2007 Annual Report
It has been a challenging and very public year for the Reserve Bank of New Zealand. Most of the focus has been on the state of the economy and the role of monetary policy. But this should not detract from other important developments that have been happening in foreign exchange, banking, financial systems, payment systems and currency
The economy slowed a little during 2006 in response to monetary policy tightenings, but by the start of 2007 it was clear that the housing market was strengthening again and international dairy prices were rising rapidly. Because of this, the Bank resumed its monetary policy tightening, with four increases in the OCR by August 2007.
Until recently, this has been an unusual period of strong international liquidity, low risk premia, falling yen and US dollar, and strong demand for commodity currencies. Like the Australian dollar, the Canadian dollar, and other currencies, the New Zealand dollar has traded at two-decade highs. This has put pressure on some parts of our export sector, focussed media attention on the NZ/US exchange rate, and made our monetary policy decisions harder.
Since balance date, there have been changes. Developments in the US subprime mortgage market have seen global investors become more risk-averse, seeking ‘safer havens’, with resulting pressures on global liquidity.
Along with other markets, the New Zealand dollar has come off its highs. Moreover, the difficulties faced by some finance companies in New Zealand have added to the sense of uncertainty among local investors. We have taken some action to ensure the smooth functioning of our financial markets, and we will continue to monitor developments
Meanwhile, we have had many discussions about ways to lessen the impact of the OCR on the exchange rate, and have developed some ideas about supplementary instruments. The Finance and Expenditure Committee of Parliament has commenced an inquiry into monetary policy. We welcome this inquiry and the open debate it will bring on the objectives and instruments of stabilisation policy.
Our monetary policy framework is now very conventional by international standards. Since its inception in 1989 it has successfully delivered average inflation of around 2.5 percent. But monetary policy cannot do everything and it cannot easily dampen the exchange rate, especially when abnormal international or domestic pressures arise. The best it can do is to maintain stable prices so businesses can invest for growth in a secure environment. To help this, it is worth the appropriate agencies looking more closely at the tax environment for housing, measures to enhance housing supply, and ways to limit fiscal pressures when the economy is tight.
This year the Reserve Bank intervened to sell the New Zealand dollar as it continued to be at unjustified and exceptionally high levels. The Bank has also developed its foreign reserves policy further. The Bank has now sold New Zealand dollars in order to hold some of its foreign reserves on an unhedged basis. This ‘passive intervention’ is to give us better insurance in the event of a New Zealand dollar crisis. In addition, under certain defined conditions, we may carry out limited ‘active intervention’ to help stabilise currency peaks and troughs. This is similar to the Reserve Bank of Australia’s approach.
We continue to hone our oversight of the financial system. Overall we think it is sound and well-placed to deal with less favourable economic conditions, although there is never room for complacency. We note that household debt has doubled in the last five years in a benign lending environment, and this could lead to greater asset quality problems for lending institutions in the future.
It has been an important year for our main commercial banks. We are working through new capital requirements with them to meet enhanced ‘Basel II’ accreditation standards. In addition they are putting new outsourcing policies in place to meet our requirements. The trans-Tasman legislation to ensure that the Reserve Bank and the Australian Prudential Regulation Authority (APRA) can support each other in performing their existing regulatory responsibilities has been working well.
Cabinet has decided the Reserve Bank will take over the lead regulation for finance and insurance companies, and for anti-money laundering regulation in this sector. That means a lot of work designing legislation and, in due course, helping institutions meet the new standards.
Behind the scenes away from the public eye, we run New Zealand’s wholesale payment and settlement systems. With approximately $40 billion of transactions a day, this is a crucial part of New Zealand’s financial infrastructure. This year we have put in place a technological upgrade and new governance rules to stay at the forefront of international practice.
One of the biggest physical projects the Bank has undertaken this year has been to upgrade New Zealand’s small denomination coins. We have collected the old cupro-nickel coins, sold them for recycling at very advantageous prices, and introduced new coins that incorporate leading-edge developments in metallurgy. This all happened very smoothly for the banks, retailers, vending machine operators and the public. The Bank won a number of awards for this exercise.
All these developments are detailed in this Annual Report. They only happened with the hard work, professionalism and energy of our staff, and with the advice and monitoring of our Board. I thank them all.
27 August 2007