External Risks Mean Rate Hikes Off The Table
BMI View: In line with our expectations, the Reserve Bank of New Zealand (RBNZ) announced on May 8 revisions to the calculation of capital requirements for loans with low equity buffers, the central bank's first use of macro-prudential policies to tame credit growth. We believe the deterioration in data from key trading partners will keep the central bank from hiking interest rates despite its desire to tame the growth in housing credit. Instead, we expect the monetary authorities' use of the macro-prudential tools to increase and dampen the profitability of banks, while interest rates are set to remain at all-time lows of 2.50% until 2015.
Although house prices in New Zealand continue to linger at historically high levels, we maintain our expectations for the Reserve Bank of New Zealand (RBNZ) to avoid using its official cash rate to rein in the demand for mortgage credit, which grew at 4.9% year-on-year (y-o-y) in April, the highest rate since end-2008 (see, RBNZ To Maintain Rates Despite Rising Housing Market, Feb 27). Indeed, the RBNZ maintained its policy rate at 2.50%, opting instead to use the new macro-prudential tools, for which it has signed a Memorandum of Understanding with the government.
|Authorities Keen On Restraining House Price Growth|
|New Zealand - House Price Index (LHS) & Growth, % chg y-o-y|
More Regulation To Come As Financial Stability Remains A Priority
Due to come into effect from September 30, the RBNZ's newest stipulation, announced on May 8, will mean that banks will need to hold more capital against loans which are 80% or more than the value of the underlying house. Given the low level of equity buffer for these loans, a renewed economic downturn could cause increasing difficulties for mortgage owners to service their loans as house prices fall and the labour market deteriorates further. Indeed, the new regulation is likely to increase the stability of the banking system as an increasing proportion of new mortgage lending is of a higher loan-to-value (LVR) ratio, which has recently risen to 30%, versus approximately 25% in early 2012.
|Current||As of September 30|
|Source: BMI, Reserve Bank of New Zealand|
|Correlation for LVR under 80%||15%||15%|
|Correlation for LVR 80-89%||15%||20%|
|Correlation for LVR 90% and over||15%||21%|
Moreover, given that households are now releveraging , with household credit growing at 4.7% y-o-y, the highest pace in five years, we believe that the new LVR capital requirements is but the start of more macro-prudential policies to be implemented. We believe that the central bank is likely to tap on instruments such as sectoral capital requirements, quantitative restrictions on the share of LVR loans and countercyclical capital buffers to cool the speed of credit growth and limit the growth of higher risk lending. Implementing these tools will likely dampen the profitability of New Zealand banks as they restrain the amount of credit and increase the costs of lending. However, these measures could make the system more resilient in a downturn and would afford the monetary authority scope to restrain credit growth in areas of the economy which are economically unproductive, such as residential housing, without stifling business spending.
|Credit Growth Fastest In Mortgage Sector|
|New Zealand - Total Private Sector & Housing Credit, % chg y-o-y|
Growing External Risks Make Macro-Prudential Tools More Valuable
We believe that this flexibility will become increasingly valuable as growing external risks could threaten the current recovery we see in the private sector. A slowdown in Australian and Chinese economies will likely weigh on exporters and could derail recent improvements given that almost 40% of all outbound shipments are bound for these two destinations. With the plunge in Australia's services' performance index and a weak print for Chinese manufacturers' Purchasing Manager Index in May, further deterioration, we believe that New Zealand manufacturing and services sectors are likely to see a dip in activity in the quarters ahead. As such, we believe that the RBNZ will be more inclined to keep interest rates at current all-time lows of 2.50% for an extended period. We expect the central bank to maintain the official cash rate at the current rate until 2015 as the long deleveraging cycle runs its course.