David Hargreaves thinks the RBNZ Governor may have just given a historic speech – in a bad way

By David Hargreaves

As an an English-born football tragic, well accustomed to watching a national side consistently performing in a manner guaranteed to disappoint, I am well acquainted with the term: “What did he do that for?”

It’s the multi-functional question that embraces everything from the ridiculous cross-field pass to the nonsensical sending off of the best player, but it’s never simply rhetorical. “What did he do that for?! No, really, I want to know. What the hell did he think he was going to achieve?”

And of course this soul-searching question finds its way into every day life as well. Attempting to discover just what was in someone’s mind when they did or said something is, I suppose something that helps to make the world go around.

Well, I think our Reserve Bank Governor Graeme Wheeler has just had a “what did he do that for?” moment.

Some context: The RBNZ has set piece events in the shape of the regular OCR reviews and two Financial Stability Reports in a year in which it lays out economic forecasts and its views on the economy. Additionally, the top RBNZ officials are a busy lot and they get around a lot. They speak widely and frequently, usually on an off-the-record basis. But what they can do, when they decide they want to say something publicly – and there isn’t either an OCR review of FSR due – is turn the tap on, and publicise whatever speech is being made. There’s been now eight such speeches this year.

That was the decision the RBNZ made this week when it decided to publicise Wheeler’s speech to INFINZ in Auckland. By so doing the clear inference to be drawn is that the bank wanted to say something publicly and therefore in effect steer market thinking in a direction that was somewhat different from the last OCR review just last month and ahead of the next review at the end of this month.

Every RBNZ speech tends to be heavily nuanced and messages are delivered through raised eyebrows rather than with a ball-pane hammer.

What I take from the speech is that the RBNZ is not at this stage intending to further cut interest rates at its October 29 review, but that it may intend to cut once more. Once more. That, however, will be it, and the RBNZ is definitely trying to put a solid floor (as opposed to the pencilled-in floor that’s been there till now) on the OCR at 2.5% And, in what is an amazing about-turn to me, the RBNZ’s being heavily influenced by rising house prices in that decision to attempt to put a solid floor at 2.5%.

Back in March, when the OCR was sitting at a too-high 3.5%, Wheeler said that rising house prices in Auckland were not a factor in the decision to then keep rates unchanged.  “No. We’re concerned about the Auckland house prices for financial stability reasons,” he said then.

But the Governor this week? Well: “…Housing market considerations do influence our thinking on the OCR”.

Okay, so we’ve now got an RBNZ apparently hell-bent on keeping interest rates higher than they should be to quell the housing market – which at this point remains a financial stability issue, not an inflation-related monetary policy issue. In simple terms the RBNZ should NOT be keeping rates up to control the house market, not while inflation is virtually non-existent and a mile away (as it has been now for a long time) from the 1-3% range that the Governor has an agreement with the Minister of Finance over.

The RBNZ is expecting that the falls we saw in the value of the Kiwi dollar earlier this year will really fire up inflation in the first half of next year. But of course a rising dollar again could quickly undo that. And what might cause the dollar to rise? Well, indicating that you don’t want to drop interest rates any further might help.

Just before Wheeler’s speech was released this week the NZ dollar was worth about US66.6c. As I write this it is flirting with US68c. Now, that’s not all about what our Governor said, of course. There was more extremely lacklustre economic information coming out of the US again overnight. It is now becoming hard to see how the US central bank can possibly justify raising interest rates this year.

But if we are now in a situation where rate rises are looking unlikely in the US, and our rates are that much higher than many places, and we have a central bank trying to put a floor on the rates here at 2.5%, what do you think is going to happen in the immediate future? Okay, expected benign inflation figures out tomorrow might take some wind out of the Kiwi dollar’s sails, but in the short term, surely the general direction of the Kiwi dollar’s only going to be one way and it won’t be down.

Since bottoming out on September 23, our dollar is up over 8% against the American currency and over 6% on the trade weighted index basket of 17 trading partner currencies. At the moment on a trade weighted index basis the dollar is nearly 7% ahead of where the RBNZ is predicting it will finish in the December quarter. It’s about 11.5% higher than the RBNZ’s picking by the middle of next year.

If the dollar continues to outperform RBNZ predictions then we can reasonably forget about inflation kicking up to anything like the levels the RBNZ sees for the middle of next year.

So, to go back to the very start and the “what did he do that for?” question. I can only conclude that the Governor is getting his excuses for why he’s again going to miss his inflation target next year in very early. It’s those darn houses, you see.

I just wonder for how long this is all going to wash with Bill English.

Here’s my drastic suggestion: The RBNZ should right now abandon the loosening of the ‘speed limit’ on LVRs outside of Auckland. Keep them at 10%. And widen the currently Auckland-target 70% LVR lending limit for investors to the whole country. Then next year let’s look at some sort of income-to-debt-funding ratios.

…And, let’s have interest rates that are targeted at getting inflation between 1% and 3%. If that means reducing them to levels similar to those in other countries. We should do it. No 2.5% floor. No floor at all.

I think Wheeler’s speech this week will be looked back on – and not in a good way – as a watershed.