Global factors make for low rates

The RBNZ’s Annual Report 2014-15 shows that while New Zealand’s economy has performed much better than many other economies, it remains subject to major challenges in the global environment.

Governor Graeme Wheeler said international forces remain a major influence on the economy.

These include large declines in commodity prices – particularly dairy and oil, low international interest rates, and record net immigration levels.

Wheeler said the RBNZ aims to support the New Zealand economy’s adjustment to these forces.

For this reason, when inflation remained below the target range and the exchange rate had not adjusted sufficiently to the decline in dairy prices, the RBNZ made cuts to the OCR, starting in June.

“The decision to cut interest rates was aimed at buffering the decline in the terms of trade and contributing to moving inflation back towards the mid-point of the target range,” Wheeler said.

However, statistical data revisions suggested that capacity pressures were less than forecast.

The report stated the RBNZ also remains conscious of the impact that low interest rates and aggressive lending competition among banks might have on house price inflation.

Economists have speculated that these factors mean the RBNZ will hold the OCR at 2.75% in October.

NZIER senior economist Christina Leung doesn’t see the RBNZ cutting the OCR in October, although she thinks interest rates should remain low for the coming year.

The RBNZ has indicated that a further OCR cut is likely at some point, she said.

“But they will want to reserve some ammunition. Economic activity has softened but not to the degree that emergency intervention is needed.

“The Reserve Bank will want to keep some fire power in case of a real emergency situation.

Leung said that, while the dairy sector remains a key risk and there are downside pressures, there are lots of positives in the New Zealand economy.

“The sharp depreciation in the New Zealand dollar has helped buffer the decline in dairy prices and boosted activity in other export industries, like tourism.

Until there is a sustained pick-up in inflation, the OCR is unlikely to be going up any time soon, Leung added.

Westpac’s economists have also said they expect the Reserve Bank to pause at the October OCR review, before delivering a cut in December.

ANZ economists have said that, like the RBNZ, they believe the risks are skewed lower, and all else equal, that implies lower short-term interest rates.

The main focus of the RBNZ’s annual report was on how well the bank achieved its strategic goals over the last year plus its accounts, but it also touched on the fast-approaching LVR restrictions.

Wheeler said the bank remains concerned about the financial stability risks that could come from a major correction in Auckland house prices. 

A strong supply response over several years is needed to address Auckland’s housing imbalance, but macro-prudential policies will help, he said.

“The LVR measures and the Government’s tax policy initiatives should begin to ease the impact of heightened investor activity and help lower the financial and economic risks while important regulatory and infrastructure issues are addressed and additional investment in new housing takes place."