Transmission Of Monetary Policy To Financial Conditions- A Speech By Assistant Governor Karen Silk

Financial conditions are significantly influenced by monetary policy settings and are therefore something that we monitor closely. The banking system is a key channel through which monetary policy settings influence financial conditions in New Zealand.

Specifically, monetary policy affects bank funding costs and, in turn, the lending rates banks offer. This impacts the amount of money that households and businesses have to spend and shapes their inclination to save and invest.

During the post-COVID period, tight monetary policy settings implemented to reduce inflation have made financial conditions more restrictive. This has contributed to a weakening of aggregate demand in the economy and increased our confidence that consumer price inflation is moving sustainably back to its target mid-point of 2%.

However, the ongoing effects from the monetary and fiscal policy response to the COVID-19 pandemic, which significantly increased liquidity in the banking system, have supported lower bank funding costs. This has impacted the extent to which banks have increased their lending rates.

The upshot of this is that financial conditions were less restrictive during the recent tightening cycle for the same level of the Official Cash Rate (OCR) when compared with previous cycles. However, through ongoing monitoring we have been able to identify and factor this into our decision-making to ensure that financial conditions have been where we needed them to be to achieve our monetary policy objectives.

As liquidity is being drained from the banking system, bank funding conditions have been normalising towards their pre-COVID state. Over time, this is likely to influence the amount of decline in bank lending rates, even as wholesale rates fall, as banks seek to maintain their net interest margins.

The factors discussed in this speech are important for understanding the effectiveness of monetary policy transmission, but there are many others that are considered in monetary policy decision-making. While we remain confident that inflation will converge back to the 2% target midpoint in the medium term, we will continue to assess and respond to the risks arising from broader economic conditions to manage inflation back to this level.

During the post-COVID period, tight monetary policy settings implemented to reduce inflation have made financial conditions more restrictive. This has contributed to a weakening of aggregate demand in the economy and increased our confidence that consumer price inflation is moving sustainably back to its target mid-point of 2%.

However, the ongoing effects from the monetary and fiscal policy response to the COVID-19 pandemic, which significantly increased liquidity in the banking system, have supported lower bank funding costs. This has impacted the extent to which banks have increased their lending rates.

The upshot of this is that financial conditions were less restrictive during the recent tightening cycle for the same level of the Official Cash Rate (OCR) when compared with previous cycles. However, through ongoing monitoring we have been able to identify and factor this into our decision-making to ensure that financial conditions have been where we needed them to be to achieve our monetary policy objectives.

As liquidity is being drained from the banking system, bank funding conditions have been normalising towards their pre-COVID state. Over time, this is likely to influence the amount of decline in bank lending rates, even as wholesale rates fall, as banks seek to maintain their net interest margins.

The factors discussed in this speech are important for understanding the effectiveness of monetary policy transmission, but there are many others that are considered in monetary policy decision-making. While we remain confident that inflation will converge back to the 2% target midpoint in the medium term, we will continue to assess and respond to the risks arising from broader economic conditions to manage inflation back to this level.

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