeler said.
ANZ Senior Economist Mark Smith said the Reserve Bank had stayed on message and there were limited market implications from the speech.
Westpac Chief Economist Dominick Stephens said the speech had poured cold water on financial market speculation about rate cuts.
"We suspect that some market participants (wrongly) interpreted last week's OCR Review as a gate-opener to imminent cuts," Stephens said.
"Consequently, this speech was a "hawkish" surprise relative to the median market expectation," he said, adding markets had priced out any chance of a March cut and the two-year swap rate had risen four basis points.
Some still saw the speech as opening the door for cuts, particularly in the wake of Australia's surprise cut. TD Securities Economist Annette Beacher said the speech may have been netural, but "they could be the next central bank to cut."
"Inflation has tipped into deflation and New Zealand’s real yields are some of the highest in the developed world. We now expect consecutive 25bp cuts in March and April to 3% if the RBNZ is serious about keeping the NZD under pressure," Beacher said.
"Today’s speech buys the RBNZ time to adjust to the new “central bank” world of 2015, where they say one thing and do another. We add the RBA to the growing list that includes the SNB, Bank of Canada and the MAS," she said.
Political reaction
Labour Finance Spokesman Grant Robertson said the Government had failed to deal with the housing crisis and had effectively outsourced it to the Reserve Bank.
“But Governor Graeme Wheeler clearly expects the Government to do its duty by saying today: ‘Resolving the housing shortages is key… in Auckland, much more needs to be done, especially in creating opportunities for residential construction’," Robertson said.
“In the diplomatic language of the Reserve Bank this means: ‘pull your weight Mr Key’. The Government should not leave the housing crisis to the Reserve Bank. John Key needs to build more houses in Auckland," he said.
(Updated with market reaction, more detail, political reaction)
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