Prolonged Monetary Stimulus Necessary
The Monetary Policy Committee agreed to maintain the current stimulatory level of monetary settings in order to meet its consumer price inflation and employment remit. The Committee will keep the Official Cash Rate (OCR) at 0.25 percent, and the Large Scale Asset Purchase (LSAP) Programme of up to $100 billion and the Funding for Lending Programme (FLP) operation unchanged.
Global economic activity has increased since the November Monetary Policy Statement. However, this lift in activity has been uneven both between and within countries.
The initiation of global COVID-19 vaccination programmes is positive for future health and economic activity. The Committee agreed, however, that there remains a significant period before widespread immunity is achieved. In the meantime, economic uncertainty will remain heightened as international border restrictions continue.
Economic activity in New Zealand picked up over recent months, in line with the easing of health-related social restrictions. Households and businesses also benefitted from significant fiscal and monetary policy support, bolstering their cash-flow and spending. International prices for New Zealand’s exports also supported export incomes, although the New Zealand dollar exchange rate has offset some of this support.
Some temporary factors were currently supporting consumer price inflation and employment. These one-off factors include higher oil prices, supply disruptions due to trade constraints, the recent suite of supportive fiscal stimulus, and a spending catch-up following the easing of social restrictions.
The economic outlook ahead remains highly uncertain, determined in large part by any future health-related social restrictions. This ongoing uncertainty is expected to constrain business investment and household spending growth. The Committee agreed that inflation and employment would likely remain below its remit targets over the medium term in the absence of prolonged monetary stimulus.
The Committee agreed to maintain its current stimulatory monetary settings until it is confident that consumer price inflation will be sustained at the 2 percent per annum target midpoint, and that employment is at or above its maximum sustainable level. Meeting these requirements will necessitate considerable time and patience.
The Committee agreed that it remains prepared to provide additional monetary stimulus if necessary and noted that the operational work to enable the OCR to be taken negative if required is now completed.
Summary Record of Meeting
The Committee reviewed recent international and domestic economic developments, and their implications for the outlook for inflation and employment. Members noted the lift in domestic economic activity, as evident across a range of indicators including inflation, employment, household spending, GDP, and asset prices.
The Committee discussed the key factors supporting the pickup in economic activity. Household and business balance sheets have fared considerably better than was anticipated at the start of the pandemic. This is in part due to the responses of monetary and fiscal policy, but also due to a number of other factors, in particular the containment of COVID-19 that has enabled ongoing domestic economic activity. People who arrived in New Zealand during the early stages of the pandemic and subsequently stayed on, are contributing to both housing and broader demand pressures. New Zealand’s commodity export prices and volumes have also remained robust despite the global economic slowdown.
The Committee agreed that several of the factors supporting economic activity are likely to prove temporary. Fiscal policy will continue to support the economy, but its impulse is unlikely to be as strong as last year. In addition, economic uncertainty persists due to the sustained closure of international borders and the manifestation of new strains of the virus. These factors continue to weigh on business confidence and investment intentions.
Several members noted the projected increase in headline inflation can also in part be explained by one-off factors, particularly oil price increases. The Committee agreed that the interaction between the headline, core, and wage inflation, and inflation expectations, will be important in determining the sustainability of inflation pressures in the medium-term.
The Committee noted the labour market has proved more resilient than anticipated at the outset of the pandemic, although unemployment has risen. The Wage Subsidy scheme played an important role in helping businesses maintain employment. However, labour market conditions remain uneven across sectors and regions. Those sectors most reliant on tourism-related business activities continue to lag behind on job opportunities, with this likely to persist as long as international borders remain closed. Some members noted that labour effort is being reallocated to other activities and saw the potential for construction activity to remain strong. The Committee expects to see an ongoing gradual recovery in employment towards its maximum sustainable level.
The Committee noted that although the recovery in economic activity was uneven across countries, the performance of some of New Zealand’s main trading partners, in particular China, has been more resilient than expected. The stronger performance of economies geared more towards global goods demand, which has provided continued support to New Zealand’s commodity exports. However, the gains from higher export commodity prices have been somewhat offset by the stronger New Zealand dollar.
The Committee noted that the spread of more virulent strains of COVID-19 presents an ongoing risk to global economic activity. However, the development of effective COVID-19 vaccines has improved the medium-term economic outlook, helping to reduce uncertainty and boost confidence. Members noted the global economic recovery remains dependent on health outcomes and the success of the COVID-19 vaccine programmes.
