By Roger J Kerr
The contrast in the execution of monetary policy management between Australia and New Zealand could not be more starkly demonstrated than the events of the last two months.
The Reserve Bank of Australia (RBA) took the opportunity in April to surprise the markets with an unexpected 0.25% cut in their OCR which was the catalyst to drive the AUD/USD exchange rate down six cents from 0.7800 to 0.7200. The RBA’s decision and timing was exquisite, obtaining maximum FX market impact and achieving their goal to get the currency value down. Australian’s CPI inflation rate is well above New Zealand’s, however the RBA had no hesitation to reduce their official interest rates to 1.75%.
In contrast, the Reserve Bank of New Zealand (RBNZ) has now failed to take advantage of two opportunities to cut the OCR (late April OCR review and last Thursday’s MPS) to drive the NZD/USD exchange rate lower. The local financial markets were not anticipating cuts in April or last week, therefore the opportunity to surprise the markets to make an impact on the forex market and push the NZD lower was available.
The result of the RBNZ’s unnecessary hesitation and caution is a dramatically higher NZD value, completely the opposite of their own intention and desire that “further depreciation appears warranted”.
At 75.80 the TWI Index is now 8% above the RBNZ’s assumed level. At some point the RBNZ have to do “less hui hui, and more doey doey”. To consistently warn and threaten for the last 12 months that the NZ dollar exchange rate needs to be lower and then not follow through on those verbal threats with overt action, reduces the RBNZ’s credibility and influence to get the markets to take notice when they make warnings in the future. Their words become increasingly hollow, and thus they have lost one of the tools needed for effective monetary policy management.
What will be doubly galling to the productive export sector in the NZ economy is that every time the RBNZ have made a monetary policy statement over the last six months they have been responsible for pushing the NZ dollar higher (refer TWI chart below with circles around the December 2015, April 2016 and June 2016 RBNZ statements).
The currency appreciation caused by the RBNZ reduces profits, business investment and jobs in the export economy.
The RBNZ may still talk the NZD down, however they are doing so from a progressively higher NZD level that they have unwittingly (naively?) orchestrated themselves.
The RBNZ do appear to be somewhat oblivious to the fact that their decisions have a direct impact on subsequent exchange rate movements.
They are not casual observers on the sidelines of the forex markets, they are right in the middle of the game and cause change/outcomes.
Last Thursday’s Monetary Policy Statement (MPS) from the RBNZ stated that the rise in the overall TWI value over recent months has been entirely due to offshore events with improvement in investment/financial market risk appetite and a weaker US dollar. My interpretation of FX market movements is that the NZ dollar has appreciated on a TWI basis primarily because the RBNZ has not cut interest rates.
It can only be independent NZD strength that pushes the TWI higher, nothing much to do with other currency movements. If the USD weakens against all currencies – the AUD, EUR, GBP and CNY cross-rates to the NZD all remain stable and the TWI does not change.
The RBNZ’s Policy Targets Agreement (PTA) states that “the target shall be to keep future inflation outcomes between 1% and 3% on average over the medium term”.
When inflation is outside the band, or projected to be outside in the future, the RBNZ is required under their Act to explain how such outcomes have occurred and what measures they are taking to return inflation to within the 1% to 3% band i.e. temporary breaches are allowable, however action has to be taken to rectify to get back within the limit.
Every FX dealer and Corporate Treasurer understands such rules around trading, risk and hedging limits.
The annual inflation rate has been below the bottom limit of 1% since September 2014. It can no longer be a temporary breach no matter what the extraordinary global events with deflation etc.
In last week’s MPS in deciding to hold the OCR at 2.25%, the RBNZ state that they are justified in continuing to breach the PTA’s 1% minimum inflation limit as to do more monetary stimulus now (to return inflation to target a little sooner) “would generate more volatility in non-tradables inflation and output than is necessary”. It is difficult to agree with this reasoning and justification for delaying an OCR cut.
More volatility in the exchange rate and damage to productive sector output appears to have been caused by the RBNZ themselves through not cutting. What benefit they see in delaying a cut to August is also very hard to fathom.
The RBNZ’s Chief Economist stated that by August they will have more up to date CPI and GDP growth data and be in a better position to make a decision. Monetary policy should be managed on a 12 to 18 month forward forecast of the economy, not waiting two months for some already out of date historical economic data.
Various commentators are of the view that the RBNZ has “bought some time” to implement further macro-prudential bank lending controls over the housing market. Unfortunately the FX markets move considerably quicker than getting new bank lending controls in place.
The RBNZ will now have to work a lot harder to get the NZD/USD exchange rate back to the mid 0.6000’s, a level that returns inflation to the 1% to 3% band and a level that the dairy industry may be able to survive at.
Bank and broker analysts are all generally supportive of the RBNZ’s decision to hold rates at this time, I take the opposite view and see it is a monetary policy mistake that will have unnecessary negative impacts on the export productive sector that always determines our economic performance.
Roger J Kerr is a partner at PwC. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com