Gareth Morgan, Director of Gareth Morgan Investments
The tension between market expectations of interest rates and the Reserve Bank’s monetary stance has heightened of late. The yield curve has taken on a fairly sharp ‘L’ shape reflecting this difference, with rates dropping away sharply from the 90 day anchor. The international capital market in its wisdom has decided some or all of the following apply;
- Inflation is set to fall significantly and with that the pressure the RB has been applying to monetary conditions
- The economy is faltering and so rates will fall
- Now that the political impediment to a clear view of NZ’s economic outlook looks less foreboding, the gap (risk premium) between NZ and global interest rates should be reduced
- With global interest rates falling – namely in Europe and Japan, NZ rates look increasingly attractive
Arguably all four apply, although expectations of a weakening economy are unlikely to be that widespread. What the market clearly gives little cognisance to is the following;
- The new government is likely to adopt a significantly expansive fiscal stance thereby raising the figures for outstandings of government paper
- The tradeables sector – exporters and all those firms who have to compete(either directly, or indirectly) against imported product at home- are spewing over the currency appreciation, and the current account deficit is embarking on significant deterioration
- Inflationary pressures are more widespread than they have been with the property sector for now, no longer the dominant driver of domestic inflation
- Recent experience in the housing market would lead one to believe that a sudden emergence of fixed rate mortgages of say 1-3 years duration, priced at rates 1-2% lower than the current floating rate of 11½ %, will be leapt upon by householders who see these as cheap.
From this cacophony of signals the market has decided lower interest rates and a higher dollar are appropriate. Should it decide to maintain this change then the RB will have little choice but to ratify the changed mix in monetary conditions, irrespective of the impact on the tradeables sector. As the Governor has said, ultimately he cannot decide the mix. It’s the market’s view that disinflation from here should be accomplished by more exchange rate pressure rather than the current interest rate pressure.
In this context it seems vacuous to blame the RB for “the high dollar’ as the market has the choice of how to assign interest rates and the dollar their roles in any given monetary settings. Objection to NZ monetary policy can only be launched on three grounds
- The 1% inflation goal is too low – measurement errors, forecasting errors and implementation lags make it too difficult to maintain on an ongoing basis. Relaxation of the target either by lifting it and/or shifting to it as a medium term rather than continual objective, is appropriate.
- The market doesn’t know what its doing driving the currency up- an indictment of market rational expectations.
- Inflation is dead and the RB is ignorant of it. In light of the track record on inflation and the bias the RB has against getting inflation down near the bottom of the 0-2% range, this view has little credence.
For a proponent of price stability and rational markets there is no place to hide.
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