The Monetary Policy Committee has agreed to significantly expand the Large Scale Asset Purchase (LSAP) programme potential to $60 billion, up from the previous $33 billion limit. The LSAP programme includes NZ Government Bonds, Local Government Funding Agency Bonds and, now, NZ Government Inflation-Indexed Bonds.
The global economic disruption caused by the COVID-19 pandemic is expected to persist and lead to lower economic growth, employment, and inflation both in New Zealand and abroad. Even if New Zealand successfully contains the spread of disease locally, reduced world activity will mean lower demand for many of New Zealand’s exports.
The Monetary Policy Committee is committed to achieving its employment and inflation objectives. The main support for the economy in this environment is appropriately being provided through increased fiscal spending. However, monetary policy will continue to provide significant support through keeping interest rates low for the foreseeable future.
The balance of economic risks remains to the downside. The expansion to the LSAP programme aims to continue to reduce the cost of borrowing quickly and sharply. This is preferable to delivering a smaller amount of stimulus now, only to risk later realising more should have been done.
We expect to see retail interest rates decline further as lower wholesale borrowing costs are passed through to retail customers. It remains in the best long-term interests of the banking sector to promptly maximise the effectiveness of our LSAP programme.
The Official Cash Rate (OCR) is being held at 0.25 percent in accordance with the guidance issued on 16 March. The Monetary Policy Committee is prepared to use additional monetary policy tools if and when needed, including reducing the OCR further, adding other types of assets to the LSAP programme, and providing fixed term loans to banks. The Committee’s decisions are guided by the Reserve Bank’s mandate and our decision making principles on the use of alternative monetary policy instruments.
Summary Record of Meeting – May 2020 Statement
The Monetary Policy Committee noted that the economic situation has deteriorated since the previous policy meeting. The COVID-19 pandemic is affecting economic activity throughout the world. The unprecedented health crisis has led many countries to introduce measures to contain the spread of disease. In New Zealand, activity has fallen sharply as a result of the pandemic and containment measures. The sharp contraction in activity is expected to reduce inflation and employment below the Bank’s objectives for several years.
Members discussed the significant uncertainties surrounding the economic outlook. The pandemic and restrictions on the movement of people are uncharted territory for modern economic policy. Here, and overseas, there is uncertainty about the impact of containment measures on economic activity. Monetary policy is using tools which have not been deployed before in New Zealand, and their degree of success is something that will become evident over time.
To help understand the uncertainties, the Committee discussed several different scenarios for the economic outlook. Members agreed that the situation is too uncertain to allow any one scenario to be treated as a central projection. Three scenarios were discussed, including what could happen if extended containment measures are required. Members noted that the baseline scenario was the most optimistic of the three. All three scenarios involved a significant and unprecedented decline in economic activity and employment.
The Committee noted that more stimulus is needed to support a medium-term recovery in economic activity, employment, and inflation. Members noted that the main thing needed to support the economy is fiscal stimulus, given that fiscal policy is best placed to directly support households and businesses. The role of monetary policy is to support the economy by ensuring that interest rates remain low, which will complement the effects of fiscal measures.
Members discussed the fiscal assumptions in the economic scenarios. It was noted that the government has publicly announced that $52 billion has been made available for pandemic recovery packages. This figure is used as the core fiscal spending assumption in each scenario.
Members agreed that a ‘least regrets’ monetary policy approach is needed, delivering stimulus sooner rather than later, and thus minimising the risk that the stimulus delivered turns out not to be enough.
The Committee discussed the world economic situation. Members noted the global environment is volatile and uncertain. Some commodity prices are strong, but many of New Zealand’s trading partners are experiencing economic disruption and declining activity. Despite pockets of relative strength, conditions in trading partners will be a drag on domestic activity.
The Committee discussed the balance of risks around the baseline scenario and agreed that the risks are to the downside. Activity could be lower than expected as a result of containment measures having more severe economic effects than assumed. Another risk is that the pandemic itself lasts longer or has more severe effects on trading-partner economies than assumed. There is also uncertainty about the impact of monetary policy actions on the economy.
Members noted some chance that activity could be higher than expected. There is some possibility that trans-Tasman travel could restart earlier than assumed, or that a return to alert level 1 could happen sooner than expected. Either of these events would result in spending and employment recovering faster. Another possibility is that supply-chain disruption leads to relative price shifts for specific consumer products, keeping average inflation higher than expected. Members agreed that these possibilities were not material enough to shift the overall balance of risks around the baseline scenario.
The Committee noted evidence on the effects of the Large Scale Asset Purchase (LSAP) programme so far. Members were pleased to note that both wholesale and retail interest rates have fallen. The functioning of markets has also improved – a secondary goal of the LSAP programme. Further declines in retail interest rates would be needed to fully deliver the stimulus. The Committee noted that long-term interest rates in the government bond market are also sensitive to a number of factors outside the LSAP programme, including bond issuance and foreign bond yields.
The Committee discussed the secondary objectives of monetary policy. Some members expressed concern about financial stability due to the economic disruption of the pandemic. The Committee noted that the banking system is sound and markets are functioning satisfactorily. Members agreed that all policy areas – monetary, financial stability, and fiscal – are mutually reinforcing in this environment, all working to achieve complementary goals.
The Committee discussed the range of monetary policy options. Members noted that there are policy tools available that have not yet been used. The Committee agreed that it will stand ready to deploy further tools as needed, should the need for stimulus continue to increase. Tools available include further reductions in the OCR; a term lending facility; and adding other asset classes, such as foreign assets, to the LSAP programme.
The Committee noted that a negative Official Cash Rate (OCR) will become an option in future, although at present financial institutions are not yet operationally ready. The current goal of monetary policy tools is to reduce borrowing rates for New Zealanders, and further OCR reductions at this stage would not be effective in achieving that. Consequently, the Committee reaffirmed its forward guidance that the OCR will remain at 0.25 percent until early 2021. It was noted that discussions with financial institutions about preparing for a negative OCR are ongoing.
Members agreed that an expansion to the LSAP programme is the most effective way to deliver further stimulus at this time. The Committee noted advice that adding inflation-indexed government bonds (IIBs) to the LSAP would improve both market function and policy effectiveness. The Committee agreed to add IIBs to the LSAP.
The Committee discussed ways to measure how much stimulus is delivered by a given volume of LSAP. It was noted that while more purchases will deliver more stimulus, it is not easy to translate this directly to an OCR-equivalent measure. The Committee noted that the size of the LSAP programme needed to be sufficiently large to keep interest rates lower across the yield curve. Members agreed that the LSAP programme can be scaled as needed in future.
Members noted that additional LSAP purchases are covered by an updated Crown indemnity, which represented a ceiling, not a target, for the total volume of LSAP.
The Committee reached a consensus to:
- expand the LSAP programme to purchase up to a maximum of $60b over the next 12 months;
- delegate to staff the composition and pace of purchases within the LSAP programme, across the eligible asset classes of NZ Government Bonds, NZ Government Inflation-Indexed Bonds, and Local Government Funding Agency bonds; and
- hold the OCR at 25 basis points.
Reserve Bank staff: Adrian Orr, Geoff Bascand, Christian Hawkesby, Yuong Ha
External: Bob Buckle, Peter Harris, Caroline Saunders
Observer: Caralee McLiesh
Secretary: Gael Price