Reserve Bank doesn't hold miracle cure for coronavirus ills

Saturday, 15 February 2020

Some feel Reserve Bank governor Adrian Orr undercooked the response to the coronavirus, but the bank could still act at any time.

ANALYSIS The Reserve Bank has been accused of downplaying the likely impact of the coronavirus when it decided to hold the official cash rate at 1 per cent on Wednesday.

'Please notify the World Health Organisation that Mr Orr said the virus will be over by July,' was the response of one unimpressed Stuff reader, referring to the bank's governor Adrian Orr.

Ratings agency Fitch thinks it won't be plain sailing.

'We at Fitch Solutions maintain our forecast for the Reserve Bank of New Zealand to cut rates by 25 basis points to 0.75 per cent in 2020,' it said defiantly on Friday.

* Would an OCR cut help vaccinate the economy?

* ASB forecasts NZ economy will decline, but interest rate cut may not be a cure**

'We expect the novel coronavirus outbreak in China to have a major impact on New Zealand's exports and tourism sectors, thus inducing further monetary easing to support the economy,' Fitch said.

The Reserve Bank's current assumption that the overall economic impact of the coronavirus outbreak on New Zealand would be of 'a short duration' may not indeed age well.

Speaking to Channel 4 News for a special programme on the coronavirus, Professor Neil Ferguson from Imperial College London expresses his concerns over the virus, saying: 'This probably concerns me...

Not if the forecast of a World Health Organisation adviser that the virus could infect two-thirds of the world's population proves correct.

But to be fair, the Reserve Bank has not been attempting to out-guess medical professionals about of the likely length and depth of the health crisis.

As ANZ noted, it has 'no more information than anyone else on how things will pan out from here' – and it hasn't pretended to.

Nor did the Reserve Bank go as far as assuming that the coronavirus itself would be quite that transient.

Rather what it said was that for the purposes of setting the OCR on Wednesday, it assumed 'most' of the impacts on the New Zealand economy would occur in the first half of the year.

That could hold true even if the virus does become a pandemic.

The main economic impacts of the virus to date have come from the early and intense efforts to contain the spread of the virus in China, rather than from the disease itself.

It doesn't seem ridiculous to speculate that either the virus is likely to be on the wane by July, or that it will be a fact of life everywhere.

That means at least some of the economically-disruptive efforts to contain the virus – such as constraints on global travel – could have gone out the window by then, regardless of the impacts of the disease on human health.

It is also worth bearing in mind that the Reserve Bank 'locked in' its economic assumptions on February 5, a week before the OCR announcement.

Disruption at Chinese factories supplying western companies with manufacturing inputs is an emerging concern.

Those assumptions included a 0.3 per cent hit on GDP from the virus in the three months to the end of March, which is at the low-end but not miles out of step with the forecasts of New Zealand's major banks.

Reserve Bank chief economist Yuong Ha says the timing of the monetary policy statement meant the bank needed to make its call a little ahead of what have since become mounting concerns about the disruption to the supply of 'intermediate' goods from China.

These are products that manufacturers outside of China rely on to maintain their own production.

There are fears shortages of goods from computer components to steel could disrupt global supply chains.

While the main economic concern to date has been the impact of the virus on the export sector, a large proportion of manufacturing inputs come from China, Ha notes.

'We are starting to hear now of potential disruptions around local manufacturing and we have got our ear to the ground.

'We are very mindful of the risk that this thing prolongs, and that is when you do start to get some of the secondary effects that would start to matter for the economy more seriously,' he says.

If those 'secondary effects' did emerge strongly, the bank could revisit rates at its next OCR review in six weeks time, or even sooner.

It would be unsettling for the bank to change the official cash rate outside of its normal six-weekly review cycle, but the option is there.

Just how much of a role monetary policy could and should play in tackling an issue like the virus is another debate though.

Monetary policy may be a useful tool to counteract business cycles and to get businesses out of a self-induced funk.

It can also be handy in acting akin to chemotherapy to kill off exuberant growth in the boom times, hopefully before poisoning the bulk of normal economic activity.

But if the coronavirus bites deeply, what might be required is more targeted support for the sectors of the economy and people most affected.

This may not be the best time to issue a more general prescription, such as a rate cut, that might then result in a clash of medications.

If it was possible to put the coronavirus aside, which is hard, then the Reserve Bank's monetary policy statement would have swept away any remaining assumptions that it was still part way through an easing cycle.

'If we look back over the past six to 12 months we have been telling a story that momentum was slowing through 2019 and we were always forecasting a pick-up through 2020 and beyond,' Ha says.

'We were getting a little bit nervous about how confident we were that pick up would eventuate. '

'But since that time what we have seen is the monetary policy we put through last year and low interest rates do seem to be flowing through as we would expect.'

So, if the Reserve Bank's assumptions about the economic effects of the virus do hold, there is no reason to think the 1 per cent OCR is going anywhere fast, and growing reason to believe the next move on the more distant horizon will be a raise.