OCR losing its merit in NZ financial market

The RBNZ did not raise the official cash rate from 2.5 per cent last week, despite expectations emerging in the market that it was likely to do so, and in the face of rising term deposit rates.

Reserve Bank of New Zealand governor, Alan Bollard, made a point of stating quite clearly that there will be no increase in the OCR before the second half of next year. The only concession in his statement to those who think rates should be going up was the removal of the easing bias.

While the strength of the recovery of the New Zealand economy can be debated, the rationale for holding the OCR at current levels is the possibly vain hope that doing so will keep appreciation pressure off the New Zealand dollar and thereby help facilitate an export-led recovery rather than a rout.

New Zealand Prime Minister, John Key, threw his support behind Alan Bollard the next day, saying that any increase in the OCR would be disastrous for exporters.

However, this approach appears to ignore two major influences on the value of the New Zealand dollar. One influence is relative value - relative to the US dollar, in particular.

The fact is that the US dollar is in for possibly a long period of decline and a weak US dollar suits the US government just fine.

In this respect, both Australia and New Zealand are in the same boat - we are going to have to learn to live with a weak US dollar that makes our exports comparatively more expensive.

The other major influence is what is happening with market set interest rates in New Zealand - they are going up.

Strong competition among the banks for term deposits is rapidly driving up term deposit rates, so much so that the ANZ said on Thursday that this was a contributing factor to the second half loss incurred by its New Zealand business.

The RBNZ has contributed to this situation by insisting that the New Zealand banks obtain more of their funding in the domestic market, preferably through term deposits, and decrease their reliance on the international bond markets.

The New Zealand banks appear to be toeing the line. Our records show that there was no international bond issuance in October with the exception of government- owned Kiwibank's A$250 million kangaroo issue.

New Zealand government bond yields are also rising, especially those with shorter maturities.

So with rates on bank deposits and government bond yields increasing anyway, what happens (or doesn't happen, in this case) with the OCR may well be irrelevant. Those investors pursuing the global carry trade are likely to still see New Zealand dollar denominated investments as a very attractive opportunity. The talk about what is not going to happen with the OCR simply looks like an attempt to talk down market enthusiasm.