Economic Week - November 27
by Nick Clark
Monetary policy and housing
Runaway house prices have proven to be an early headache for our newly-minted government. The underlying problem is a lack of supply of houses to meet strong demand, but the Reserve Bank’s unprecedented monetary stimulus has also come under fire for stoking that demand.
This year the Reserve Bank has been very successful in driving down interest rates. While tough on savers, lower interest rates have helped householders, businesses, farmers, and the government with their borrowing costs, limiting the economic damage from COVID-19. The economy and employment have not tanked nearly as badly as originally feared, so people have been feeling less fearful about their prospects. As a result, consumers are spending and many investors and first home buyers have seen the remarkably low interest rates on offer and have decided it to be a good time to buy. They have jumped into the housing market, pushing house prices sky high and generating plenty of political heat around the affordability of housing, especially for first home buyers and renters.
This week the Minister of Finance acted, taking the unusual step of publicly writing to the Reserve Bank Governor seeking advice on how the Reserve Bank help the Government to address rising house prices. The Minister pointed to the existing Monetary Policy Remit suggesting it could be amended to say that monetary policy should seek to avoid unnecessary instability in house prices (as well as output, interest rates, and the exchange rate which are already in the Remit). Asking for ‘advice’ can be interpreted as the Government telling the operationally independent central bank what it should do without explicitly crossing the line of directing it.
The Reserve Bank quickly responded welcoming the chance to work with the Government on this issue but said its Monetary Policy Committee already considers asset prices in its forming of monetary policy. However, there is no explicit mention of asset prices in the Remit (nor previously in successive policy target agreements), so plugging this gap makes sense. Not much will happen though unless the additional wording translates to policy action.
In terms of policy action, the Reserve Bank’s proposed reintroduction of loan-to-value ratio (LVR) restrictions for property investors should help, and some banks have already moved. However, LVR restrictions (and other ideas like debt-to-income limits) have been and are being imposed to address risks to financial stability rather and not as ways to promote housing affordability.
In terms of monetary policy, it seems that the need for yet more extraordinary stimulus is diminishing. If that is the case (and there is still considerable downside risk) the best way to ensure monetary policy doesn’t drive house prices even higher would be for the Reserve Bank to find a way to return to more normal monetary policy settings and reduce the need for unorthodox policies like quantitative easing, direct lending to banks, and a negative official cash rate. This won’t be easy as higher interest rates are never popular (except with savers) and international experience shows how markets and politicians accustomed to central banks’ sugar rushes have thrown tantrums when policy makers decide it’s time to cut back on the sugar.
We have an operationally independent Reserve Bank, but it will need to show its mettle when the time comes to normalise policy and it will need a clear road map backed up by excellent communications with the market and with politicians. And if there is a need for more stimulus, perhaps the Government’s fiscal policy levers could be pulled harder. Like the economy, its position is better than earlier feared which might provide a bit more room to move.
It’s also important to remember that rising house prices is not all the Reserve Bank’s fault. There are plenty of factors at play and what is really needed is for the Government to move quickly to do what it can to make it easier and cheaper to build houses and increase supply in the market. It can do this through reforming overly restrictive planning rules, improving funding for infrastructure, and building more social housing. Taxes on capital gains and wealth are not the answer and would be counterproductive so it’s good the Prime Minister has ruled them out.
Christchurch shows what’s possible. After the 2010-11 earthquakes damaged and destroyed a lot of the city’s housing stock, the Government helped facilitate a surge in house building in Christchurch (and its neighbouring districts Waimakariri and Selwyn) which dramatically increased supply. This kept the city’s house price inflation well-contained for several years and has made it our most affordable major city to buy a house.
Let’s get on with it.
RBNZ Financial Stability Report
Meanwhile, the Reserve Bank’s six-monthly Financial Stability Report was also released this week. It observed that with the New Zealand economy having done better than expected, the financial system has not been tested as severely as it could have been. The banking system has maintained strong buffers of capital and liquidity, and the insurance sector remains well capitalised.
However, despite significant fiscal and monetary support preventing a substantial rise in unemployment, the Reserve Bank considers that there remains much downside risk and that some sectors will continue to experience stress.
