Analysis: RBNZ Likely to Launch Funding Program But Some Rate Cut Still Possible

–RBNZ Likely to Alter Forward Guidance

By Sophia Rodrigues*

The Reserve Bank of New Zealand is likely to keep the official cash rate unchanged at 0.25% and launch funding program for banks to provide stimulus to the economy ahead of rate cut next year.

However, some form of interest rate cut cannot be discounted so long as it doesn’t compromise on the RBNZ’s forward guidance. This could include a cut in the interest rate on excess balances in the Exchange Settlement Account System (ESAS) to 10bps from the current 25bps.

Back in March, when the RBNZ lowered the OCR to 0.25% from 1.0%, it also issued forward guidance stating the rate “will remain at this level for at least the next 12 months.”

Since then, the RBNZ has left the OCR unchanged at 0.25% and reiterated that it was doing so in accordance with the guidance issued on March 16.

The guidance was aimed at providing clarity to financial market participants that a negative OCR would not be implemented over the 12-month period. At the time, the RBNZ was paying OCR less 25bps on excess balances in the ESAS account under its credit tier system.

A few days later, the RBNZ announced it will remove its allocated credit tiers and pay the OCR rate on all amounts in the ESAS account.

The RBNZ could technically reduce the OCR to 10bps, and that would still be true to its forward guidance that it is not implementing negative rate.

But such an option doesn’t look likely because of the difficulty in communicating that its interest rate move was not in divergence with forward guidance.

A more likely option – if it wants to implement lower rate – would be to reintroduce credit tiers and remunerate excess balances in ES account at 10bps, instead of 25bps.

It must be stressed that the RBNZ may have reservations about this option because its aim is to keep the overnight cash rate close to the OCR, even though in the last few months the rate has dropped as low as 10bps on some days and not traded on several other days.

FLP MORE CERTAIN

What looks more certain on Wednesday is an announcement on Funding for Lending Programme (FLP). This would be broader, expanded term lending programme compared with the funding that the RBNZ currently provides under the government’s Business Finance Guarantee Scheme.

The FLP is likely to be similar to the RBA’s Term Funding Facility or the Bank of England’s Term Funding Scheme, and could be for a term of three or four years.

The RBNZ may announce an initial allowance linked to banks’ outstanding loans. This could be around 5%, and translate to NZ$25 billion, with incentives for more allowance based on lending. Given the RBNZ’s focus would be on business lending, such incentives could be bigger for business lending, mainly small and medium-sized businesses.

An important decision for the RBNZ would be on the interest rate on such funding.

The RBNZ could offer funding at the OCR rate but make it floating, rather than fixed. A fixed rate is unlikely to attract any drawdown given market expectation of cut in the OCR to negative by April next year.

Alternatively, the RBNZ could announced a deadline to access the initial drawdown at the current fixed OCR rate. But in the context of near-zero interest rates globally and the RBNZ’s own guidance for zero or negative OCR, a 25bps rate on FLP may be seen as less stimulatory.

The option of reducing the OCR to 10bps looks appealing in such a scenario because it can be immediately passed on to the lending rate on FLP.

FORWARD GUIDANCE, INTEREST RATE SWAPS

Apart from FLP, the RBNZ is likely to alter its forward guidance, following the trend among global central banks to make more effective use of this unconventional tool. It is also in line with what the RBNZ has discussed before.

The RBNZ’s current date-based guidance is one of its kind because it relates to a “promise” about not taking OCR to negative until March 2021. It is a guidance about lowering rates, in contrast with forward guidance used by central banks about hiking.

The RBNZ’s guidance in September said, “Members agreed that monetary policy will need to provide significant economic support for a long time to come to meet the inflation and employment remit, and promote financial stability. They also agreed they are prepared to provide additional stimulus.”

This could be altered to include a more definite date-based and event-based guidance.

DOVISH BUT NOT QUITE

While the overall tone of the RBNZ’s statement is likely to be dovish to account for uncertainties ahead, its comments may push back against the idea that the OCR could go as low as 0.5% next year.

It is important to note the RBNZ has always said “lower or negative OCR” when discussing future moves, thus leaving itself the wiggle room to stop at zero OCR should the outlook improve versus its forecasts.

*All views, opinions and insights are those of Sophia Rodrigues, an RBA watcher and reporter and guest contributor to InTouch Capital Markets