The impact of Brexit on the New Zealand economy should be limited when you consider the following statistics:
- 3.5% of total exports from NZ go to the UK – mainly sheep and wine.
- 2.7% of total imports from the UK to NZ – mainly transport goods
- 6.7% of all short-term visitor arrivals come from the UK
When the UK joined the EEC (as it was then know as) in 1973 there was a major shift away from trade with the Commonwealth. However New Zealand has been able to move away from the traditional dependency of the Commonwealth to become increasingly integrated to the Asia Pacific region.
Reserve Bank of New Zealand
The RBNZ is a good position even with a record low OCR of 2.25% which paradoxically is among the highest in the developed world. By not being aggressive with OCR cuts the RBNZ has the ammunition to stimulate aggregate demand further which is in contrast to the European Central Bank and the Bank of Japan who are in negative territory. With the turmoil in Europe over Brexit the US Fed will most likely hold off on a rate hike to ease the pressure on markets – it may even cut the US Fed rate.
Gold and Sterling – US$ rate
The graph below shows the reaction to the Brexit – GBP drops significantly against the US$ and gold, as a safe investment, appreciates in value. The uncertainty that surrounds Brexit saw more investors buy gold, which rose to about $1,315 an ounce on June 24th, up by 4.7% on the previous day. This was the largest increase since the global financial crisis in 2008. The rise was in stark contrast to the plunging pound, which tumbled to its lowest level in 30 years.
Below is video from the FT looking at Five Consequences of the UK’s exit form the EU.
The 0.1% inflation rate in New Zealand has largely been attributed to the 50% drop in oil prices since the start of last year – see chart. Although oil prices are referred to as a volatile item they have been low for sometime and are expected to remain subdued. Lower fuel costs have reduced prices for services such as air travel, and have dampened prices on shop floors as the distribution costs for retail items have declined.
However low inflation doesn’t just reflect movements in the price of oil. Even excluding petrol prices, inflation has been below 1% for most of the past year, and it’s set to remain low through 2016. The weak inflation figure has also been due to the low global inflation holding prices down and with the trend likely to continue for some time given the deterioration in global trade and widespread falls in commodity prices. Add to this the slowing growth of the Chinese economy and with its importance to global growth (see chart) you have a serious threat of deflation. This is particularly a concern if the Chinese authorities decide to further devalue their currency – the Renminbi. The RBNZ will have a tough job ahead of it to generate a sustained increase in inflation.
Today Graeme Wheeler the RBNZ governor announced at 0.25% cut in the OCR – now 2.25%. He listed the following reasons for the cut:
- Significant fall in inflationary expectations. The RBNZ has forecast that inflation will only reach 0.5% by September this year and 2% in March 2018. Since the GFC in 2008 weak inflation has been prevalent in the world economy and with the collapse in oil prices it has got weaker in the second half of last year.
- Globally there is also decline in core inflation – a measure of inflation that excludes certain items that face volatile price movements. Therefore there is little or no imported inflation to talk about. A depreciation of the $NZ could mean an increase in the price of imports but would make New Zealand exports more price competitive – something that Graeme Wheeler is keen on given the weakness of New Zealand export prices.
- A decline in the global outlook – interest rate cuts in Japan, EU and the UK accompanied by weaker growth in China. See graph below of Central Bank rates.
Surprisingly enough he said that the lower Fonterra milk payout was not a major factor in the bank’s decision as it was just a reflection of weaker global demand. Graeme Wheeler did suggest that one more rate cut might be on the cards – ‘monetary policy will continue to be accommodative’
Below is a very informative video from the Reserve Bank of New Zealand about smoothing out the boom bust cycles in the New Zealand economy. There are some notes that follow which have been edited from the transcript.
Objectives macro prudential policy.
- To build resilience of the financial system so that it can cope with the business cycle if it turns from boom to bust.
- To be proactive in dampening the risk to begin with. This could include dampen the growth of credit, house prices or other asset prices. An example of this was in New Zealand in the late 1980’s – share market crash and the plunge in commercial property prices.
Macro Prudential Tool Kit – 4 Tools
1. Counter-cyclical capital buffer
This is where the banks are required to hold an extra margin of capital during the boom part of the cycle so that if the boom turns to bust the banks have an extra margin of capital that they can then call on to meet loan losses.
2. Sectorial capital overlay
This is very similar to a counter-cyclical capital buffer but it is about holding extra capital against a particular sector that the banks might be leaning to, for example the household sector, the farming sector, or potentially the commercial property sector.
3. Loan to value ratio for residential housing lending
This is a limit on the amount of high loan to value ratio lending or low deposit lending that the banks are able to do for the household sector. High LVR lending potentially fuels rapid house price growth and so that might be another reason why you would use that particular instrument.
4. Core funding ratio
This is a tool that has been a permanent fixture for the banks. There are a number of reasons why the core funding ratio might change. Potentially if the banks are facing an increase in risk, the Reserve Bank could require them to hold more core funding, funding that would be more likely to remain in the system during a downturn. By holding more of that stable funding, they’d be less likely to stop lending in a downturn because the funding would remain in the system.
