By Roger J Kerr
When RBNZ Governor, Graeme Wheeler took on his new job last year I doubt that he would have expected to have such a major dilemma so early on in his term in the hot seat.
The over-heating housing market poses a real inflationary threat, yet he knows that increasing interest rates to rein it in would only send the high NZ dollar even higher and thus damage the export sector where the economy’s income is generated.
To say that he is between a rock and a hard place is a gross understatement.
What does he do now and what implications do those decisions have on the economy later?
He is already on record as stating that the macro-prudential credit control tools that could be used instead of raising the OCR may only be effective on the margin.
The RBNZ are only now doing the consultation process on the possible new capital adequacy and mortgage LVR controls. He has to hope the threat to use such policy measures will force the banks to pull their horns in on aggressive home mortgage lending practices and thus the housing market levels off. As new house builds increase the under-supply situation and current demand pressures will slowly ease.
With all the monetary policy options available to him at this time he would have to conclude that NZ dollar currency market intervention may be his best bet as he has reasonable chance of success and the export industries can live another day if the Kiwi dollar depreciates back to the mid 0.7000’s as a result.
Only a lower NZD/USD exchange rate to the mid 0.7000’s region would provide the opportunity for the RBNZ to increase the OCR to control inflation without killing the patient with the medicine.
Currency speculators and hedge funds are perhaps less likely to take the RBNZ on in a currency showdown if global equity and commodity markets are falling and investor risk is being taken off the table.
Advice to Graeme: wait for your opportunity to strike.
While the annual inflation rate may be low now, last week’s QSBO survey results with capacity utilisation increasing again highlighted how quickly future inflationary risks can gather.
Smart monetary policy management is all about pre-emptive measures and the RBNZ know they cannot afford the get complacent about future inflation.
They know that if they can get the exchange rate down, the current tradable deflation will no longer be available to offset non-tradable price increases (building costs etc).
Inflation targeting and control through monetary policy management becomes nigh impossible in a two-speed economy where record low interest rates are driving house prices (and ultimately inflation) up in two cities while the high currency and drought is slashing incomes and spending in the provinces.
The developing housing and currency bubbles need to be deflated.
It is a real test for the new Governor to achieve that without damaging our economic recovery.
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Roger J Kerr is a partner at PwC. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com
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