When the Reserve Bank speaks - we should all listen

reserve bank-879The Reserve Bank is a crucial part of the New Zealand economic landscape and their views and decisions can shape the outcome for us as investors. The November 2014 Financial Stability Report confirmed that the New Zealand financial system remains sound and continues to operate effectively. The banking system is well capitalised, funding and liquidity buffers are above required minima, and non-performing loans continue to decline.

However, the financial system faces four key risks:
  • Imbalances in the housing market;
  • High levels of indebtedness in the dairy sector;
  • The potential effects of a slowdown in the Chinese economy; and
  • The banking systems reliance on offshore funding.
Housing market pressures have eased since the introduction of the loan-to-value ratio (LVR) ‘speed limit’ in October 2013 and subsequent increases in the Official Cash Rate. However, risks in the dairy sector have increased. The forecast dairy payout for the 2014–15 season has been reduced significantly, and could result in rising loan defaults should the lower payout level persist. Lower global dairy prices are in large part due to reduced demand from China, highlighting New Zealand’s vulnerability to a slowdown in the Chinese economy. Risks arise from both New Zealand’s increased trade linkages, and also from potential spillover effects from a Chinese economic slowdown to global financial markets. Although the banking system’s reliance on offshore funding has reduced in recent years, banks remain susceptible to volatility in international markets.

The LVR speed limit is a temporary policy measure. The Reserve Bank intends to ease or remove the restriction when a sustained moderation in house price inflation is achieved, and when there is little risk of a resurgence in housing market activity. The reduction in house price inflation and housing credit growth are welcome developments, along with indications of increased residential building. However, there is a risk of a resurgence in house price inflation, particularly in light of strong immigration flows. Consequently, it is not appropriate to ease the LVR speed limit at this time. The Reserve Bank will continue to closely monitor the housing market.