Governor's statement
The outlook for the economy continues to be positive. Having peaked earlier in the year, economic growth is forecast to be 3.5 percent in the year to March 2015. Strong employment growth is expected, with the unemployment rate falling to around 5.3 percent. Consumer price inflation should increase to around the mid- point of the 1 to 3 percent target range, but some deterioration in the current account deficit is likely.
Several factors are driving the current expansion, including high export prices for many of our commodities, strong investment in construction, and a large increase in net migration. Although the Official Cash Rate (OCR) has increased four times since March 2014, its current level of 3.5 percent remains low by historic standards, and supports the expansion.
Over the past three years, the economy has grown about two thirds faster than the average growth rate of the world's advanced economies. But this stronger economic growth, higher interest rates, and the highly accommodating monetary policies adopted by central banks in many advanced economies, have made New Zealand an attractive destination for international investment flows, and these have caused a substantial appreciation in the exchange rate. The Bank considers the current level of the exchange rate to be unsustainable, particularly in light of the 41 percent decline in global dairy prices since February 2014.
The high New Zealand dollar has lowered inflation in the tradables sector, and boosted the real disposable income of consumers and those producers sourcing from overseas. In doing so, it has helped to spread the benefits of elevated commodity prices. However, the high exchange rate is a significant and unhelpful headwind for the traded goods sector. Its impact has been hardest on export firms that are not experiencing high international prices for their products, and on businesses that compete with foreign imports.
Inflation pressures also need to be watched closely in those parts of the economy that are not open to international competition, especially as levels of excess capacity in the economy are absorbed, and demand pressures continue to increase in the construction industry.
On the policy side, the Bank's increase in risk weights on housing lending and the introduction of loan-to-value ratio (LVR) level restrictions have helped both to slow the rate of house inflation, and diminish the risks to the financial sector and broader economy from any sudden correction in house prices. The economy also appears to be adjusting to the monetary policy tightening that has taken place since the start of the year. This will help ensure that future average inflation remains near the 2 percent target mid-point and does not threaten the sustainability of the recovery.
Striving to perform to a high standard
The Reserve Bank's contributions to economic activity affect New Zealanders in many ways. We provide currency to meet the public's cash needs, and our decisions on the OCR affect people's borrowing costs and their return on savings. We regulate prudential requirements for banks, other financial institutions and insurance companies, and provide services to allow financial institutions to settle payments between one another.
Given the important impact that the Reserve Bank can have on people's lives, we are conscious that the community must have confidence that we perform to a high standard.
This Annual Report seeks to demonstrate whether we achieved 'success measures' for each of our statutory functions, and how we strive to be a high-performing small central bank.
The 10 strategic priorities for the period 2013-16 that guide our development objectives are outlined on pages 18-21. These are framed around the broad goals of:
- Continuing to strengthen the RBNZ's performance.
- Developing a more integrated approach to the Bank's policy.
- Improving the Bank's infrastructure and reducing enterprise risk.
The key outcomes under each of the 10 priorities are summarised in the report, along with the success measures that the RBNZ uses to assess its performance. Some of the main developments during the year are summarised below:
- Our Economics department closely monitored the domestic and global economy, and, based on this analysis, we raised the OCR by 1 percentage point by July 2014.
- Our Financial Markets analysts and traders maintained short-term wholesale interest rates at levels close to the OCR, ensuring there was sufficient liquidity in markets. The team operated well within the risk limits established for managing the Bank's balance sheet. On the domestic markets, they recorded a profit for the year, and their management of foreign reserves outperformed their benchmark. However, unhedged reserves suffered a sizable mark-to-market loss due to the strong New Zealand dollar. This reduced the dividend to the Crown.
- We established a Macro-Financial department to lead the Bank's analysis and advice on macro-prudential policy and introduced LVR restrictions on home mortgages.
- Our Prudential Supervision department completed the licensing of insurers and put in place a regime for licensing non-bank deposit takers. It also reviewed the payments system oversight regime. New Zealand banks remain sound, maintaining capital and core funding above minimum requirements.
- The Bank's Financial Services Group initiated a review of the payment systems to develop a roadmap for the systems prior to undertaking major investment. Meanwhile, they ensured our existing technology and systems – ESAS and NZClear – met the demands of daily transactions worth almost $26 billion.
- Our Currency and Property Services department signed contracts with the Canadian Bank Note Company for the design and printing of new 'Series 7' banknotes that are due in circulation from the fourth quarter of 2015. We reviewed our procedures, controls and departmental structure for currency management to ensure that they are still appropriate, and identified new contingency reserve sites.
- On the human resources side, the Bank introduced an annual survey to examine staff engagement levels, established a mentoring programme for early-in-career staff, invested heavily in manager and leadership development, and each manager completed a 360 degree survey assessment.
These strategic priorities set a sound platform for ensuring that the Bank continues to perform to a high standard.
Graeme Wheeler
Govenor
21 August 2014