The Committee noted that global financial asset prices have been inflated by both fiscal and monetary policy stimulus, and the expectations of the success of the vaccine programmes. Members also noted that long-term sovereign bond yields had increased, in part reflecting greater expected growth and inflation.
The Committee noted that domestic financial conditions remain highly stimulatory, that is, promoting spending and investing. Since the November Statement, international and domestic long-term interest rates have risen, driven by an improved growth and inflation outlook.
However, domestic borrowing rates faced by households and businesses have declined marginally. Members agreed that domestic borrowing costs would need to remain low to achieve the Committee’s objectives.
The Committee discussed the effectiveness of monetary policy settings in delivering the necessary monetary stimulus. The level of Official Cash Rate (OCR) and forward guidance had helped anchor short-term interest rates. The Funding for Lending (FLP) programme had helped keep downward pressure on retail interest rates. The Committee noted that the Large Scale Asset Purchase (LSAP) programme had continued to apply a downward influence on long-term interest rates and provide bond market liquidity.
Members noted the FLP will continue to lower bank funding costs, even if international wholesale borrowing costs rise. The Committee noted that the decline in bank funding costs provides banks with scope to further reduce interest rates for household and businesses. The Committee agreed it expects to see the full pass-through of lower funding costs to borrowing rates, and it will closely monitor progress.
The Committee discussed how monetary policy settings were affecting financial stability. Members noted that monetary policy actions had supported financial stability as they have improved the cashflow positions of households and businesses. The Committee noted that the recent changes to the Bank’s Loan-to-Value Ratio (LVR) requirements occurred to ensure that financial system soundness is maintained.
Overall, the Committee agreed that the risks to the economic outlook are balanced, in large part due to the anticipated prolonged period of monetary stimulus. The Committee reflected on the international experience of central banks following the Global Financial Crisis. The Committee agreed that it was important to be confident about the sustainability of an economic recovery before reducing monetary stimulus. Some members also reflected on the extended period of below-target inflation in many countries, including New Zealand, prior to the pandemic.
The Committee agreed that, in line with its least regrets framework, it would not change the stance of monetary policy until it had confidence that it is sustainably achieving the consumer price inflation and employment objectives. The Committee expects that gaining this confidence will take considerable time and patience. While doing so, the Committee agreed to look through any temporary factors driving prices as required by the Remit, and noted that there will be periods during which inflation will be above the 2 percent target midpoint.
The Committee discussed the range and settings of its monetary policy tools. Members noted that the banking system is operationally ready for negative interest rates. The Committee assessed a negative OCR and the LSAP programme against its Principles for Alternative Monetary Policy. The Committee agreed that it was prepared to lower the OCR to provide additional stimulus if required.
The Committee discussed the LSAP programme and noted that many factors influence domestic long-term bond yields, including expectations for monetary policy, global bond yields, and the economic outlook. The Committee noted staff advice that reduced government bond issuance was placing less upward pressure on New Zealand government bond yields, and that domestic bond markets had continued to function well. Members noted that staff had adjusted purchase volumes since the November Statement, in light of these conditions.
The Committee agreed to continue with the LSAP programme with purchases of up to $100 billion by June 2022. The Committee also endorsed staff continuing to adjust weekly bond purchases as appropriate, taking into account market functioning. The Committee agreed that weekly changes in the LSAP do not represent a change in monetary policy stance.
The Committee agreed that current monetary policy settings were appropriate to achieve its inflation and employment remit. The Committee agreed it would maintain monetary stimulus until it is confident that consumer price inflation will be sustained around the 2 percent target midpoint and employment is at or above its maximum sustainable level. The Committee expects a prolonged period of time to pass before these conditions are met.
On Wednesday 24 February, the Committee reached a consensus to:
- hold the OCR at 0.25 percent;
- maintain the existing LSAP programme of a maximum of $100 billion by June 2022; and
- maintain the existing FLP conditions.
Reserve Bank staff: Adrian Orr, Geoff Bascand, Christian Hawkesby, Yuong Ha
External: Bob Buckle, Peter Harris, Caroline Saunders
Observer: Bryan Chapple
Secretary: Nicholas Mulligan