Opinion: The Reserve Bank might have just avoided itself a whole heap of trouble as the election looms

Election year 2014 could potentially have been a very bad one for the Reserve Bank.

But in my view the central bank has so far this year played a bit of a blinder. Keeping the sports analogy going, it has displayed the kind of nimble footwork that makes Lionel Messi widely regarded as currently the best thing to kick a piece of leather (or whatever the balls are made out of these days) around a football field.

As 2013 gave way to 2014 the RBNZ faced two huge issues that could have put it slap bang into the middle of the election campaign; firstly its introduction in October last year of 'speed limits' on high loan-to-value lending and secondly, the fact that it was faced with a need to raise interest rates this year.

Now government agencies are supposed to be a-political; that is, they don't favour the policies of either side. But it they are smart they will certainly be political in the sense that they will have a good appreciation of when policies they are espousing might put them in the centre of the debate.

I suspect that Governor Graeme Wheeler, bearing in mind he's been in this job only since September 2012 and so he's probably still learning, was taken aback at the public response to the LVRs move. What to his mind was a practical step to protect financial stability and into the bargain maybe cool that pesky overheating Auckland property market became immediately the worst of things, the political football.  The message is: Don't mess with the New Zealand housing market or the perceived right of all Kiwis to own their own homes.

So, as we came into this year, we had a central bank sitting on two toxic policies - the nasty LVRs and the nasty upcoming decisions to raise interest rates. These two things headed in the same direction: An election campaign punctuated by pictures of doe-eyed couples clutching babies, standing outside a house they couldn't afford.

The National Party kept its hands off the RBNZ when the LVRs were introduced - but still made it clear it wasn't a fan and that it would have liked the first home buyers exempt. The Labour Party's promising changes to the RBNZ's mandate.

Houses are a huge part of the NZ psyche. The election campaign could have been a battle of housing policies (and might still be to a fair degree). But the RBNZ has now got itself the leeway to wriggle out of the middle of the arguments and save itself from being a political punchbag.

That it is in this position is due in large part to the LVRs policy having worked spectacularly better than, certainly the average run of the mill economist expected. The banks, having been growled at over their expansionary high-LVR lending policies, have retreated to their corners - with the 10% limit on such lending set to be well and truly met when the first measurement is made at the end of this month. Having the LVR policy linked to the banks' conditions of registration has clearly assisted in providing clarity of thinking for the banks - IE that this is a rule they can't break.

It's probably therefore not surprising at all that the banks have moved into line.

But what is surprising is that the LVR policy really does seem to have dampened the housing market. The RBNZ's figures so far suggest a 2.1% reduction in house price inflation since September - which is very much in the mix regarding the central bank's earlier picks of a 1-4% effect across the first year of the LVR policy.

Also, the RBNZ earlier picked that the effect of the policy could equate to a reduction of about 30 basis points in Official Cash Rate rises. In other words, the presence of LVRs would mean that the OCR would need lifting by 30 basis points less than would otherwise be required.

In his speech this week Deputy Governor Grant Spencer said the current estimates were that the LVR policy effect was worth about 25 to 50 basis points of OCR rises. Take the mid-point of that and you get 37.5 basis points, which suggests that just maybe the LVR policy is so far proving a little bit more successful than the RBNZ had thought.

Remember, there was widespread scepticism outside of the RBNZ that the policy would have much impact at all. So, thus far, our central bank can tentatively chalk up a win here.

Does it therefore mean that the policy can now be removed?

It's worth looking at the exact text in the Spencer speech that refers to this, so it's included in full here:

In this regard, as interest rates move back to more normal levels, we will expect to have greater scope to ease or remove the LVR restrictions.

The Reserve Bank stated from the outset that the LVR restrictions are not intended to be permanent.

They will be removed once housing market pressures have moderated and when we are confident there will not be a resurgence in house price inflation.

But how should the exit be coordinated with the expected OCR tightening cycle?

