When will central banks react to inflation?
- Higher inflation and the prospect of a reduction in central bank support is becoming a concern among financial market participants.
- We think this risk is low given most economies have spare capacity that is keeping unemployment rates higher and inflation lower than central banks desire.
- The ongoing threat of higher inflation and reduced monetary stimulus, however, is likely to lead to choppy trading conditions as investors manage the transition away from the low inflation and falling interest rate environment seen in recent years.
- We hope that the following Q&A gives you an insight into our thought process.
RBNZ to drive retail rates lower
- The RBNZ has confirmed that cheaper bank funding will be here in time for Christmas via its Funding for Lending Programme (FLP).
- This will provide fresh impetus for banks to lower lending and deposit rates.
- Lower mortgage rates will likely boost an already-booming housing market. Lower term deposit rates may encourage consumer spending and a hunt for yield.
Economic strength to challenge the RBNZ’s dovish stance
- Market expectations of additional Reserve Bank of New Zealand (RBNZ) stimulus, for instance moving to a negative Official Cash Rate (OCR), have been tied to continued cautious communication from the central bank. Interest rate markets today price an OCR of -0.25% in one year’s time.
- The economy, however, is in much better shape than the RBNZ expected, which presents a challenge to its uber-dovish stance and the prospect of a negative OCR next year.
- In our view, the likely launch of a Funding for Lending Programme (FLP) as part of its 11 November Monetary Policy Statement (MPS) further reduces the need for additional stimulus.
- We see the distribution of future interest rate outcomes skewed higher.
The further consequences of lower interest rates
- As market interest rates in New Zealand decline further, additional consequences are revealing themselves. The theme of accelerating progression of longer-term trends continues.
- Wholesale interest rates continue to decline, with the Government’s PREFU announcement being the catalyst this week, due to a $10bln reduction in the size of the Government Stock issuance program for the 2020/21 fiscal year. The five-year New Zealand Government bond now trades at a negative yield, joining the one and two year maturities. 35% of outstanding nominal New Zealand Government Stock is now in the “negative rate” club.
- This week the Auckland Council issued the longest maturity bond in New Zealand for more than fifty years. The ability of a council to issue 30-year bonds in the domestic market is a notable milestone in the ongoing development of the New Zealand capital market.
Negative cash rates – The afterburner for asset prices
- The RBNZ’s stated preference for a negative OCR, should further stimulus be required, has encouraged the New Zealand market to expect negative wholesale cash interest rates next year
- This forward guidance on the potential for negative rates has led to large declines in retail interest rates and is having a powerful and positive impact on all asset prices
- This week a New Zealand government bond closed with a negative yield for the first time
Bond market takes note of RBNZ dovish shift
- We think the RBNZ reaction function has become more dovish with lower and flatter yield curves the primary goal in the face of persistent health-related downside economic risks.
- The Bank expanded its QE programme by more-than-expected last week from $60bn to $100bn and said it is prepared to implement a negative OCR alongside direct lending to retail banks at interest rates close to the OCR, if required.
- Interest rates have fallen in response, but NZ government bonds now look expensive versus their global peers and a sharp rise in breakeven inflation rates suggest that economic risks may lie in both directions.
Shadow banks shine light on mortgage deferrals
- Some of New Zealand’s non-bank mortgage lenders have provided detailed data that illustrates they appear well-positioned to weather an increase in non-performing loans when COVID-related loan deferrals expire
- Our various probes into the big banks indicate no cause for alarm, albeit we expect loss provisioning needs to rise and small to medium-sized enterprise (SME) lending trends need to be monitored
A bold bounce
- Many economies, including New Zealand, are re-opening and recovering faster than expected
- High growth rates are normal after such a large contraction in activity and the recovery, so far, is partial
- Ongoing policy stimulus is expected, given the residual uncertainty
Large Fiscal Spending Promises
- Budget 2020 revealed larger-than-expected potential spending in response to COVID-19.
- However, detail was lacking on many spending priorities.
- The accompanying larger bond issuance programme may prove difficult for the market to digest, placing upward pressure on government bond yields.
Will RBNZ QE help bridge the gap and how does it work?
What is the Reserve Bank of New Zealand’s (RBNZ’s) Quantitative Easing (QE) programme?After cutting the Official Cash Rate (OCR) by 75bp to 0.25% on March 16th, the RBNZ launched its Large Scale Asset Purchase (LSAP), or QE programme, just one week later. LSAP has a target to buy $30bn of government bonds over the next year; equivalent to 10% of Gross Domestic Product (GDP) and, at the time, almost 50% of outstanding bonds ma...READ MORE