Reserve Bank’s bazooka just the first volley
The Reserve Bank fired its biggest bazooka to help the Government prepare for a new stimulus plan within days that should top 10 percent of GDP and include much wider income support. Bernard Hickey reports as NZ Inc reacts on the most economically shocking day in our history.
"This is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning."
Winston Churchill said this on November 10, 1942, just after the darkest point of World War II. British, Australian and New Zealand troops had just defeated General Erwin Rommel's Afrika Korps at the second battle of El Elamein in Egypt and US troops had just landed in French North Africa. Soviet troops were still 10 days away from launching a counter-attack at Stalingrad that would prove the war's true turning point.
It may seem extreme to invoke war-time moments and speeches that bottle it into a few words, but yesterday felt a lot like that moment.
First, the 'Bazooka'
First, we saw the Reserve Bank unveil a Quantitative Easing programme of Government bond buying that even it thought unthinkable just a few weeks ago, and at a size that took other central banks a decade to build up to, as the chart below via Capital Economics shows.
The Reserve Bank announced the plan to buy NZ$30 billion worth of Government bonds over the next 12 months, including front-loading it by buying $750 million per week in the first few months and the first $500 million later today. The Reserve Bank will buy more than half of all the Government bonds on issue in less than a year. Right now, that is as much as it technically can buy without drying up liquidity in the market. The Government will need to borrow faster and faster just keep enough bond 'water' in the market pool for it to operate.
"This package is huge," ANZ Strategist David Croy said.
"Our analysis last week flagged the need for purchases of $15-20b per annum, if not more, and this announcement is even larger than that. Our expectations were at the top end of market expectations, so we expect this package to have a significant impact," he said.
It did. Investors pushed down long term interest rates by buying Government bonds, which pushes up their total price but pushes down their 'yield' or interest rate. The 10 year Government bond yield fell sharply yesterday morning and closed last night under 1.0 percent. Market interest rates had spiked up last week because banks and pension funds had frozen their buying, forcing the Reserve Bank's hand earlier than it expected.
In financial market terms, this was the 'Big Bazooka' and is akin to the promise the European Central Bank's President Mario Draghi made in July 2012 to buy as many bonds as was needed to stop the euro collapsing. "Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough," Draghi said then.
This was the Reserve Bank's 'whatever it takes' moment. Or perhaps its first 'whatever it takes' moment, as the ECB has discovered since 2012, and will find in the days ahead. Draghi's successor Christine Lagarde unleashed a €750b programme of QE on Friday night with this tweet: "Extraordinary times require extraordinary action. There are no limits to our commitment to the euro."
So what next?
Most think this will not be the last 'bazooka' to be fired by the Reserve Bank.
"While monetary and fiscal policy are now firing on all cylinders, more stimulus is likely to be needed," said Capital Economics' Australia and New Zealand economist Ben Udy.
"We expect the RBNZ to figure out how to operationalise negative interest rates in the coming months," Udy said.
Just last week (which already seems like last century) the Reserve Bank said it would not go lower than its current 'bottom' of 0.25 percent, in part because bank computer systems literally cannot cope with a negative interest rate sign. It is the local equivalent in these times of the Y2K bug. No one is quite sure what the bank's computers will do with negative interest rates. But the Reserve Bank is working with the banks to recalibrate their computer systems.
"We then expect the Bank to cut the OCR into negative territory as the forthcoming surge in unemployment will make it very difficult to meet its inflation and employment targets," Udy said.
Udy estimated a massive hit to GDP from the move to at least a one-month lockdown.
"Those measures will have an enormous impact on GDP. Production, manufacturing and sale of supermarket food will still take place, as will health services. But we estimate that around 80 percent of economic activity will cease over the next four weeks," he said.
"We now think GDP will contract by 40 percent in Q2 from the same quarter a year ago. And while growth may bounce back in the second half of the year, output won’t return to pre-crisis levels until near the end of 2021. Indeed, we expect activity to decline by 15 percent over the whole of 2020."
The last time New Zealand saw anything like that type of GDP decline was over a three-year period in the early 1930s, not a single quarter.
"We believe the Bank will cut the OCR to -0.75 percent by the end of the year."
We have yet to get an indication from the bank itself.
Where is the Governor?
Reserve Bank Governor Adrian Orr stayed behind the scenes yesterday, not appearing in interviews or a news conference as the focus quickly turned to the the 12.30pm briefing by the Ministry of Health's Director General Ashley Bloomfield. By then it was becoming clear, and the Governor must have known, that the Prime Minister Jacinda Ardern was about to pull the trigger on a move towards a national shutdown.
The Governor will have to talk publicly today. I was very concerned to hear Assistant Governor Christian Hawkesby gave a private phone briefing to bank and other private sector economists yesterday, but not the financial media. That included notice of a drop in the interest rate for the Term Auction Facility for bank lending set up just last week. It was effectively another slight easing of monetary policy without telling the public. The Governor has spoken to Morning Report this morning. I will listen later. He needs to do a news conference later today at the latest, in my view.
The Reserve Bank has to be careful to take the public along with it with Quantitative Easing, which has earned a bad reputation as simply a vehicle for 'printing money' and funnelling cash to banks and the rich, rather than helping people directly, which could be done with direct financing of Government deficit spending.
QE for the people?
Direct financing is where the Reserve Bank buys the bonds directly from the Government rather than through the secondary market and the Government distributes the cash directly to the public. If the Reserve Bank were to directly pay the public, which has been proposed in other countries, this would be known as 'helicopter money', which refers to the description Chicago School economist Milton Freidman used in the Vietnam Era for direct financing where a central bank literally drops bundles of cash down into a city for the people to pick it up off the ground and start spending.
Here's an example of that criticism, from Raf Manji on Interest.co.nz yesterday arguing: "Don't make the mistake of previous overseas QE programmes by focusing entirely on supporting the financial markets."
Then the true shock and awe
In the early afternoon, we watched with a nation as our Prime Minister stepped up to the Beehive Theatrette lectern and did what so many had wanted for so many days, and with such directness and steel and empathy.
If Churchill's speech at Mansion House in London in 1942 was one of his best, this was our Prime Minister's finest hour so far.
Finance Minister Grant Robertson then announced the removal of the $150,000 cap on the wage subsidy and signalled a bigger package to come in the next day or two, including a wider package of income support.
It will be needed, if only to soak up the wave of demand for Government bonds in the financial markets in the days and weeks ahead.
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