The five hot topics for the Reserve Bank in 2021

Thursday, 7 January 2021

Reserve Bank Governor Adrian Orr says targeted government policy could do much more for the property market than monetary policy can. (First published November 2020)

ANALYSIS: Should the Reserve Bank be applauded for cushioning the economy from Covid and saving jobs, or blamed for putting a rocket under house prices and exacerbating inequality?

2020 saw the bank embrace “unconventional” monetary policies to stimulate the economy, and debate over its role boil over as the housing market sizzled.

What has the bank done so far and what is supposed to be happening next?

Quantitative easing

This was the first “unconventional’ monetary tool that the Reserve Bank reached for and is now approaching its halfway-mark in terms of dollars spent.

The bank got the green light to print up to $100 billion to spend on buying back central and local government bonds, in a bid to pump more liquidity into the economy and reduce retail interest rates.

QE kicked off in March and is due to run until June 2022, and so far the Reserve Bank has spent $43b of that allocation.

The amount of money the Reserve Bank spends on QE varies from week to week.

The Reserve Bank’s spending on ‘QE’ has topped $43 billion, with weekly bond buy-backs due to resume on January 18.

It states enigmatically that “staff have the flexibility to adjust the pace of purchases as market conditions dictate”.

Currently QE is taking a four-week summer holiday with bond repurchases set to resume on January 18.

Spending on QE was always expected to start strong and tail off over time and the bank is under no obligation to run right up to its $100b cap.

But it is still notable that bond purchases fell to $4.1b in November after spiking at nearly $7.7b in September.

Could that be a sign that criticism the Reserve Bank has fuelled a housing and asset bubble might be getting to the bank?

It would probably be a stretch to claim that so soon, but the rate of decline in spending on QE in 2021 will be one statistic watch.

Funding for Lending

This second unconventional tool has seen the bank decide to create up to $28b of new money to lend to banks at the Official Cash Rate, currently 0.25 per cent.

An unnamed bank or banks (the Reserve Bank won’t say who) made their first big drawdown under the scheme on December 21, tapping the central bank for $1b.

An unnamed bank or banks borrowed $1b from the Reserve Bank under its Funding for Lending programme just before Christmas – the first big loan under the $28b scheme.

That was after some institution dipped its toes into the water by claiming a $40m loan, 10 days earlier.

The Reserve Bank first promoted Funding for Lending as a means to ensure banks would be able to pass on any further reductions in the OCR to borrowers, given that it is impractical for banks to send savings rates below zero.

But the broader the impact of the scheme should be to lower retail interest rates by reducing banks’ funding costs, so Funding for Lending could also be “blamed' for pushing up house and share prices.

Unlike QE, which requires the Reserve Bank to actively run weekly auctions to buy bonds, Funding for Lending appears more automatic, in that qualifying banks have a straightforward entitlement to the loans.

So unless the central bank were to scrap the scheme early or expand it, this horse has bolted and there appear to be no other decisions to make.

A negative OCR

What does the official cash rate mean?

This is the most conventional of all the unconventional monetary tools at the bank’s disposal.

The Reserve Bank has hinted it could lower the OCR to a floor of about -0.75 per cent without encountering the risk that the normal operation of financial markets might start to break down.

But governor Adrian Orr promised to leave the OCR unchanged for a year on March 16 last year, so there should be no immediate change when it issues its next monetary policy statement on February 24.

Up until November, most economists assumed the Reserve Bank would cut the OCR below zero this year.

But those expectations cooled rapidly as a result of a strong-than-expected post-lockdown bounce.

A compromise might be for Reserve Bank to start moving the OCR in smaller increments, perhaps following the Reserve Bank of Australia in switching the rate to 0.1 per cent.

Further cuts to the OCR would send a strong signal to home buyers that this was still a good time to borrow-up large, but it seems simply too soon to make any meaningful forecast about how likely that is.

Foreign asset purchases

This dark horse in the Reserve Bank’s unconventional toolkit could yet get a dusting off in 2021.

The Reserve Bank said in its last monetary policy statement in November that foreign asset purchases were still under consideration, without dwelling much on the idea.

The Reserve Bank has said foreign asset purchases that could see it create New Zealand dollars to buy foreign bonds or other overseas assets remain an option.

The policy would see the Reserve Bank print New Zealand dollars to exchange for foreign government bonds, such as US Treasury bonds, or other assets that were not denominated in New Zealand dollars.

Pivoting to buying foreign assets could prove attractive in a situation where house-price inflation sapped the bank’s appetite for QE or lower interest rates, but where it remained concerned by an appreciation of the New Zealand dollar.

The bank has said the most direct impact would be to bring down the exchange rate, improve the competitiveness of exporters and raise inflation by making imports more expensive.

The Reserve Bank has previously described that as a potentially useful move “if a specific economic shock was from offshore and resulted in an overvalued New Zealand dollar”.

Arguably that is the situation that may now be building, with New Zealand free of Covid restrictions, the pandemic plaguing many of our trading partners, and the kiwi trading above 72.5 US cents and closing in on a five-year high.

But it may be that the exchange rate hasn’t reached the trigger point for such action just yet.

Loan-to-value restrictions will come into effect in March but they are expected to do little if anything to bring prices down from their current levels.

Housing controls

Loan-to-value restrictions on bank mortgage lending will take effect again from March, though the Reserve Bank has forecast the move will have only a 1 to 2 per cent downward impact on house prices.

To be clear, that doesn’t mean the bank is forecasting house prices will fall by that much, merely that house prices will be 1 to 2 per cent lower than they would otherwise be if it wasn’t taking the action.

As before April last year, banks will only be able to write a fifth of the total value of their new lending to owner-occupiers who have less than 20 per cent equity, and at most 5 per cent of new lending to property investors at LVRs above 70 per cent.

But it expects the impact of the policy will be lower than previously, given that banks have already stepped back from more risky lending.

Debt-to-income ratios are another bandaid that could help ensure home buyers don’t get over their heads in debt if the Reserve Bank keeps its foot down on its untargeted monetary stimulus, though like LVRs, they also won’t change the underlying supply and demand for housing.

What if any other specific steps the Reserve Bank or Government might take to rein-in the housing market promises to be the subject of intense discussion between the bank and Finance Minister Grant Robertson.