Reserve Bank would rather do 'too much': Will it come to regret that?

Tuesday, 13 October 2020

Infometrics economists talk about confidence.

Home loan rates could get as low as 1.5 per cent as the Reserve Bank throws its weight behind stimulating the economy.

It has been stoking the monetary flames with quantitative easing, which pumps cash into the system, a record low – and potentially falling – official cash rate and an upcoming Funding for Lending programme (FLP) designed to make it easier for banks to lend to customers at lower interest rates.

The FLP is expected to have an immediate and lasting impact on retail rates. Heartland became the first New Zealand bank to offer a home loan rate under 2 per cent this week.

While the central bank is aware of the risks from rapidly rising asset prices – including increasing inequality – it considers economic risks a more pressing concern, and the potential for rising unemployment a bigger threat than rising house prices.

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The central bank’s chief economist Yuong Ha said it would rather decide it had done too much too soon in response to the downturn caused by Covid-19, than too little too late.

NZIER principal economist Christina Leung said the “least regrets” strategy posed a risk to financial stability and could have a destablising effect on the economy in future, if people who borrowed large amounts of money when rates were low found they could not service their mortgages.

“Other unintended consequences include these measures largely benefiting those who have the equity in the first place to take advantage of the lower interest rates, with the surge in house prices making it harder for those trying to save up for a deposit able to get that first rung on the ladder. Conditions which favour borrowers will tend to magnify the ups as well as the downs of asset prices.”

Infometrics economist Brad Olsen said 1.5 per cent home loan rates seemed likely by mid-2021, but he did not expect them to fall below 1 per cent.

“Low interest rates are here to stay until business investment starts to stagger back to its feet.

Christina Leung says the country could hit trouble in future if people who borrow heavily now find they cannot pay their loans.

“The conversation has shifted from ‘should we borrow?’ to ‘how much should we borrow?’, and people are now steering clear of savings because of how low interest rates have headed.

“The risk, if the Reserve Bank did nothing, is that without interest rates, the conditions wouldn’t be right to boost investment and spending from businesses and households in the future.”

ASB economist Mike Jones said interest rates would fall below 2 per cent out to terms of two years in 2021. ASB now thinks the house price correction that was expected this year has been and gone, and house prices will rise 11 per cent in the year to June 2021. “The [Reserve] Bank is not particularly concerned about booming asset prices. In fact, if anything the bank is actively encouraging asset price cycles.”

NZ Initiative chief economist Eric Crampton said the Reserve Bank would think that overshooting its inflation target of between 1 per cent and 3 per cent was preferable to undershooting, and that that would be consistent with its mandate to achieve maximum sustainable employment.

“In the long run, maximum sustainable employment is best achieved through low volatility in inflation rates around a low level of inflation, so there is no conflict between a 2 per cent inflation target and maintaining maximum sustainable employment.

“Going into a pandemic-induced global recession makes for tricky territory. The pandemic has been both a supply and a demand shock, and inflation forecasting will be harder.

“At the same time, the Government has signalled it wants a substantial increase in the minimum wage during a recession, which will hammer employment among vulnerable groups. Inflating away some of the effects of the minimum wage hike would be tempting, if the bank wanted to prioritise its employment mandate, though doing so would come at some risk to long-term inflation expectations.”

He said the Reserve Bank’s statements about wanting to prop up house prices to stop a falling market reducing people’s wealth were more worrying.

“Asset price inflation is at best an unwanted side-effect of monetary policy aiming to keep inflation above the lower bound. The bank should really not be aiming to ‘do too much’ in propping up house prices.”

Westpac chief economist Dominick Stephens said there were signs that Reserve Bank could have already “over-egged the salad”. Data from the Real Estate Institute on Tuesday showed prices up 11.1 per cent in September compared to a year earlier.

He said that would come as a surprise to the central bank, which in August had forecast a 7.7 per cent fall in house prices in the six months to September.

“The Reserve Bank is going to have to make a major adjustment to its house price forecast, and therefore to its consumer spending forecast (because one reliably influences the other).

“This may call into question just how much monetary stimulus the Reserve Bank really needs to deliver. We continue to forecast that the official cash rate will drop to -0.5 per cent in April next year, because the inflation outlook is so low. However, we do acknowledge that [the] data is a mark against that forecast.”

Kiwibank economists said the Reserve Bank would probably try to tackle the market with the reintroduction of loan-to-value restrictions.

ANZ chief economist Sharon Zollner said the risk of the Reserve Bank overshooting seemed low in terms of inflation and GDP and if the FLP was successful, it reduced the chances of the official cash rate dipping below zero.