Turning to agriculture (one of the sectors it keeps a close eye on), the Reserve Bank had this to say…
The agriculture sector continues to show relatively less strain than other business sectors in New Zealand. Food production was considered essential during the higher Alert Levels, allowing firms to continue operations throughout the restrictions. The sector’s resilience has also been aided by the comparatively rapid recovery seen in the Chinese economy, New Zealand’s biggest trading partner.
Banks’ appetite for overall agricultural lending has remained steady, with the shift towards greater diversification in their portfolios continuing. Horticultural lending, led by the kiwifruit industry, is growing at an annual rate of 15 percent. Banks will need to monitor emerging risks associated with this growth, in light of potential constraints to labour availability in the near term due to the ongoing border restrictions.
Uncertainty surrounding global economic conditions is adding to the limited demand for dairy lending, particularly for farm expansion. Dairy farmers appear to be taking a more cautious approach to long-term capital investment in light of the global economic recession and ongoing consequences of COVID-19. Banks have been working with overextended dairy farmers and encouraging them to de-lever, by taking advantage of favourable commodity prices and historically low interest rates to repay loan principal and reduce their vulnerability to another dairy downturn.
However, there are still a number of dairy farms that remain financially vulnerable. This is particularly significant as some dairy farms remain highly indebted after experiencing two downturns in the last decade and require a high milk price just to remain operational. Furthermore, restrictions on foreign investment introduced in recent years continue to exacerbate issues with illiquidity in the farm land market.
Banks’ limited appetite for new dairy lending also reflects concerns around the cost of compliance with new environmental regulations on farm incomes, such as stock exclusion from waterways, the nitrogen fertiliser cap, and the introduction of agriculture to the Emissions Trading Scheme in the near future.
Fiscal deficit smaller than expected
The Government’s Financial Statements for the year ended 30 June 2020 recorded a huge operating deficit but one that was $5 billion smaller than forecast in the May Budget.
The operating balance before gains and losses was a deficit of $23.1 billion (7.5% of GDP), a $30.5 billion turnaround on the $7.4 billion surplus for the year ended 30 June 2019. Despite this blowout the deficit was $5.2 billion less than forecast in the Budget. The smaller deficit was due to core Crown tax revenue being $2.8 billion higher than expected and core Crown expenditure being $5.2 billion lower than expected.
Net core Crown debt was $83.4 billion on 30 June 2020. This was up from $57.7 billion at the start of the financial year. As a percentage of GDP net core Crown debt had risen to 27.0% but this was less than the 30.2% forecast in the Budget.
The $23.1 billion fiscal deficit for 2019/20 is a lot bigger than 2010/11’s previous record deficit of $18.4 billion. Interestingly though, 2019/20’s deficit as a percentage of GDP is smaller (7.5% vs 8.9%). The 2010/11 monster deficit was due mainly to costs associated with the Canterbury earthquakes which came not long after the recession associated with the Global Financial Crisis.
The previous National-led government kept a firm lid on new spending and, helped by a growing economy, oversaw a return to surplus only four years later in 2014/15. The circumstances this time are different, with no one expecting such a quick return to surplus and the Pre-Election Economic & Fiscal Update suggested it would take at least a decade. However, the previous experience shows what could be possible.
Record annual trade surplus
October saw falls for both exports and imports and the highest annual goods trade surplus since 1992, according to Statistics NZ’s monthly Overseas Merchandise Trade statistics.
Goods exports were worth $4.78 billion in October 2020, down $222 million (or 4.4%) from October 2019. It was a mixed picture for our main exports, with most of the decline due to dairy and meat and wool. Exports of milk powder, butter, and cheese were down 13.7% to $1.25 billion meat and edible offal down 19.3% to $468 million; and wool down 35.0% to $40 million.
On the plus side exports of logs, wood, and wood articles were up 22.1% to $464 million; preparations of milk, cereals, flour, and starch up 3.8% to $223million; fruit up 9.2% to $170 million; and wine up 7.3% to $202 million.
Goods imports fell by even more. They were worth $5.29 billion in October 2020, down $759 million (or 12.6%) from October 2019. There were declines for all of our top four import commodities, with especially large falls for mechanical machinery and equipment (down 31.1%) and petroleum and products (down 33.0%).
The monthly goods trade balance was a $501 million deficit, $537 million smaller than that for October 2019. Deficits are typical in October.
