Reserve Bank Governor Adrian Orr has said that New Zealand’s foreign currency settings were at the right level given that New Zealand's terms of trade were at record highs. His comments represent a significant shift from previous Governors, who have often noted the currency's strength.
Orr said that he was a supporter of the bank’s ‘traffic light’ system for intervening in the exchange rate, but saw no need for using it at the moment.
The traffic light system was created so the bank was be sure the currency is 'extreme, unsustainable and that any intervention was consistent with current monetary policy.' All three conditions or 'lights' have to be green for intervention to be considered.
“I’m a big supporter of intervention and the traffic light system,” Orr said, adding he invented the system when he was Deputy Governor before 2007.
But he said that New Zealand’s terms of trade were good and he would not be looking to intervene.
“Terms of trade have returned to record highs,” Orr said.
“It hasn’t felt like that because we all stare at Fonterra and worry about dairy prices,” he said, “but when you map the terms of trade against our Trade Weighted Exchange Rate you can largely explain the types of levels we’ve been at,” he said.
Orr was speaking after delivering his first Monetary Policy Statement or MPS as Reserve Bank Governor. He held rates at 1.75 percent and pushed out the bank’s projection for a rate rise from June 2019 to September 2019.
He also did not mention the currency in the Reserve Bank's opening statement. Previous Governors have regularly commented on the New Zealand dollar's strength over the last decade.
Rates could go up — or down
Orr also said that the direction of the bank’s move was “equally balanced up or down,” meaning the bank could potentially cut rates even lower.
“Only time and events will tell the timing of that,” he said.
He said that faltering international growth or a tightening in international financial conditions, like rising interest rates could encourage the bank to cut the rate.
He also said that sluggish wage growth would encourage the bank to keep rates low for longer.
“Probably the most perplexing thing for us has been the very suppressed wage inflation,” Orr said.
“If that continues to be backward looking it will take longer for us to reach that mid-point,” he said.
There have been calls to cut rates further, given the still high levels of labour underutilisation in New Zealand. Low interest rates and low unemployment have yet to lead to significant wage inflation suggesting there is still room for rates to go lower.
This was the first MPS delivered by a Reserve Bank Governor using the Government’s new ‘dual mandate’ to consider maximum stable employment alongside keeping inflation within its target range.
“Yes, there is an argument,” said Orr about cutting rates to reduce under-utilisation, “but likewise there’s an argument to be raising rates."
He did not think interest rates and inflation needed to be higher to give the bank a buffer in the event of a downturn.
“You can double-guess yourself too much,” he said.
Watching the banks
Orr also indicated the Bank was watching costs pressures facing New Zealand’s banks. The MPS showed banks’ costs of borrowing had increased due to the increased costs of borrowing US dollars at short terms.
The banks had not as yet passed those costs on to consumers.
“We have been interested in the fact that it hasn’t been passed on as much and we try our best to understand what the dynamics have been,” Orr said.
He believed this could be put down to the high level of competition in the industry.
“The banking sector is very competitive so being able to simply pass on all costs can’t simply happen like that,” he said.
Orr said he was open to using the banks' tools to react, including loosening policy to offset higher mortgage interest rates because of higher interest costs.
“That’s not to say they won’t pass it on and if they do pass it on via higher interest rates then we have more work to do than otherwise,” he said.
Orr also highlighted some of the risks the Bank had been looking at, including high levels of household debt, a high concentration of debt in the hands of property investors as well as certain rural sectors like the dairy industry.
“We’ve been talking very bluntly with the banks around their lending behaviours around their commitment to responsible lending,” he said.
A vote of confidence
Orr also lent some support to the Government in its ongoing battle against declining business confidence.
Prime Minister Jacinda Ardern described low business confidence as the “elephant in the room” at a lunch hosted by Business NZ last week and expressed hope that businesses adjusted their pessimistic outlook to what she perceived to be a positive reality.
“Personally I’m surprised at how low business confidence is,” Orr said.
“Generally its businesses sense of their own activity that provides a better indicator of what they themselves will do,” he said.
Businesses’ confidence in their own outlook has remained high.
Orr said that businesses should be investing based on the banks projections of upcoming capacity constraints.