Election 2017 scenarios and implications: interest rates
This weekend's election result could come in three flavours of new Government. Bernard Hickey analyses the implications for interest rates of each.
Now the parties have released almost all their policies and the smoke is clearing around the polls just days from the election, it's worth looking at what the three different flavours of potential new Governments might mean for businesses and consumers, including firstly for monetary policy.
There is still the small chance National will be re-elected with its current support partners to repeat the current formulation of Government for a fourth term. But National's fall in the polls and the departure of Peter Dunne make that increasingly unlikely and its policy formulation is well-known.
So in the next couple of days I'll focus on the key differences in the policy mixes of the following three options:
A Labour-led Government with a supply and confidence agreement with New Zealand First.
A National-led Government with a supply and confidence agreement with New Zealand First.
A Labour-led Government with supply and confidence agreements with the Green and Maori parties.
Interest rates will not rise more
One concern some in business and people with big mortgages have is that a change of Government might blow out debt, push up interest rates and undermine foreign investor confidence. National has certainly focused on that fear.
That is not justified given the current fiscal plans agreed to by the major opposition parties and the mood on global markets right now.
Labour's fiscal plans involve increasing net debt by around $7 billion more than the existing Government's plans to a peak of $68 billion by 2019/20, before reducing debt to $67.5 billion and 20 percent of GDP by 2021/22 from 23 percent this year. That means Labour is reaching the 20 percent threshold two years slower than National. Labour is forecasting surpluses would rise from $2.5 billion this year to $6.6 billion in 2021/22.
Bill English argued on Sunday that Labour's plans would increase interest rates beyond the increase already expected by the Government. (Treasury is already forecasting 150 basis points of rate hikes by 2021, although this is a more aggressive forecast than the Reserve Bank's own forecast for just one 25 basis point hike by late 2020).
But as former Reserve Bank economist Michael Reddell pointed out this week, National's own forecast is for rising interest rates. He also cited research from Adrian Orr (now NZ Super Fund CEO) and Paul Conway (now Productivity Commission Economics and Research Director) in 2002 that suggested that Labour's relative increase in the net debt track would increase long term bond yields by one basis point. That's 0.01 percent.
Currently, the New Zealand 10 year Government bond yield is 2.50 percent and down from as high as 3.02 percent at the end of last year. It is also down from 2.62 percent since the start of the campaign. It is also down from just over 7.0 percent at the end of 2007. Most other OECD countries have much higher debt to GDP ratios and international bond investors see a percentage point or two difference as neither here nor there.
Global investors are not concerned about potential for a change of government. The New Zealand dollar has been slightly more volatile in recent weeks, but remains entrenched in range from 71.5 USc to 73 USc. Compared to the volatility of the pound and the US dollar during the Brexit and Trump elections, the Kiwi is dollar is becalmed, despite the reports of the currency 'plunging' or 'spiking' on various polls results.
English argued on Sunday that New Zealand First's largely uncosted and expensive fiscal policies (which include forgiving student loans for graduates who stay in New Zealand, removing GST from food, employing an extra 1,800 police officers and returning GST from tourists to councils) would also blow out any Labour-led Government's debt.
Firstly, Labour would have to agree to those policies, which it would be unlikely to do without New Zealand First gaining a much bigger share of the vote than the six to eight percent currently indicated by the polls. Secondly, National would also face those same pressures.
Labour and the Greens have also agreed a fiscal responsibility pact that includes remaining in surplus through the economic cycle and reducing net debt to 20 percent of GDP by 2021/22. The Green Party reaffirmed that commitment with its final fiscal plan released on Monday, which actually had a slightly faster debt repayment track than Labour.
Interest rates could actually fall
One implication of a Labour-Green-Maori or Labour-New Zealand First flavour of Government is that there could be room for lower interest rates and a lower currency.
One of the first actions of a new finance minister (almost certainly Grant Robertson) would be to agree a new Policy Targets Agreement (PTA) with the by-then interim Reserve Bank Governor Grant Spencer (the incumbent Graeme Wheeler is due to retire next Wednesday). Both flavours of centre and left Government have said they want the Reserve Bank to put more weight on reducing unemployment and getting the currency down to better levels for exporters.
The Government cannot simply direct that to happen and at least initially there's not much it could do. It would have to write a PTA that suggests inflation has fallen too low within the 1-3 percent target band and that the bank has to move inflation higher. Wheeler ran a relatively tight policy during his five year term in charge which forced underlying inflation down from the top of the band to the bottom of the band. Some economists argue the Reserve Bank could cut interest rates to closer to 1.0 percent from the current 1.75 percent and not create an inflationary spike.
However, the bank would be unlikely to change its view early on without a change of personnel at the top of the bank and a move to a different way of setting interest rates and different targets. In the longer run, there would need to be a more 'dovish' Governor appointed (which is possible after Spencer retires in March) and a potential rewrite of the Reserve Bank Act to include full employment as a target alongside stable prices. Labour, the Greens and New Zealand First all voted in 2013 for a private member's bill from Winston Peters that would have re-written the Act along those lines.
Labour and the Greens have also both expressed an interest in moving away from the Governor being the single decision maker for the Official Cash Rate towards an Australian, British and US style monetary policy committee. Wheeler set up an internal committee of Reserve Bank executives that he said he has never defied, but the decision still rests with the Governor personally under the Reserve Bank Act. A full monetary policy committee would include external members and its results would be published in minutes after each decision.
Real changes are unlikely in the long run without a new Governor and a new Act, which is more likely under the Labour-Green-Maori and Labour-New Zealand First flavours than a National-New Zealand First flavour. National Leader Bill English has said he won't let Winston Peters anywhere near monetary policy.
However, a more dovish monetary policy making system could lower the currency, help exporters and help businesses invest more with cheaper interest rates.
But the LVRs may have to stay
However, lower interest rates would also add more fuel to the fire under house prices.
The other half of the Reserve Bank's job is to keep the financial system stable. It introduced loan to value ratio restrictions in 2013 to reduce the risks of a housing market slump to bank balance sheets. It has tightened those restrictions twice since then after house price inflation flared up just months after the restrictions were put in place.
Its current 40 percent deposit requirement for landlords nationwide appeared to have more effect, but it's worth remembering that its restrictions in 2014 slowed the market down before the 2014 election. Prices jumped another 30 percent in Auckland after that election.
Any move to further lower interest rates would keep the pressure on the Reserve Bank to at least keep its current restrictions on LVRs and potentially introduce Debt to Income Multiple controls (DITs). It is already considering those. Banks have been reducing their fixed mortgage rates again in recent weeks, which is warming the market for Spring and certainty after the election. New Zealand still has a long-term shortage of up to 500,000 houses and a record high net migration rate.
Labour has said it would like to see the restrictions eased for first home buyers, which is possible under the current version of LVR restrictions put in place by the Reserve Bank, but the risk is it would simply allow more debt to be pumped into prices at auction rooms.
Any two new flavours of Government are likely to see the benefits of keeping restrictions in place for landlords, and possibly tightening them with new restrictions on debt to income multiples for landlords, as is the case in Britain.
The Reserve Bank is also considering increasing capital requirements for banks, which would make lending slightly more expensive for them and reduce their ability to pass on lower wholesale interest rates. Depending on whether the capital requirements are aimed at reducing bank exposure to housing markets, this could make it relatively cheaper for banks to lend to businesses and farmers.
In my next scenarios and implications, I'll look at what tax changes might mean for businesses and consumers.