Rosier outlook may trim $100b QE programme, says BNZ

Wednesday, 16 December 2020

The forecasts are changing on Reserve Bank governor Adrian Orr.

The Reserve Bank may not need to spend as much as once thought on quantitative easing because of the stronger economic bounce-back from Covid reflected in better Treasury forecasts, BNZ says.

BNZ chief economist Stephen Toplis said the Treasury’s half-year fiscal update on Wednesday continued to paint the economy in a very good light “under the circumstances”.

The Treasury now forecasts net core Crown debt will peak at just under 53 per cent of GDP, rather than topping 55 per cent, and is tipping unemployment to peak at 6.9 per cent rather than 7.8 per cent.

Toplis said the outlook could actually be better than that as the Treasury’s forecasts were signed off on November 13, since when economic data had surprised to the upside.

Only $40m had been drawn down from the Reserve Bank’s Funding for Lending scheme as of Tuesday.

* Hope raised that interest rates won't go negative next year

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The level of government debt was also exaggerated by “noise” associated with the Reserve Bank’s Funding for Lending Programme (FLP), under which the Reserve Bank has agreed to lend up to $28b to banks, he said.

“An accounting quirk means the liabilities associated with the FLP are included in the Government’s net debt figures but the, largely offsetting, assets are not.”

If the impact of the Reserve Bank’s actions were ignored, then the Treasury would be expecting net debt to peak at only just over 44 per cent of GDP, he said.

“This makes New Zealand’s public debt look even better, compared to its peers, and will be the envy of most of the developed world.”

The “good news” kept coming, Toplis said.

The Government still had more than $10b of its Covid Fund unspent, which could be applied to reducing debt if it didn’t need to be spent to cushion the impact of any future lockdown, he said.

Stats NZ will release New Zealand’s GDP figure for the three months to the end of September on Thursday.

That look in the rear review mirror is expected to confirm a bounce-back in GDP of about 13 to 14 per cent from the second quarter when GDP fell an unprecedented 12.2 per cent.

Toplis said the Treasury’s forecast was consistent with BNZ’s view that the Reserve Bank would not need to apply as much monetary stimulus as it felt it needed when it issued its last monetary policy statement in November.

The Reserve Bank expanded the cap on its QE programme to $100b in August but has dialled back its bond purchases in recent weeks.

BNZ is not forecasting by how much the Reserve Bank might undershoot its $100b cap.

But it noted the Reserve Bank’s spending on the programme was effectively constrained by the level of issuance of government debt, which will be lower than had been expected if the Treasury’s latest fiscal forecast prove on the money.

“The fact of the matter is they can only hold up to a certain percentage of any given bond,” Toplis said.

“The smaller the fiscal requirement, the less need [the Government] will have for the central bank to purchase paper.”

By Tuesday, banks had drawn down only $40m of the additional $28b of new Reserve Bank funds that could be made available through the separate FLP programme since that scheme was launched on December 6, Toplis said.

Like QE, that programme is designed to lower interest rates.

The Reserve Bank is understood not to have expected a strong early draw-down and Toplis cautioned against reading too much into the statistic.

“I think what you will see is as banks’ expensive funding rolls off, they will turn to FLP if they need it.”

But if demand for lending stayed low, there might not be a massive draw-down, he said.

Just the existence of the FLP would allow banks to lower the interest they paid on savings, which would have a similar impact on interest rates as them drawing down the Reserve Bank's money, he noted.

“Even if nothing was drawn down from that programme, it probably has already had a significant impact – knowing that it is there.”

Toplis did still have some words of caution.

“Key to the Treasury forecasts is the assumption of a full border opening on January 1, 2022,” he said.

“There is clearly a risk that this does not occur. On the flip side, the Treasury assumes that a partial opening occurs in June, but it now looks like March will be the starting point.”