Governor's statement
The Bank has been active on many fronts. The global economy and financial markets have been challenging for monetary policy, the Bank has an intensive programme of work in respect of prudential oversight and macro-prudential policy; and it also has more major operational projects underway than in recent years.
Nearly 10 years on from the start of the global financial crisis, global economic growth remains disappointingly weak in many regions. Global growth in 2015, at 3 percent, was the weakest since 2008 and well below its long-term average. This was despite unprecedented monetary stimulus and commodity prices that remain well below the levels two years previously. Unfortunately, 2016 has seen further downward revisions of growth forecasts by the International Monetary Fund (IMF) and the Organisation for Economic Co-operation and Development (OECD).
Against a background of large global excess capacity, declining volumes of merchandise trade and rising protectionism in G20 countries during 2016, the New Zealand economy is performing relatively well. The economy is in its eighth year of expansion and annual gross domestic product growth of 3 – 3½ percent is forecast over the next two years. Current economic growth is above trend, employment growth has been strong, labour force participation is high and the unemployment rate continues to decline. Furthermore, real wage growth has been quite strong; until recently, the household savings rate has been rising, and increasing economic growth has not been accompanied by the sharp deterioration in the current account that has characterised previous recoveries. Not least, the cost of living, as measured by the consumers price index (CPI), has been rising slowly.
As with every economy there are also some negative aspects: domestic economic growth has been weaker on a per capita basis; the global dairy market has serious oversupply problems that depress our dairy returns (despite more recent signs of improvement); excessive house price inflation is creating financial stability risks; our exchange rate is too high and affecting the competitiveness of our export and import substitution industries; and headline inflation lies below the target band in the Policy Targets Agreement. In addition, the strongest migration cycle in several decades is creating stresses as well as positives for the economy.
Inflation has remained lower for longer than forecast, primarily because of unforeseen and unforeseeable global events. Inflation in the tradables sector, which accounts for almost half of the CPI regime, has been negative for the past four years. This has been due to the subdued global inflation, falling global commodity prices and the high New Zealand dollar exchange rate. Given the outlook for global inflation and policy interest rates, low tradables inflation appears likely to continue for some time yet. Inflation in the non-tradables sector has averaged 2 percent in the past two years. Reduced government charges, such as the decline in ACC levies, have lowered non-tradables inflation, but we have also seen wage moderation as the surge in net migration since 2012 has increased the labour supply by around 4.5 percent. The Bank’s measures of core inflation currently lie within the lower half of the inflation target band.
In response to the low inflation and high exchange rates, the Reserve Bank’s Governing Committee, which comprises the Bank’s four Governors, lowered the Official Cash Rate six times since June last year. Policy rates are currently at historic lows and this has supported economic growth, and helped to prevent a decline in long-term inflation expectations. However, despite the cuts in the OCR, the trade-weighted exchange rate remains 2½ percent higher than in June last year, and there has been some weakening in short-term inflation expectations. A key rationale for cutting the OCR has been to lower the risk of a further decline in short-term inflation expectations.
At the same time the country is experiencing major imbalances in the housing market. In the past year house prices have increased by 15 percent and house-price-to-income ratios in Auckland, at around 9.5, are among the highest in the world. House-price-to-income ratios average around 5.4 for the rest of the country, but are increasing as annual house price inflation outside Auckland and Christchurch is currently running at 20 percent.
The historic surge in net migration in the past three years, the decline in global interest rates, and policy cuts by the Bank have stimulated housing demand. Even though annual building consents for the country as a whole are at an 11-year high, additional supply is needed. This would be facilitated by addressing issues relating to the costs and delays associated with planning approvals, choices in respect of housing densification within urban limits, and the productivity of the building and construction sector that is linked to scale and other factors.
Our concern is that a severe housing correction would pose substantial risks for financial system stability and the broader economy. The banks are heavily exposed to housing, with mortgages making up around 55 percent of their total assets. Household debt, at 163 percent of household disposable income, is at a record level.
We remain vigilant about financial stability risks arising from imbalances in the housing market. High prices and excessive leverage – both in Auckland and elsewhere – highlight the risk that a major price correction could occur. We deployed macro-prudential policy, in the form of loan-to-value ratio limits, to address some of the financial risks posed by the housing market. These measures have reduced credit risks associated with bank mortgage lending, and in doing so have helped to improve the resilience of bank balance sheets.
Striving to be a high-performing central bank
Innovation is one of the Bank’s core values and central to what we do. We continue to invest heavily in initiatives that strengthen our management, knowledge and technical capabilities while improving efficiency.
The Annual Report outlines the Bank’s vision and strategic direction, our core functions, our 10 strategic priorities and the work programmes that stem from them. As well as outlining the environmental conditions experienced during the year and how the Bank responded, the Report also discusses our success measures and whether we met our goals.
Some of the more significant developments during the year are summarised below.
- We released the first of the Series 7 Brighter Money banknotes into circulation, and ran a nationwide multi-channel public awareness and education campaign to increase awareness of the new notes and their modern security features. The $5 note was named Banknote of the Year in an international banknote design award.
- The architecture of the Bank’s financial management systems was finalised and is being implemented. More modern systems will assist in decision-making and reduce operational and market risks by providing market-standard trade valuation, position and collateral management, and enhanced risk and performance reporting.
- Important progress was made with major projects to replace and improve our payments and settlement systems.
- The Macro-Financial and Prudential Supervision departments have worked closely with banks to develop a comprehensive stress-testing framework to gauge the resilience of the banking system to adverse shocks. Considerable work was undertaken on loan-to-value and debt-to-income instruments.
- The Prudential Supervision department has undertaken a major review of bank prudential regulation with industry collaboration, resulting in consultations on an enhanced disclosure framework, as well as more clarity around the policy-making process. It has issued two consultative documents on bank outsourcing; and consulted on potential revisions to the regulatory framework for financial market infrastructure. The department also extended its engagement with boards and senior executives of banks and large insurers.
- The Bank continued to focus on keeping staff well connected, providing growth opportunities, and recognising performance. We have further developed our high-performance framework and continued to build leadership and management competencies through development programmes for managers and emerging leaders.
- We extended our outreach programme with external stakeholders – by participating in more than 100 speaking engagements around the country, expanding our use of digital channels, and identifying opportunities to help stakeholders better understand and connect with the Bank.
All of the Bank’s work has been undertaken within the constraints of a tight five-year funding agreement that provides for annual funding increases of around 1 percent a year. This has involved careful expenditure management, several redundancies last year and a major review of the Bank’s space needs. We are currently preparing to lease out an additional three floors of our Wellington building.
The Bank is fortunate to have talented and hardworking staff who are deeply committed to obtaining good outcomes for New Zealand in carrying out their broad range of responsibilities. I wish to thank my Bank colleagues, including the senior management team and my fellow Governors on the Governing Committee for their professionalism and dedication in ensuring that the Bank met high standards in fulfilling its extensive responsibilities.
I wish to pay tribute to the Reserve Bank Board. The Board met 10 times during the year and, under the leadership of Dr Rod Carr, provided strong support and advice while also probing and questioning to ensure that the Bank fully met its responsibilities.
Graeme Wheeler
Governor
26 August 2016