9 things of note from the RBNZ's March MPS

The Reserve Bank published its March Quarter Monetary Policy Statement (MPS) , held a news conference and appeared before Parliament's Finance and Expenditure Committee on Thursday. Here's the nine key things of note from the set-piece statement and the ensuing commentary.

Flat and short

The Reserve Bank held its Official Cash Rate at 3.5% as expected, but the most notable (and almost comical) feature of the MPS was its completely flat line forecast for the 90 day bill rate at 3.7% until March 2017. This is the bank's best proxy of what it expects to do to the OCR in the coming months and sent the clearest signal possible that it has a 'neutral' outlook and that interest rates were on hold. The December MPS forecast the 90 day bill rate rising to 4.4% by March 2017 so the bank has effectively lowered its forecast track by at least 70 basis points.

But the forecast was also truncated to just March 2017, whereas the last forecast went out as far as December 2017. The Reserve Bank said this reflected the uncertainty in the outlook, but some of the more hawkish economists thought the bank's internal forecast beyond March 2017 would have shown increases. They suggested the bank had truncated the forecast to ensure a clear message of flat rates was sent to international investors.

No petrol here

Graeme Wheeler downplayed any suggestion the Reserve Bank was holding off any rate cuts because of fears it would pour more fuel on the fire in Auckland's property market. He said the bank was not seeing the sort of 'wealth effects' on household spending that pushed up CPI inflation in 2006/07.

"No. We're concerned about the Auckland house prices for financial stability reasons," he said when asked if the Reserve Bank had not cut rates because of fears about further inflating the Auckland market.

That appeared to clear the way for rate cuts if the CPI inflation outlook allows it in coming months and reduced any concerns the bank was holding off rate cuts because of the Auckland market.

More Macro-Pru...maybe

Wheeler was circumspect about the prospects for more Macro-Prudential measures that might be similar to the high LVR speed limit imposed in 2013. He referred to the announcement last week of a proposal to sub-categorise rental property mortgages for capital adequacy purposes, which would give the bank the flexibility to impose tougher capital rules and therefore potentially increase interest costs for investors.

But he again referred to it as a Micro-Prudential tool, even though the announcement itself talked about how it would help the bank implement targeted Macro-Prudential policies in future.

"We haven't made any judgment or decisions on macro-prudential," he said, adding there had been discussions internally at the Reserve Bank about the sorts of loan to income multiple tools used by the Bank of England.

He then referred to the Reserve Bank's toolkit of macro-prudential measures in its May 2013 memorandum of understanding with Bill English, which include the potential for a Counter Cyclical Capital Buffer and a Sectoral Capital Overlay, that would allow increased risk weightings for capital requirements for housing loans.

"We talk about those as possibilities and also look at what other countries have done -- Ireland and England -- but we really haven't made any decisions on this," he said.

The rental property investor categorisation is scheduled to apply from July 1, although the bank has indicated a nine month transition period for whatever capital rules it applies. This would leave plenty of time for the more bullish rental property investors to get in under the wire.

'We're exceptional'

Wheeler was repeatedly pressed in the news conference and the select committee hearing about why New Zealand was not following the rest of the developed world's monetary policy easings.

Wheeler argued New Zealand's economy and employment was growing strongly, which contrasted with the seven other developed economies where central banks had eased policy this year. He even described it as a "standout" performer in the select committee hearing.

"We're in a different situation. We've got an economy that's growing at around 3.25% to 3.5%, and we're projecting it to continue to grow at those sorts of rates over the next two years. We've got a positive output gap. We've got strong employment growth over the last 12 months of 3.5% and record levels of net migration running at 48,000 to 50,000 and record levels of (workforce) participation at around 70%," he said.

"Our situation is quite different to those economies that have eased monetary policy or cut interest rates. The cost of capital here doesn't appear to be a major constraint for business and we still believe monetary policy is expansionary, and we've seen falls in fixed term interest rates."