The factors to consider include: 

• The degree of moderation achieved in rates of house price inflation and credit expansion; 
• Factors that might affect the potential for a resurgence in house price inflation following the removal of the LVRs, such as the dampening effect of increased housing supply and mortgage rates, and the stimulatory effect of higher net immigration flows; 
• Any distortions or inefficiencies that become apparent as a result of the policy.

A decision to ease or remove LVR restrictions will ultimately take into account both the financial stability and price stability implications of doing so.

We will be alert to the risk that the removal of LVR restrictions could produce a resurgence in house price inflation, which would potentially undermine both financial and price stability.  

Reserve Bank communications with the wider public tend to be nuanced beyond nuances. They take the art of 'raised eyebrow' communication to a whole new level. Generally there will be a message that is being communicated without being communicated in as many words. So, the audience has to look at which eyebrow is raised and in which direction it is arching, in order to determine what's being said.

So, in this latest speech did Deputy Governor Spencer say that the LVRs are about to be lifted? Or did he just have an itchy nose that prompted him to arch his eyebrows?

The key part of the above text for me is the sentence: In this regard, as interest rates move back to more normal levels, we will expect to have greater scope to ease or remove the LVR restrictions.

To narrow it down further, the real crucial bit is probably the term "as interest rates move back to more normal levels". Does this mean the RBNZ waits till official rates get back to the perceived 'neutral' level of around 4.5% in 2016 - as a colleague I spoke to while writing this thought?

Or does it mean the RBNZ is free to lift the LVR limits at any stage as it is moving the rates more back toward those neutral levels?

I reckon it is the latter. And I'm going to stick with my earlier view that the LVRs will be lifted some day quite soon.

Why? Well, if it lifts the LVR limit now the RBNZ can claim success. The house market has been dampened and the banks have backed off from their high levels of high-LVR lending. Now, yes the RBNZ would have to be concerned about what the banks would do once the LVRs are gone. But remember, it can bring them back at very short notice. The other interesting point to note is that the banks appear to have surprised themselves at their success in attracting increased levels of low-LVR lending and maybe won't be as inclined in any case to go quite so gangbusters at the high-LVR end of the market once the limits are lifted.

And of course the other reason why the RBNZ can lift the LVR limits right now is that it is in the midst of raising interest rates - the heavy lifting tool that is guaranteed to dampen a rising house market, albeit that it can sometimes take more time than anticipated.

So, if the LVRs are gone by the middle of the year that is one political weapon that cannot be wielded in the run-up to the September 20 election.

What about interest rates themselves then? Well, doe-eyed couples and babies can certainly be brought out for the cameras by rising interest rates too. LVRs don't have the monopoly on that.

But perhaps the RBNZ has caught a bit of a break with the timing of the election. By having the election in September, rather than the usually expected November, it means that the central bank actually has two OCR reviews between this year's election and Christmas.

The expectation at the moment is for 125 basis points worth of rises this year. With the way the election is falling now, the RBNZ could put rates up in both the April and June reviews, giving 75 basis points worth of rises so far this year, and then holster its guns till after the election - again removing a very useful political football.

After the election the RBNZ could then come back in with two more rises before Christmas, giving it the full 125 basis points of rises. Or would it consider lifting rates by less? Perhaps just 100? We don't after all know exactly when the central bank concluded, as per the Spencer speech, that the LVRs might have had the bang of as much of 50 basis points on the OCR. If this information has been garnered subsequent to the last OCR review on March 13, then maybe the RBNZ is considering a slightly lighter hiking cycle for this year. That's purely conjecture though.

What all this means, however, is that the central bank appears to have worked its way very nicely out of a tight corner. It can be seen to have done its job without landing itself and its actions right in the middle of the election campaign.

Personally, I think that's a very good thing. Having an independent central bank free of direct government meddling is something we should cherish. Presumably the people at that central bank also cherish such independence. And the way things have panned out for them so far this year bode well for the preservation of the status quo.