A Review of the RBNZ’s Annual Statement of Intent

30 June 2016, 09:51
Sherif Hasan

Let’s step back from all this Brexit hubbub and constant focus on the pound, shall we? Having said that, the Reserve Bank of New Zealand (RBNZ) released its annual Statement of Intent (SOI) earlier.

Great, but what is it and what does it have to do with the forex market, you ask? Well, as you (hopefully) learned from our school’s lesson on Why Interest Rates Matter for Forex Traders, central bank biases and decisions make the forex world go round most of the time… unless there are other major risk events like Brexit, of course. And the SOI, according to the RBNZ, “sets out the objectives for the next three years and the budget for the first year of that period. The SOI also details the Bank’s strategic priorities for the next financial year.” In short, it tells us what the RBNZ will be focusing on and what it plans to do.

On New Zealand’s economy

According to the RBNZ, New Zealand’s economy expanded by 2.3% in 2015, which is a solid pace of growth and “in line with the average pace of expansion since 2010.” This steady growth “has been supported by a low policy rate, high house price inflation, strong inward migration, continued construction growth and a decline in the exchange rate since April 2015.”

The RBNZ also noted that despite solid economic growth with “spare capacity near zero,” inflation remained well below the RBNZ’s 1-3% target. The RBNZ attributed this to “an elevated exchange rate, falls in oil prices and spare capacity in the global economy,” as well as “stronger-than-expected growth in labour supply” that has dampened wages and consumer spending, which then weakened domestic inflationary pressure.

The RBNZ then lamented that it has already cut the key policy rate by 125 basis points since the start of 2015, and yet inflation remained persistently low. And since the RBNZ is cautiously upbeat on the economy, and having identified low inflation as a major and persistent problem, the RBNZ said its usual mantra that “Further policy easing may be required to ensure that future average inflation settles near the middle of the target range.”

After that, the RBNZ announced that it will keep a close eye on the following key developments:

  • whether inflation expectations fall further as a result of recent weak inflation and become embedded in price and wage setting behaviour
  • developments in the Chinese and emerging Asian economies as they affect global financial market volatility and the New Zealand economy through trade and the exchange rate
  • global dairy prices and their effects on farm incomes and the wider economy
  • high net immigration in New Zealand and the net demand impact on the economy
  • demand and supply imbalances in the housing market
  • weak world demand and how this affects oil and other import prices over the medium term

Interest rate junkies may wanna monitor the above, since those are the key events that are most likely to affect the RBNZ’s views on inflation, which would then affect the RBNZ’s monetary policy decision.

On the financial market

The RBNZ noted that liquidity in the global financial markets have been reduced, “driven by changes to bank and financial intermediary business models, deteriorating profit outlooks and an increased focus on the efficient use of capital.” As such, liquidity in New Zealand’s financial markets have also decreased.

This doesn’t seem all that noteworthy at first glance, but it gets more interesting if you compare it to last year’s SOI and notice that the RBNZ added the following to its financial market function (emphasis mine):

“enhancing the Bank’s ability to respond with appropriate operational liquidity facilities for New Zealand banks, ensuring an operating environment that can withstand anticipated shocks, as well as flexibility to contain unexpected shocks in both offshore and local markets.”

The highlighted part means that the RBNZ is ready to intervene. And this probably includes intervening in the forex market because as stated in its scope of operations for monetary policy formulation, the RBNZ can “where appropriate and feasible, intervene in the foreign exchange market to influence the level of the exchange rate, consistent with the objectives of the Policy Targets Agreement.”

But, as I discussed in my write-up on the June RBNZ statement, RBNZ Boss-Man Wheeler admitted that the RBNZ’s ability to intervene in the forex market is limited. Wheeler also said, however, that the RBNZ will only trigger its intervention system during times of limited liquidity when an intervention can be most effective. And maybe it’s just a coincidence, but the RBNZ said that liquidity is drying up, as I noted earlier.

On macro-financial stability

The RBNZ was practically bragging when it said that:

“From a financial stability perspective, New Zealand’s financial system remains sound and well placed to support economic expansion. New Zealand banks are well capitalised, funding and liquidity buffers are above required minimums, and profitability is strong.”

However, the RBNZ also expressed concern over signs that house prices in Auckland are beginning to pick up again, not to mention rapidly rising house prices in other parts of New Zealand. The RBNZ blamed this mainly on low mortgage interest rates, which implies that the RBNZ is reluctant to cut further since cutting rates would only encourage even more borrowing and increase the risk of a housing bubble.

Other than rising house prices, the RBNZ also singled out low global milk prices as a major risk factor since it created “significant financial pressures for dairy farms, with a significant proportion of the sector facing a third consecutive season of operating losses.” This is bad because it would lead to an increase in non-performing loans, and one way to alleviate this is to cut rates further.

The RBNZ is therefore faced with a dilemma: if it cuts rates to aid the dairy sector, the threat of a housing bubble become more real, but if it doesn’t, New Zealand’s dairy farmers and lending institutions are going to suffer.

The RBNZ didn’t offer an immediate plan of action, but it said that it is exploring other macro-prudential tools to limit housing demand, and it also plans to assess the resilience of the banking system in light of the aforementioned risks.

On Brexit

None. Nada. Next!

On the Kiwi

Other than expressing its disappointment that the recent rise in the Kiwi is weighing down on inflation, the RBNZ didn’t really talk about the Kiwi much. The RBNZ also refrained from discussing the potential effects of a Brexit or what the RBNZ plans to do about it.

Luckily for us, New Zealand Finance Minister Bill English was interviewed by Bloomberg earlier, and he talked about both. Specifically, he said that if uncertainty and turmoil over Brexit continues, then New Zealand is “in a very small group of countries – the others being Iceland, South Korea and Australia – that have got a combination of reasonable government finances, a reasonable growth path, and room for interest rates to move.” He then added that “Relative yield in New Zealand just remains better, and that’s held up longer and stronger than people might have expected.” He’s basically saying that New Zealand would attract more investors because of its relatively strong fundamentals, which would naturally mean a stronger Kiwi.

And as you may or may not know, the Kiwi is actually the third best-performing major currency of the year as of yesterday (June 28, 2016), losing out only to the safe-haven yen and the Loonie. And in the Loonie’s case, all you have to do is check out your charts to see that NZD/CAD has been steadily rising after bottoming out back in April, so there seems to be steady and broad-based demand for the Kiwi, even though most market analysts don’t really talk about it.

The Kiwi’s relatively strong performance is bad enough, but if the Finance Minister’s expectations that investors will go to New Zealand do come true, and the Kiwi continues to appreciate, the RBNZ may need to do something to curb the Kiwi’s strength in order to limit the deflationary effects, as well as to help the export-oriented dairy sector. The RBNZ heavily implied that it’s reluctant to cut rates further, however, since that would only pump more air into a possible housing bubble. But it also implied that it had other tools, which includes currency intervention.

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