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Why the RBNZ might cut another one percent

The Reserve Bank issued a dramatic monetary policy statement on Thursday, signalling it had accepted the economy had slowed, but some banks don’t believe the bluster, Thomas Coughlan reports

Adrian Orr’s second MPS as Reserve Bank governor was full of bluster. It acknowledged low business confidence, weakening growth – it even included a dramatic scenario in which GDP growth falls below 2.5 percent, causing the bank to slash the official cash rate (OCR) by 100 basis points.

The market certainly got the memo, with the New Zealand dollar falling to 66.7 US cents, a two and a half year low, on the news.

This is good for exporters, who have been hurt by a high dollar, but other observers will be less pleased by the Bank’s cautious tone.

The big news is that the RBNZ will hold off raising the OCR for another year – September 2020 is the earliest it sees a rate rise, and even then it will only be minor, up from 1.75 percent to 1.9 percent. As recently as May, the bank had projected raising the rate in September 2019.

The radical readjustment of the forecast was designed to send a signal. Previous monetary policy statements have tended to adjust their forecasts by a quarter or two – rarely by a whole year.

Over the road

The decision was picked apart across the road in Parliament where Finance Minister Grant Robertson and National's finance spokesperson Amy Adams have been locked in a war of words over business confidence and the state of the economy.

Adams said the MPS vindicated National's claims about the flow-on effects poor business confidence was having on the economy.

“Orr made it very clear that low business confidence can have an impact on growth and employment,” she said.

"While Government ministers have been repeatedly now doubling down on comments about how little interest they take in it, the governor has been very clear low business confidence is a worry and does have an impact on growth and unemployment.”

The Reserve Bank noted that low business confidence had fed into their decision to revise growth projections downwards, but Orr cautioned it was businesses assessment of their own activity rather than the headline business confidence figure that had contributed to the revision.

Robertson remained positive, noting that over the medium term growth is expected to average just above three percent over the next three years.

He noted the bank also said it was a good time for businesses to invest.

Robertson said the economy was transitioning away from the previous Government’s reliance on housing speculation and population growth.

But Adams argued that the Government-led growth in the form of the families package and KiwiBuild was a short “sugar hit” and not indicative of a sustainable economy.

The disaster scenario

Attention was also focused on a negative scenario the bank included in the statement - a scenario in which GDP growth remained below three percent over 2019.

Growth is predicted to reach 3.5 percent in 2019. But the current annual growth rate is just 2.7 percent, and this low growth could continue to play out if, for example, the expected stimulus from the families package and KiwiBuild fails to materialise.

The Reserve Bank would then be forced to cut the OCR by a dramatic 100 points to stimulate the economy.

Orr urged caution, noting that the scenarios included in the MPS were intended to show that “there is always time to do something about it with regard to monetary policy”.

“All of these things are within the realm of possibilities but also within the realm of management inside of our inflation mandate on the way through,” he said.

But the scenario rattled politicians.

Later in the day, when Orr appeared before Parliament’s Finance and Expenditure Select Committee, Adams put it to him that cutting the rate by 100 points to 0.75 percent would leave the Bank little room to cut further in the event of a prolonged period of slow growth.

Orr said that should this scenario eventuate, the bank had a set of “unconventional tools” that it had been developing.

Assistant governor John McDermott spoke in May about five unconventional tools the bank had been working on that could be used during a financial crisis. One of these is quantitative easing, essentially the practice of printing money to buy bonds to stimulate the economy.

The bank would buy Government and commercial bonds as well as foreign government bonds, with the intention of weakening the Kiwi dollar.

Other approaches the bank could take include negative interest rates of as low as -0.75 percent, and guaranteeing bank liquidity by offering term lending facilities for banks.

But this scenario remains unlikely – it would effectively be a crisis occurring on top of an existing crisis.

McDermott told Bloomberg in May that the bank would not launch into quantitive easing without the support of the Government.

“I don’t believe growth is going to get below that level, I think the medium and long-term forecast is still very sound so I don’t believe that occurrence is going to happen,” he said.

However, he added he was not alarmed by talk of quantitative easing, as it had been used around the world.

Bank reaction

Bank economists received Orr’s signal loud and clear, with Kiwibank chief economist Jarrod Kerr noting the statement was “blatantly dovish” - though some pondered whether his decision to push the rate rise out so far was more message than material,

ANZ chief economist Sharon Zollner said there was “little practical difference” between projecting a rate rise in late 2020 as opposed to late 2019.

“They are all effectively ‘wait and see’ placeholders,” she said.

“The key information is in the signalling: the RBNZ has very consciously sent a message that they have become more dovish in the past six weeks.”

Kerr echoed a comment by Orr that now was the time to simply "watch, worry and wait".

ASB’s Chief Economist Nick Tuffley was also weary of changing his forecast. He left his projection for a November 2019 rate rise unchanged.

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