1 Comment 1 Commentby Susan Edmunds
He told the Auckland Institute of Directors today that he will likely have to use all the tools available to him to achieve price and financial stability in “extraordinary times”.
He said the economy was struggling with drought, the rebuild of Christchurch, a high dollar and house price inflation.
“Many of these challenges will be with us for some time. Meeting our price and financial stability objectives will require us to draw on the full array of policy instruments, including macro-prudential instruments, as appropriate.”
He said the exchange rate and the housing market presented difficult challenges for monetary policy when both the currency and asset prices appeared to be overvalued and investor demand was expected to remain strong.
He said investors were unconcerned by the fact the exchange rate was overvalued, the current account deficit was sizeable and private sector indebtedness was high. He said they also downplayed the liquidity risks of a small market such as New Zealand.
“The Reserve Bank has been responding to the rising exchange rate through two avenues: in maintaining the Official Cash Rate at an historically low level; and through a degree of currency intervention.”
He said the high dollar was putting downward pressure on inflation, which meant that interest rates could stay lower than they might otherwise.
“Risks associated with excessive housing demand could normally be constrained by raising official interest rates and letting them feed through into higher mortgage costs. However, this would carry significant risks of a further strengthening in the exchange rate and further downward pressure on tradable goods prices. This might, in turn, be expected to push CPI inflation further below the 1 to 3% target range. This is where macro-prudential policies can play a useful role in promoting financial stability. Capital and liquidity overlays can help build up buffers in the banking system while adding to the cost of bank funding. And loan-to-value restrictions may help to reduce the actual supply of mortgage lending.”
He said, if house price pressure cooled, it would increase the chance the OCR could stay at its current level beyond this year. “Similarly, if housing pressures are much less of a concern and the exchange rate continues to appreciate and the inflation risk looks low, it may create opportunities to lower the OCR.”
He said: “Macro-prudential measures can be useful in helping to restrain housing pressures, but they are no panacea. This reinforces the importance of measures to enhance productivity in the construction sector, free up land supply, and examine related tax issues.”
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