'Look at the oil and the kiwi'

Wheeler was also repeatedly challenged about his compliance with his September 2012 Policy Targets Agreement, which specifies a target of around 2% within a 1-3% band. Annual CPI inflation has been below the mid-point of the bank's 1-3% target range since September 2011 and is forecast to be below 1% for five consecutive quarters until March next year. The bank itself forecast 0.0% annual inflation in the current March quarter.

He pointed to the 0.9% reduction in inflation because of last year's slump in the oil price as the key factor driving inflation below the target, along with the strong New Zealand dollar, and was confident inflation was headed back towards the mid-point, although the bank's own forecasts show it only rising to 1.7% by March 2017. The MPS also included a special chapter on the impact of the oil price fall.

"The main reason why inflation has been below the mid point is primarily because of the high exchange rate and inflation in the traded goods sector. Tradables inflation has been negative now for three years and it's due to many factors, including low overseas inflation. It's due to exporters cutting prices to maintain market shares and its due to falling capital goods prices and it's due to our high exchange rate," Wheeler said.

Wheeler said non-tradable inflation had fallen from around 3% to around 2.5% and he expected it to gradually pick up over time as the output gap is forecast to increase.

"There's sound reasons why we've been below the mid-point, but we see future inflation heading towards the midpoint again as the oil price effects work through the economy," he said.

Critical expectations

The most interesting part of the MPS for those hoping for rate cuts was Box A, which included a scenario where inflation expectations halved from their current levels of around 2% to 1% in the coming year. The bank's scenario included a 50 basis point fall in the 90 day bill rate, implying the bank would cut the OCR by that 50 basis points to 3%.

The bank's inflation expectations surveys have been relatively low-key affairs until now, but Box A will refocus attention on them, although the 'expectations' referred to don't relate to any single measure in the survey and are instead an unspecified 'range of expectations' that do not relate directly to any of the surveys' measures.

Wheeler made a point of referring to that scenario when asked about the potential for rate cuts.

"The key issue for us will be to what extent does wage and price setting behaviour change in the economy. That's the most critical thing," he said.

"The issue will be: will wage and price setting behaviour moderate further, causing inflation expectations to fall. If that did, and we were assessing that to be something that would be sustained over time, then that's something that would affect our thinking on monetary policy."

The new neutral

Wheeler spoke in both the news conference and the select committee hearing about the Reserve Bank revisiting its assessment of the 'neutral' interest rate, which it currently sees at around 4.5%. Box B in the MPS also talks about whether the neutral rate should be lowered again, having already been lowered immediately after the Global Financial Crisis.

"However, it remains an open question whether these changes were sufficient to reflect developments in recent years, including the more recent signs that longer-term inflation expectations have adjusted lower to being more consistent with the midpoint of the Bank’s target range," the bank said.

Wheeler told the committee later the bank was working on its neutral rate assumptions, and if it was lowered, that may mean lower levels of interest rates were sustainable.

Swedish lessons

Wheeler was asked in the select committee about Auckland's housing market and the role of the bank in addressing asset bubbles. He referred to the Swedish Central Bank's failed attempts to 'lean against' its inflated house prices and debt to income ratios.

The Riksbank raised interest rates prematurely to target its housing market and "they over-cooked it", he said. Sweden had ended up with deflation and had recently had to cut interest rates to reverse its failed experiment.

The uncooperative New Zealand dollar

Wheeler toughened his jawboning over the New Zealand dollar in his policy assessment statement, repeating his comments about the currency being unsustainably and unjustifiably high and adding this: "A substantial downward correction in the real exchange rate is needed to put New Zealand’s external accounts on a more sustainable footing."

The currency markets promptly ignored this by pushing the New Zealand dollar up almost a cent during Thursday. It rose another cent overnight and is just under 74 USc this morning. Economists said foreign exchange markets, who are used to rate cuts and policy easings, were disappointed the statement was not more dovish.

Wheeler said in the select committee he wouldn't read too much into the market reaction.