On an annual basis, goods exports were worth $60.07 billion for the year to September 2020, up $734 million (or 1.2%) on the year to October 2019. Most of our key commodities were up for the year, except forestry and wool:
- Milk powder, butter, and cheese up 6.5% to $16.21 billion;
- Meat and edible offal up 5.3% to $8.23 billion;
- Logs, wood, and wood articles down 12.5% to $4.48 billion;
- Fruit up 13.1% to $3.88 billion;
- Preparations for milk, cereals, flour, and starch up 4.0% to $2.40 billion;
- Wine up 8.7% to $2.00 billion; and
- Wool down 25.3% to $385 million.
Goods imports were down dramatically for the year, falling $6.51 billion (or 10.1%) to $57.87 billion. Of our major import commodities there were particularly large falls for aircraft and parts (down 50.0% to $676 million); vehicles, parts, and accessories (down 24.5% to $6.45 billion); and petroleum and products (down 27.5% to $5.35 billion).
For the year to October 2020 the goods trade balance was a surplus of $2.19 billion, a huge turnaround from a $5.06 billion deficit for the year to October 2019. It is the largest annual goods trade surplus since the year to July 1992.
Spending splurge
The country’s cash registers and Eftpos machines were busy in the September quarter, according to Statistics NZ’s Retail Trade Survey.
Comparing the September 2020 quarter with the September 2019 quarter, the total value of retail sales rose 7.4% and the total volume of sales (adjusting for price effects) rose 8.3%.
12 of the 15 industries had higher sales values, with the biggest percentage increases for electrical and electronic goods (up 25.3%); non-store and commission-based retailing (up 21.0%); liquor (up 20.7%); recreational goods (up 20.1%); and hardware, building and gardening supplies (up 15.8%). There were declines though for accommodation (down 11.9%); fuel (down 8.1%); and food and beverage services (down 3.1%).
14 of the 16 regions posted increases in sales values, with the biggest percentage increases for Marlborough (up 22.5%), Hawkes Bay (up 15.6%), Northland (up 14.4%), and Gisborne (up 14.0%). The declines were in West Coast (down 1.4%) and Otago (down 0.3%), the two regions with the biggest drops in the June quarter.
NIWA Soil Moisture Data
NIWA’s latest soil moisture maps (as at 9am Thursday 26 November) show the effect of heavy rain with many areas now wetter than usual or close to average. Much of the North Island’s soils are significantly wetter than usual, especially in the Hawkes Bay region. Conditions are also wetter than usual in Nelson-Tasman. In contrast much of the Far North district is significantly dryer than usual, as is South Westland-North Fiordland.
Exchange Rates
The NZ Dollar had another good week, strengthening 1.3% against the TWI. It was up against all our major trading partners and is now over 70 US cents and 95 Australian cents.
NZ Dollar versus
|
This Week
(26/11/20)
|
Last Week (19/11/20)
|
Last Month (27/10/20)
|
Last Year (26/11/19)
|
US Dollar
|
0.7008
|
0.6904
|
0.6683
|
0.6410
|
Australian Dollar
|
0.9513
|
0.9471
|
0.9374
|
0.9459
|
Euro
|
0.5877
|
0.5833
|
0.5654
|
0.5822
|
UK Pound
|
0.5234
|
0.5218
|
0.5132
|
0.4970
|
Japanese Yen
|
73.11
|
71.70
|
70.04
|
69.90
|
Chinese Renminbi
|
4.6101
|
4.5173
|
4.4766
|
4.5074
|
Trade Weighted Index
|
74.11
|
73.18
|
71.84
|
71.20
|
Source: Reserve Bank of NZ
Wholesale Interest Rates
Over the course of the week the 90 Day Bank Bill interest rate was unchanged, but the 10 year Government Bond yield held up a further 6 basis points to 0.92%.
The Reserve Bank will next review monetary policy settings (including the OCR) on 24 February 2021.
|
This Week
(26/11/20)
|
Last Week (19/11/20)
|
Last Month (26/10/20)
|
Last Year (26/11/19)
|
OCR
|
0.25%
|
0.25%
|
0.25%
|
1.00%
|
90 Day Bank Bill
|
0.25%
|
0.25%
|
0.27%
|
1.22%
|
10 Year Government Bond
|
0.92%
|
0.86%
|
0.57%
|
1.31%
|
Source: Reserve Bank of NZ