2006 Annual Report

Governor's statement

It has been another challenging year for us at the Reserve Bank. A number of planned projects came to fruition. While we worked away at a number of strategic priorities, we were faced with a few surprises too.

Looking back, there are some solid achievements to report on in the following pages. We have also faced substantial challenges, especially in monetary policy.

Domestic inflation pressures have been strong, reflecting a sustained period of growth in the economy, which has stretched productive resources. Global inflation pressures have intensified. Many economies in the OECD have experienced rapid increases in house prices, which have fuelled consumer spending, while prices for oil and other commodities have been increasing markedly.

As we began 2005/06, we were projecting inflation to rise from 2.8 percent in the year to June 2005 to above 3 percent by late 2005, and saw it moving back below 3 percent by early 2007, given evidence of a slowing in economic activity.

In the event, however, the rise in oil prices proved more protracted. Economic activity did not cool to the degree we had expected, and domestic inflation pressures remained strong. This led us to adjust the OCR by a further 50 basis points in the second half of 2005.

By June 2006, CPI inflation was at 4 percent, and our projections indicated it was likely to remain above 3 percent until late 2007. However, economic activity was moderating, giving us confidence that underlying inflation pressures are beginning to ease.

Throughout this period, monetary policy has been clearly focused on ensuring inflation will return to within the 1 to 3 percent target band in the medium term.

Such experience underlines the need to have an understanding of how uncertainty can be handled within forecasts. Accordingly, we set a strategic priority for this year to improve our forecasting and monetary policy decision-making under uncertainty, which in turn would lay the foundation for redevelopment of our current forecasting model. Both those projects have progressed well, yielding promising results.

In addition we committed resources to other important projects in the economic field, such as research into what drives household behaviours that affect inflation. Other initiatives were not in the year’s plan, but had the potential to add to our toolkit. One such initiative was a joint project with The Treasury looking at supplementary stabilisation instruments, which is explained in more detail on page 26.

Each year, we set ourselves a budget and business plan to maintain business-as-usual activities, as well as a programme of initiatives to address especially pressing issues. These are captured within each of our functions and internal services. A handful or so are identified as strategic priorities.

They become the significant goals we aim to achieve in the immediate future and fit within our longer-term plans, expressed in our five-year Funding Agreement with Government and our Statement of Intent (SOI).

The wide range of policy initiatives undertaken in banking supervision fitted this pattern of planning and resourcing over multi-year timelines. This year we implemented policies on key regulatory issues: outsourcing, the Basel II capital adequacy regime for banks, local incorporation and bank failure management.

Less predictable has been the potential expansion of our supervisory role into the non-bank financial sector, identified in policy work led by other Government agencies. The initial analysis is almost complete and proposals will be considered by Government in 2006/07.

Foreseeable activity in 2005/06 included preparations for the distribution of new, smaller and lighter plated-steel coins to replace the cupro-nickel 10, 20 and 50 cent coins, and the removal of the 5c coin, introduced in 1967. This project will be completed in 2006/07, and will return substantial benefits to the New Zealand public.

In market operations, our strategic priority to ensure adequate liquidity in the banking system resulted in the implementation of a new liquidity management regime. This received overwhelming support from market participants, removing the volatile and misleading pricing that previously existed.

And there has been the development of a heritage museum, recently opened to the public, explaining our role in the New Zealand economy through an array of static and audio-visual media, as well as displaying unique and valuable banking artefacts. We hope this will add to New Zealanders’ understanding of their economy and institutions, as well as providing the opportunity to view historical items previously held in our vaults.

There is much more covered in this Annual Report. As our workload adapts and increases, it underlines the reliance we place on the talents and dedication of our people. I am very aware and appreciative of the commitment and energy from staff and the Board needed to make this a successful institution.

Alan Bollard
Governor