The Reserve Bank of New Zealand (RBNZ) governor, Graeme Wheeler, yesterday delivered a speech to the Auckland Institute of Directors suggesting that it is just days away from launching loan-to-value ratio (LVR) limits on mortgage lending, in order allow the RBNZ greater flexibility to lower interest rates and take pressure off the overvalued kiwi dollar without re-igniting a housing bubble. From Wheeler’s speech:
“[New Zealand has] to adjust to heavy capital inflows that cause our exchange rate to appreciate and reduce the profitability and competitiveness of our tradables sector.”
“And we need to do so at a time when house price inflation is increasing risk in the New Zealand financial system.”
“Many of these challenges will be with us for some time. Meeting our price and financial stability objectives, will require us to draw on the full array of policy instruments, including macro-prudential instruments, as appropriate.”
Mr Wheeler said that the exchange rate and the housing market present difficult challenges for monetary policy when both the currency and asset prices appear to be overvalued and investor demand is expected to remain strong.
“New Zealand’s exchange rate is significantly overvalued. Fortunately it has retreated a little in recent weeks with a stronger US dollar…
“The Reserve Bank has been responding to the rising exchange rate through two avenues: in maintaining the Official Cash Rate (OCR) at an historically low level; and through a degree of currency intervention.
“The downward pressure on inflation exerted by the high exchange rate means that the OCR can be set at a lower level than would otherwise be the case. In recent months we have undertaken foreign exchange transactions to try and dampen some of the spikes in the exchange rate…
Mr Wheeler said that the Bank is also concerned about the financial stability risks associated with the housing market, in particular the scale of housing lending, and especially high loan-to-value ratio (LVR) lending.
“Risks associated with excessive housing demand could normally be constrained by raising official interest rates and letting them feed through into higher mortgage costs. However, this would carry significant risks of a further strengthening in the exchange rate and further downward pressure on tradable goods prices. This might, in turn, be expected to push CPI inflation further below the 1 to 3 percent target range.
“This is where macro-prudential policies can play a useful role in promoting financial stability. Capital and liquidity overlays can help build up buffers in the banking system while adding to the cost of bank funding. And loan-to-value restrictions may help to reduce the actual supply of mortgage lending.
“If house price pressures abated, it would increase the possibility that the OCR could remain at its current level for longer than through this year. Similarly, if housing pressures are much less of a concern and the exchange rate continues to appreciate and the inflation risk looks low, it may create opportunities to lower the OCR,” Mr Wheeler said.
“Macro-prudential measures can be useful in helping to restrain housing pressures, but they are no panacea. This reinforces the importance of measures to enhance productivity in the construction sector, free up land supply, and examine related tax issues.”
Bravo RBNZ. Instead of sitting on its hands, as Australia’s Reserve Bank has done, letting the high exchange rate kill New Zealand’s tradeables sector, it is taking concrete action to lower the currency through a combination of lower interest rates and direct currency interventions. At the same time, the RBNZ is moving to implement macro-prudential tools, including caps to LVRs, in order to limit the extent to which lower interest rates flow into increased borrowing and house price appreciation, thus reducing imbalances and improving financial stability.
Slow learners we Aussies are.
