Will the RBNZ Cut Interest Rates Despite the Property Bubble?

The New Zealand Dollar has remained largely buoyant over the past few weeks despite a range of sentiment swings to and from the US Dollar. Despite this level of resilience, there are some concerning signs building within the economy that could spur the Reserve Bank into action and send the venerable Kiwi Dollar tumbling. Subsequently, the question remains if the RBNZ will move to cut the Official Cash Rate (OCR) in an attempt to depreciate the overvalued NZD.

Given the relative importance of the dairy market to New Zealand’s net exports, it is no surprise that constant declines within the index are cause for concern for both the government and the central bank. The latest auction result again puts dairy prices in the spotlight given its contraction of 1.4% and an average price near the USD$2,203/MT mark. Subsequently, given the countries relative lack of GDP diversity, such a result is likely to have some significant flow on effects within the domestic economy.

Further complicating New Zealand’s economic outlook is Australia’s own monetary and fiscal policies which have recently exacerbated the trade problem. Given that Australia represents the economies largest trading partner (12B annually) any move by their Reserve Bank to depreciate the Australian Dollar complicates cross-Tasman trade. Subsequently, yesterday’s move by the central bank to cut rates by 25bps to 1.75%, and thereby depreciate the AUD, will impact New Zealand exports relatively strongly.

It is this environment that the Reserve Bank of New Zealand now faces as we move towards the June monetary policy meeting. Subsequently, there are a variety of building pressures for the central bank to cut the official cash rate and thereby depreciate the New Zealand Dollar strongly. However, the bank also faces some potential pitfalls with any easing, with the Auckland property market playing a starring role.

For some time a bubble of monumental proportions has been expanding within the New Zealand housing market. Prices are rising at an astounding rate as record levels of immigration, and little growth to housing stocks, buoy demand. In addition, rampantly competitive domestic mortgage markets have meant that consumers can access debt funding with little difficulty. Subsequently, demand has surged, leaving a fragile bubble that could threaten the stability of financial institutions within the nation.

Although the RBNZ has undertaken a range of macro-prudential moves to try and quell the rises (at least the high LVR ones). It appears to have had little long term impact and may have just excluded those at the “needy” end of the market. Consequently, the bubble continues to inflate at an astounding pace that is likely to give Graham Wheeler some sleepless nights.

Subsequently, a decision to cut rates, without somehow shielding the Auckland property market, is a relatively unpalatable choice for the RBNZ. It sends the right message to the global capital markets whilst also signalling that the good times are here to stay for the bevy of property investors. This confusingly mixed message is likely to do little but embolden the sentiment which is rapidly filling the hot air balloon.

However, despite the risk of market catastrophe should real estate collapse, it should be noted that the RBNZ doesn’t manage the money supply for the benefit of property owners (or politicians for that matter). In fact, there is an argument to be made that the venerable central bank should focus just upon the fundamental drivers of economic growth and price inflation, rather than any risks below the aggregate level. This is a valid argument and points to the fact that reserve banks are expected to stick to their remit and not attempt to use the blunt tool of monetary policy to fix domestic social and market issues.

Subsequently, it would be short sighted to think that the RBNZ will not act to stimulate the economy and depreciate the NZD in early June. I firmly expect at least a 25bps cut to the rate and a fairly rapid drop to the current NZD valuation which would restore some balance to exports between Australia and New Zealand.

In addition, it might also finally reiterate to the government of the day that the central bank is not the appropriate vehicle for domestic policy changes. Such a signal might finally spur the national government to fill the leadership vacuum that currently exists over mounting risks to real property in New Zealand. Subsequently, as we move closer towards the inevitable rate cut, look for a decisive mix to emerge between monetary and fiscal policies that could have some long lasting impacts.