Guest Post: By Simon Louison
Seemingly asleep-at-the-wheel, Reserve Bank Governor, Graeme Wheeler, apparently snapped awake today when he announced a surprise quarter point cut to the Official Cash Rate to 2.25 percent.
Wheeler finally realised things were that bad, realising more stimulatory medicine was needed to boost an economy being sucked down by the dire position of the dairy industry and shaky global markets.
Financial markets, which had believed Wheeler’s spaced out commentary about the economy being hunky dory, were jolted awake and send the Kiwi dollar down a cent and half.
Wheeler, in his quarterly Monetary Policy Statement, cited “many risks” including “difficult challenges” in the dairy sector and the fragile international situation where the risks were “on the downside”.
Of the dairy industry, he said “it’s certainly a challenging sector there’s no question.”
The RB has “stress tested” banks on the basis that the dairy price slump holds for three more years.
The full results will be released next week, but under that “pretty tough” scenario he expects dairy land prices to fall around 40 percent.
Given the sector owes banks around $40 billion, and that that debt is mostly secured on the land, that is going to cause banks pain.
“Under that stress scenario, what the results show is that about 40 percent of the debt would be impaired and actual defaults would likely be something like about 10-15 percent of dairy lending,” Wheeler told a news conference.
But he assured us that agricultural lending made up only 10 percent of bank lending and only part of total agricultural lending was in dairy.
Of course we know that a lot of the rest of the massive bank debt is totally safe in the housing market – the bulk of it in Auckland.
Wheeler believed the banks could accommodate such a downturn in dairy.
He said the RB was also comforted that Auckland house inflation has come down from 27 percent in the year to September to just 14 percent in the year to January!
Asked if he was worried if today’s cut in the cash rate, quickly followed by mortgage rate cuts by private sector banks, would put further upward pressure on house prices, Wheeler said the house price-to-income ratio in the rest of the country was only 5.1 times against Auckland’s 8.5 times and there was more scope for the rest of the country to ‘adjust”.
Assistant Governor John McDermott said one of the main reasons for cutting today was because of low inflation expectations. Inflation has been below the bank’s 1-3 percent target for five consecutive quarters.
Wheeler denied the bank was “asymmetric” in countering inflation falling below the bottom of the target rather than rising above it.
Commenting on the risks of deflation (where prices are on downward spiral), Wheeler said there were global forces at work including globisation itself, technology such as low cost communications, oil and commodity price falls and migration cutting labour costs.
But he refused to admit that monetary policy was now impotent or that inflation targeting was a waste of time.
“No central bank has abandoned flexible inflation targeting,” he said.
Dr McDermott, with a rather smug smile of his face, noted that the RB could still cut rates another 225 basis points before it got into negative interest rates already prevalent in Japan and Europe, “which is more than most central banks have.”
(Simon Louisson formerly worked for The Wall Street Journal, NZPA, Reuters and was most recently a political and media adviser to the Green Party)
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