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New Zealand Dollar Flounders as Spectre of RBNZ Rate Cut Looms Large Following Bascand Comments

 Bascand New Zealand Dollar

Above: Geoff Bascand, Deputy Governor/General Manager Financial Stability at the RBNZ. Image courtesy of Payments NZ, (C) Pound Sterling Live.

The Pound is sitting on a commanding 2.0% week-on-week advance on the New Zealand Dollar with a decent bump coming over recent hours courtesy of communications from the Reserve Bank of New Zealand (RBNZ).

The New Zealand Dollar fell right across the board after RBNZ Deputy Governor Geoff Bascand said current proposals by the Bank to increase the capital requirements at retail banks could require lower interest rates.

"If it went in the way we see it, and nothing else changed, it’s a marginal tightening of monetary conditions,” said Bascand at a news briefing. "If we were worried about that and thinking we may have an economy that’s undershooting inflation or undershooting maximum sustainable employment, we’d offset it with an OCR change."

In short, banks are instructed to hold capital to protect against any shocks to the economy, think of it is a bank's 'rainy day' reserve. "In the long run, this makes New Zealand safer and it's hard to see how it could increase the cost of funds to New Zealand, but different parts of the capital market will respond in different ways," says Bascand.

But by increasing these reserves you are asking banks to make less money available to lend, and this could in turn impact on economic growth rates.

The RBNZ believes changes to capital reserve requirements are needed as current rules distort competition.

Economists at ASB expect any changes to bank capital requirements to increase bank funding costs by around 50bps.

Therefore, if the RBNZ were to ask banks to hold more capital to guarantee their health, they risk slowing economic growth as finance to businesses becomes more expensive. The RBNZ can however help out the economy by cutting its own interest rates which would lower the overall cost of lending to business. Therefore, cutting the interest rate would offset any negatives to lending posed by increasing capital reserves.

But, from a currency perspective, the promise of lower interest rates at the RBNZ is a negative as it makes New Zealand a less attractive destination for foreign investors to park their capital and earn interest.

Thus, the New Zealand Dollar has lost ground on the headlines.

The Pound-to-New Zealand Dollar exchange rate is now quoted at 1.9178, having been as low as 1.8728 earlier in the week. If the Pound ends Friday higher than where it opened the currency will have recorded a succession of six uninterrupted days of advance.

Ahead of the RBNZ news, the New Zealand Dollar was the best performing G10 currency thus far in February after shooting to the top of the league table last week when the RBNZ took the market by surprise in reiterating its neutral interest rate stance.

Markets had prepared for guidance that an interest rate cut might be an increasing likelihood.

The communications from Bascand will therefore go someway into cancelling the supportive tones from the RBNZ seen a week earlier.

Consensus has been taking the view the RBNZ will warn an interest rate cut could be in the pipeline for the months ahead, given a slowdown in the economy during the second half of 2018 and a deterioration in the outlook for global growth going into the New Year.

The RBNZ held its interest rate at a record low of 1.75% for another month this February and said the next move could be either up or down when markets had looked for it to warn that a rate cut was becoming increasingly likely.

Rather than warning of rate cuts on the horizon, the RBNZ used its long-term projections to signal to markets that rates will remain at their current level for another two years before beginning to rise some time early in 2021.

"There are upside and downside risks to this outlook. A more pronounced global downturn could weigh on domestic demand, but inflation could rise faster if firms pass on cost increases to prices to a greater extent," the RBNZ said.

"We continue to expect an OCR cut by year end as growth disappoints (starting in Q4); we are forecasting November, with two cuts to follow next year," says Sharon Zollner, chief economist at Australia & New Zealand Banking Group.

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