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Frank Newman

Official Cash Rate Surprise


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I, like many people, responded to the decision of the Reserve Bank to reduce the Official Cash Rate (OCR) by 0.5% to 1% with some alarm: What has the Governor seen in their forecasts that is so dire as to warrant such an extraordinary reduction?

The Reserve Bank’s action says things are now more dire than they were during the Global Financial Crisis.  This is in contrast to the buzz from the Beehive which is, Don’t worry, be happy! 

Given how little faith people have in politicians, I suspect consumers and business owners will take a lead from the actions of the Reserve Bank, but not the words of the Governor who says, Save the economy: Borrow and spend. Most consumers will respond to the Governor’s words by doing exactly the opposite: Save and not spend. This will cause business confidence to decline at a faster rate than it is already.

The Governor also raised the prospect to negative interest rates – where depositors pay to have their money in a savings account instead of receiving interest! Economic theory has it this would encourage savers to invest in business, which in turn stimulates growth. The theory is wrong in practice. Savers wanting the security of cash, retirees for example, will simply cut back on spending.

If the alternatives like shares were palatable as the Governor suggests, then  why do most retirees prefer the safer option of bank deposits? Or if shares are seen as too risky by risk averse investors, perhaps Mr Orr would prefer they invest in rental property, but then the government has made that just so much more difficult. And in any event, having cash in an asset that cannot be readily drawn down as the need arises, makes this an unsuitable investment choice for many.

There will also be an impact on KiwiSaver balances. Those approaching 65 will be invested in conservative funds invested primarily in fixed interest securities. Those funds will more than likely show zero or negative returns. They will most likely respond by shifting into a growth funds, at a time when high-risk “growth” assets like shares have more risk on the downside than the upside. 

It is also quite likely that those depending on interest income will chase higher returns and be tempted by the higher returns offered by fringe finance companies, which is the very last thing they should be doing. However, this is the inevitably consequence of the Reserve Bank’s actions. Perhaps this well-being government is so insulated from reality that it does not understand the human cost of losing one’s life savings.

There are no good options. 

Rather than save the economy, the RB Governor is more likely to have accelerated the decline, because there is no doubt a decline is underway, as the property market shows.

The latest report from property data provider, CoreLogic, shows that the cities that have had the biggest sustained gains in property prices are now on the decline – Auckland, Tauranga, Hamilton, Rotorua, Napier, Wellington, and the Queenstown Lakes District.

While typically low value regions like Whanganui, Gisborne and Invercargill are still positive, in most areas how price inflation is at its lowest growth rate in four years.

Given house prices over the last five years or so has risen much faster than household incomes, it is inevitable that at some point houses will become unaffordable and the demand will fall. That is the new reality.

What we are not yet seeing in the figures, which obviously lag what is happening at the coalface, is how quiet the market has become. Building companies are slowing down . The turning point was when the Taxation Working Group released its report proposing a capital gains tax. 

That is of course flowing through to the trades and there are anecdotal reports that tradies are now available to start in a matter of days rather than weeks or months as was the case a year ago. For some the pipeline of work ahead has slowed or stopped completely. That spells a problem for those tradies with the hire-purchase utes and high overheads and could turn ugly very quickly. In my view it’s not a matter of could but will turn ugly.

This comes at a time when farmers are being villainised by jet-setting carbon producing politicians who live off the wealth produce by others, when overseas tourism numbers have declined, and when our oil and exploration sector is winding down.

So how is that export income going to be replaced? We are told by our politicians that new clean industries will emerge, but there is little of any substance to their relies when asked  what those industries actually are.

The Reserve Bank is running out of options, and it appears to have already run out of answers. Economic stimulus will have to come from elsewhere, and more than likely that will be a borrow and spend programme from central government. That will work fine for the term of this and the next government, but there will come a time when the music stops playing, and the public will be left holding the parcel. By then the current crop of politicians will be comfortably secure in their jobs and the United Nations.  

The only answer is to create a vibrant export lead economy. That would require a 180 degree turnaround by our politicians and an acceptance of the virtues of the free market. And it would require central government to lay off their persecution of farmers and to revive the oil and gas sector. Don’t expect that to happen anytime soon.