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"Very real" chance monetary policy will run out of ammo - ANZ

Monday 17th June 2019

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ANZ Bank says there is a “very real” chance that New Zealand's monetary policy will run out of conventional ammunition and suggested the central bank look at a series of unconventional measures, including quantitative easing.

With the official cash rate already at a record-low 1.5 percent “odds are rising that some kind of significant economic hit will occur before the OCR is back to anything approaching historical norms,” FX/rates strategist Sandeep Parekh and economist Michael Callaghan said in a research note.  

Hits could include a negative global shock, an extreme drought or an earthquake.

ANZ expects further cash rate cuts in November and February to take the cash rate to 1 percent.

If unconventional monetary policy were to be necessary – something they say is not a given – they recommend reducing the official cash rate to negative 0.25 percent and “provide very strong forward guidance that rate hikes are a very distant prospect.”

In order for that to happen, however, other steps would have to be taken.

Among other things, “a plan for fiscal and monetary policy coordination would need to be established and communicated, and the RBNZ would need an indemnity from the Treasury to expand its balance sheet.”

They recommend reducing the settlement system penalty rates from 100 basis points to 50 basis points, to ensure holders of exchange settlement accounts are not pushed above their credit tiers as "pushing participants to the brink of their credit tiers is associated with not only extra costs for participants but also risks to market functioning."

These penalties are essentially for parking too much cash at the RBNZ. 

They also recommend asset purchases and swap transactions to lower long-term lending rates and risk premia and free up liquidity for lending. However, “available assets for purchase are limited, so a range of securities need to be considered. The RBNZ will bear substantial financial risks.”

They noted the central bank has said it could conduct large-scale asset purchases up to 10 percent of gross domestic product. As at April 30, there were roughly $70 billion of New Zealand government bonds on issue, with roughly 54 percent of that sum held offshore. 

With the government aiming to limit debt issuance to 20 percent of GDP during its first term, but volumes near that level already, the RBNZ would be setting out to purchase roughly half of the NZGBs on issue.

However, it is unlikely the RBNZ would be able to source large volumes given how much are held offshore and minimum NZGB holding requirements imposed by participants internally for liquidity purposes. 

Other good-quality assets - such as Kauris - are also limited and hard to find in the New Zealand market. The bonds - denominated in NZ dollars but issued overseas - are typically held by interested investors and do not trade frequently in the secondary market. 

Another option is that the RBNZ could look to the stock of internal residential mortgage-backed securities warehoused on local bank balance sheets. But ANZ said it would probably be reluctant to do so as this would transfer the risk of mortgage defaults from the private sector to the public sector, and warehouse the risk of default on the central bank balance sheet.

These challenges “highlights that there is a need for clear, structured, and pre-emptive fiscal and monetary policy coordination for responding to a crisis,” they said.

“The RBNZ needs to start to map out the mechanics of what needs to happen and communicate what unconventional monetary policy could mean for domestic participants,” they said.

Finally, they recommend introducing long-term cash facilities to inject balances into the banking system.

Overall, they say there are “numerous challenges, costs and risks” to the RBNZ’s balance sheet. Market functioning and bank profitability would “be of particular concern.”

However, "unconventional monetary policy is no panacea and is distortionary, as international experience shows. But unconventional monetary policy done on the fly would be riskier still." 


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