Sludge Report #179: Steady As She Goes

Thursday, 13 September 2007, 10:34 am
Opinion: C.D. Sludge

Click for big version
Reserve Bank Governor Alan Bollard

In the wake turmoil on international finance markets and a series of Finance Company collapses over the past month - leaving close to 1.4 billion of NZ savings at risk - Reserve Bank Governor Alan Bollard today kept his head out of the line of fire at his three monthly Monetary Policy Statement announcing a decision not to raise interest rates any further.

The decision not to raise rates followed four consecutive 25 basis point rises which have seen both 2 year and 5 year fixed mortgage rates rise to around 9% - and floating rates to top 10%.

Needless to say today's announcement will be welcomed by New Zealand householders, business owners and the Government alike.

Over the past month the primary economic consideration has been turmoil in the United States sub-prime mortgage market. Effectively US, Asian and Euro banks have found themselves carrying a load of questionable debt to poor American householders.

It appears that for several years when interest rates were low a vast amount of cheap loans were lent against inflated valuations of American property to people on fixed incomes. When interest rates rose and an economic downturn hit the US hinterland those householders have started to default in record numbers.

The loss of confidence this has caused by this in the United States and Europe in particular led both the European Central Bank and the US Federal Reserve to take the unusual step of injecting massive amounts (approx NZD$200 billion) of low cost liquidity into the banking sector early last month.

And the ripples of this crisis reached as far as New Zealand in mid August where the NZ Reserve Bank also took the unusual (unique in this correspondents experience) step of easing credit supply on the inter-bank loan market in order to counteract a spike in short term interest rates. If left unchecked this rise in interbank lending rates could have led to further unplanned mortgage rate rises.

This intervention prompted one experienced economic commentator to remark that if the banks are looking sideways at each others' ability to repay overnight loans then there is a perhaps a lesson for us all in this.

As far as New Zealand was concerned the other impact of the sub-prime crisis was to almost immediately see the upwards pressure on the NZ Dollar evaporate as overseas institutions sold NZ Dollar assets in an effort to repatriate their cash to where they need it.

This morning the NZ Dollar was buying US71 cents, which - while historically on the high side - is a lot more attractive to NZ exporters than the 80+ cent levels it reached in July.

Click for big version
Reserve Bank Governor Alan Bollard

Commenting on these dual circumstances the Reserve Bank Governor remarked:

"Credit concerns and heightened risk aversion have led to significant turbulence in global financial markets. This development increases the likelihood of a weaker economic outlook for the United States and New Zealand's other key trading partners than in recent forecasts.

"The consequences of this financial market turmoil for New Zealand remain unclear at this stage. However, we continue to expect a significant boost to the economy over the next 2 years from the sharp rise in world prices for dairy products and some other commodities that has occurred over the past year."

In other words there are risks on the downside and the upside and the bank is sitting on the fence in the meantime.

On the subject of the Reserve Bank's usual bug-bear - NZ house price inflation - the Governor had this to say:

"..indicators in recent weeks suggest that previous increases in the OCR are starting to dampen domestic spending, which will help to reduce [inflation] pressures. In particular household borrowing growth is beginning to slow and turnover in the housing market continues to fall."

The bank goes on to warn that the falling dollar and rising commodity prices themselves will create inflationary pressures:

"It is important that this temporary increase in inflation does not affect price - or wage - setting behaviour in the medium term."

The bank ends its statement with a final equivocation.

"..Given the greater than usual uncertainty at present, we will be watching to see how the upside and downside risks to the outlook are developing."

Inside its formal detailed Monetary Policy Statement the bank's binary perspective on the future is illustrated in the banks forecast graphs which show two alternative scenarios to their central forecast labeled "additional inflation" and "Global downturn".

Gobal Downturn:

"On the one hand recent international turmoil could lead to a more significant slowing in world growth than international forecasters are currently projecting, and could undermine the world price of New Zealand's commodity exporters. Furthermore it is plausible that developments in the local finance company sector could have a larger impact in confidence and restrain activity in some sectors to a greater degree."

Additional Inflation:

"..it is also possible that the central projection might overstate the current weakness in the housing sector and understate domestic demand pressures generally. In particular, as has been the case over much of the past few years, the tight labour market could conceivably result in higher and more persistent wage inflation than we have assumed."

What this all means is that depending on what happens interest rates could either be on their way up further in coming months or we could also, in fairly short order, be recipients of some RBNZ largesse in the form of falling interest rates.

On the other hand the most likely outcome at this stage seems to be a watch and see waiting pattern, "steady as she goes".

Click for big version
Reserve Bank Governor Alan Bollard

Anti©opyright 2007

© Scoop Media

Alastair Thompson

Scoop Publisher

Alastair Thompson is the co-founder of Scoop. He is of Scottish and Irish extraction and from Wellington, New Zealand. Alastair has 24 years experience in the media, at the Dominion, National Business Review, North & South magazine, Straight Furrow newspaper and online since 1997. He is the winner of several journalism awards for business and investigative work.

Contact Alastair Thompson

• Linkedin
• Twitter - @althecat
• Facebook
• Email - alastair@scoop.co.nz