Banking News

RBNZ ready to use all policy tools to achieve stability

(31 May 2013 – New Zealand) "As a small open economy, New Zealand can be expected to be buffeted by an array of shocks," Reserve Bank of New Zealand (RBNZ) Governor Graeme Wheeler said.

This may lead the RBNZ to draw on all its policy instruments to achieve its price and financial stability objectives in an environment of domestic and external pressures.

Wheeler told the Auckland Institute of Directors on Thursday that "these are extraordinary times".

"Not only does the economy need to absorb the impact of a significant drought and the resource allocation associated with rebuilding our second largest city, we also have to adjust to heavy capital inflows that cause our exchange rate to appreciate and reduce the profitability and competitiveness of our tradables sector."

"And we need to do so at a time when house price inflation is increasing risk in the New Zealand financial system."

"Many of these challenges will be with us for some time. Meeting our price and financial stability objectives, will require us to draw on the full array of policy instruments, including macro-prudential instruments, as appropriate."

Wheeler said that the exchange rate and the housing market present difficult challenges for monetary policy when both the currency and asset prices appear to be overvalued and investor demand is expected to remain strong.

"The Reserve Bank has been responding to the rising exchange rate through two avenues: in maintaining the Official Cash Rate (OCR) at a historically low level; and through a degree of currency intervention."

"The downward pressure on inflation exerted by the high exchange rate means that the OCR can be set at a lower level than would otherwise be the case. In recent months we have undertaken foreign exchange transactions to try and dampen some of the spikes in the exchange rate."

Wheeler said that the Bank is also concerned about the financial stability risks associated with the housing market, in particular the scale of housing lending, and especially high loan-to-value ratio (LVR) lending.

"Risks associated with excessive housing demand could normally be constrained by raising official interest rates and letting them feed through into higher mortgage costs. However, this would carry significant risks of a further strengthening in the exchange rate and further downward pressure on tradable goods prices. This might, in turn, be expected to push CPI inflation further below the 1 to 3 percent target range."

"This is where macro-prudential policies can play a useful role in promoting financial stability. Capital and liquidity overlays can help build up buffers in the banking system while adding to the cost of bank funding. And loan-to-value restrictions may help to reduce the actual supply of mortgage lending."

"If house price pressures abated, it would increase the possibility that the OCR could remain at its current level for longer than through this year. Similarly, if housing pressures are much less of a concern and the exchange rate continues to appreciate and the inflation risk looks low, it may create opportunities to lower the OCR," Wheeler said.

"Macro-prudential measures can be useful in helping to restrain housing pressures, but they are no panacea. This reinforces the importance of measures to enhance productivity in the construction sector, free up land supply, and examine related tax issues."