Boom bust cycles are cycles in the economy and in the financial system are of course a fact of life. Macro-prudential policy certainly won’t prevent those cycles from occurring. What it will do is provide some cushioning to the cycle. It will hopefully clip the highs and the lows to some extent so that the flow of credit and the flow of financial services in the economy continue through time. It’s not about preventing the cycle or dampening it completely. It’s about taking some of the extremes out of the cycle.
Just had a great day at the RBNZ for the Monetary Policy Statement this morning – as you may know the RBNZ dropped interest rates by 25 basis points. Below is a bit of humour as to how they arrived at their decision.
And they say we are not thinking practically!
Congratulations to Martin Luk (Governor), Amanda Ngo, Jake McConnell, Shaan Keesha and Amay Aggarwal who won the Reserve Bank of New Zealand Monetary Policy Competition. The team made a 10 minute presentation on their OCR decision to three RBNZ economists Jed Armstrong and Hayden Skilling, and Assistant Governor John McDermott. They then had a 20 minute question and answer session in which they showed great teamwork in answering some very searching questions. There were 5 other schools in the national final.
A short animated video by the Reserve Bank which shows how the economy works. It also outlines the role of the Reserve Bank of New Zealand. Good for an introductory lesson.
I have mentioned the resource curse in previous posts especially those countries with natural resources. Below is an extract from a previous post.
Africa may have enormous natural reserves of oil, but so far most Africans haven’t felt the benefit. In Nigeria, for instance, what’s seen as a failure to spread the country’s oil wealth to the country’s poorest people has led to violent unrest. However, this economic paradox known as the resource curse has been paramount in Africa’s inability to benefit from oil. This refers to the fact that once countries start to export oil their exchange rate – sometimes know as a petrocurrency – appreciates making other exports uncompetitive and imports cheaper. At the same time there is a gravitation towards the petroleum industry which drains other sectors of the economy, including agriculture and traditional industries, as well as increasing its reliance on imports.
For New Zealand it seems to be working in reverse. New Zealand’s biggest export earner is dairy and with prices dropping by 23% since last year and the outlook of continued monetary easing from the RBNZ the dollar has dropped from US$0.77 on 27th April to US$0.67 today – a level not seen since 2010.
However, going against what the resource curse suggests, the weaker exchange rate will provide extra revenue for exports like the tourism industry which has been enjoying high numbers especially from Asia. Furthermore, there have been suggestions that it could surpass the dairy industry as the biggest earner of export receipts. There are further benefits for domestic companies competing against imports as the weaker dollar makes competing overseas goods more expensive relative to those produced in New Zealand.
In 2014, 9 of the 34 members of the OECD experienced deflation whilst 3 others had zero inflation. Over the whole area consumer prices rose by only 1.7% mainly due to the fall in oil prices.
However in the Euro area inflation was only 0.4% over the year which is worrying especially as the European Central Bank (ECB) targets an annual rate of 2%. With interest rates at the ECB at 0.05% there is little scope for any stimulatory activity to increase inflation. Furthermore they are also charging banks deposits on money in the bank through a negative rate of 0.2%. Although lower oil prices will benefits businesses and consumers alike it maybe paradoxical if people expect lower inflation as cheaper energy pushes the headline rate into negative territory. So, the ECB has taken a leaf out of the US Fed’s book and decided on a form of quantitative easing by purchasing covered bonds and asset-backed securities.
Mario Draghi, President of the ECB, has not ruled out using additional measures “should it become necessary to further address risks of too prolonged a period of low inflation”.
Although Japan has an annual rate of inflation of 2.9% this has been largely due to an increase in the retail sales tax – if you exclude it from the calculation the inflation rate would be 0.9%. The Japanese Central Bank has a target of 2% inflation. As with the ECB interest rates in Japan are very low – 0.1% – so this leaves no scope for any stimulatory cuts. They are hoping that a further stimulus package of ¥3.5 trillion (NZ$ 37.41billion) on 27th December will boost the economy.
In New Zealand the annual inflation rate in September was 1% – the Reserve Bank Act 1989 stipulates a band of 1-3% while targeting future inflation at 2%. Unlike their counterparts at the ECB and the Bank of Japan they do have scope for stimulatory cuts as the official cash rate is currently 3.5%.
Brian Gaynor in the NZ Herald wrote a piece on the amount of debt in the New Zealand economy and the fact that the Reserve Bank needs some fresh ideas to stem the increasing trend. With the OCR increasing this week to 3.5% the disposable income of the floating mortgage holder will reduce and ultimately impact on their ability to spend – floating mortgages represent 33% of all mortgages in dollar terms. Although higher rates help those that have money in the bank however a lot of this is from overseas investors so interest payments leave the economy. Furthermore the elderly tend to have savings in banks but they are not seen as significant spenders. The higher interest rates also attract ‘hot money’ as NZ’s rates are higher than most other industrialised countries.
The amount of debt in the economy is a major concern especially when you consider how much is mortgage debt – see below. Also the fact that debt as % GDP is now 88.5% and 145% of disposable income – this is putting pressure on inflation not forgetting that people are living very much beyond their means.
The RBNZ is concerned with this debt and introduced restrictions on high loan-to-value residential mortgage lending. They see that there is too much emphasis on housing which is being fuelled by greater access to debt. One only has to look at the Irish property to see how things can wrong – house prices dropped 50% between 2007 and 2012.