The main piece of news on the short-term economic front this week was the review of the Official Cash Rate (OCR) on Thursday (December 10) by the Reserve Bank of New Zealand (RBNZ).
Before discussing what they did, maybe one can ask whether it really matters if the cash rate falls another 0.25%.
Borrowing costs facing most people in New Zealand are now the lowest they have ever seen. If you need rates lower than they were last week to stay in business or take out a mortgage, then you are not in a sustainable/debt raising position.
Household expenses
Reacting to the low interest rates household debt growth is averaging 0.7% a month seasonally adjusted or near 8.5% annualised; that rate easily exceeds income growth.
Household spending is growing at a well above average pace as proxied roughly by the annualised rate of growth in the value of debit and credit card transactions.
The growth rate is 9%, compared to the average growth for this measure of 5.6%.
The housing market is also very firm in most parts of New Zealand.
Borrowing costs
You cannot therefore run the argument that the household sector is depressed and needs lower interest rates. What about the business sector? Borrowing costs are irrelevant to the performance of the retailers falling over this past year; they are simply being out-competed by better operators and shoppers able to make price comparisons than before.
The construction sector and the huge number of service industries it drives is booming and hence no rate cut stimulus is needed.
A net 15% of businesses in the latest ‘ANZ Business Outlook Survey’ say that they intend boosting spending on capital goods which is above the average reading of 11%. A net 14% say they plan hiring more people which is above the average of 7%.
As mentioned, outside of dairying and sheep-meat most other exporters are doing well.
These include the pip-fruit industry, Kiwifruit, beef, education, wine, and tourism which is rising very strongly.
The justification
On the basis of the state of the New Zealand economy, you cannot make a case for lower interest rates. But from the Reserve Bank’s point of view, as long as they “seek to avoid unnecessary instability in output, interest rates, and the exchange rate” the pace of growth in the economy is only relevant to the extent that it influences the rate of inflation. That is where things have come unstuck for our central bank since the global financial crisis (GFC).
Inflation in New Zealand is only 0.4% – not the 1.6% rate that RBNZ forecast it would be over a year ago. Inflation is not reaching levels we would have seen with our economy growing near 2.5% if this were the pre-GFC environment. But it isn’t and for a wide range of reasons inflation here and overseas is staying very low. Worryingly low still in the case of the Eurozone and Japan where money printing continues unabated in an attempt to boost growth and price pressures.
Controlling debt
Based on our inflation rate of just 0.4%, the case is very strong for cutting the cash rate to 2.5%. But what if inflation is still low in a year’s time while the economy grows 2.5%? Does RBNZ then cut to 1.5%? That seems ridiculous because of the extra stimulus which would be given to house price rises and household debt. Controlling that debt growth is why our central bank and others are introducing non-interest rate means of influencing household debt growth. These measures so far include the loan to value ratios and the 30% deposit requirement for buying an investment property in Auckland.
There will be more, probably eventually the debt to income restrictions in place in the United Kingdom and Ireland, plus extension of the 30% deposit requirement outside of Auckland.
Changes in the OCR are no longer available to the Reserve Bank to use as the primary means of promoting stability in the financial system.
Credit controls
They are increasingly reverting to direct credit controls.
Changes in the OCR are also minimally effective in boosting inflation.
As noted, this is a problem overseas as well and hence we are not unique.
The way that well above average retail spending growth is not producing rapidly rising retail prices illustrates the impact of changed buyer attitudes post-GFC and the impact of technology allowing easy price comparisons.
As repeatedly noted this year, we expect to see more rationalisation in the retailing sector as sellers adjust to the changed environment of consumer choice and buyer power.
RBNZ met the expectations of most forecasters this morning by cutting the cash rate by 0.25%. The rate is now back to where it was taken during the full throes of the GFC in 2009, and where it was taken back to in 2011 when the 0.5% rise to 3% of 2010 proved premature in hindsight. It is very unlikely that they will cut the rate again.
In fact, RBNZ said that it expects to get inflation back to the middle of the 1-3% target range with no further change in interest rates.
When will the rate go up?
Don’t bother asking.
There is not a single forecaster any of us can point to and say they have got their predictions on interest rates generally right since 2007.
We have proven that as yet in the post-GFC environment, we have not regained the ability to predict sustained interest rate changes.
The chances are that low interest rates will be around for a large number of years.
Tony Alexander is Chief Economist at Bank of New Zealand.
