Environmental setting
The outlook for global economic growth has increased and become more broad-based over the past six months. Activity is expanding in most major advanced and emerging economies and there are signs of a pickup in merchandise trade. However, major challenges still remain, with ongoing surplus capacity in the global economy and extensive geopolitical uncertainty.
Stronger global demand has helped to raise commodity prices over the past year, which has led to some increase in headline inflation across New Zealand’s trading partners. However, the level of core inflation has generally remained low. Monetary policy is expected to remain stimulatory in the advanced economies, but less so going forward.
New Zealand’s economy grew a little over 3 percent during 2016, which is above the average pace of expansion over the past three decades. The expansion has been supported by accommodative monetary policy, strong population growth, and high levels of household spending and construction activity. The trade-weighted exchange rate has fallen since early 2017, which, if sustained, will help to rebalance growth towards the tradables sector.
Annual headline inflation was 2.2 percent in the March 2017 quarter. The sharp increase in inflation in the March quarter is largely due to higher fuel and food prices. These effects are expected to be temporary and may lead to some variability in headline inflation over the year ahead. Non-tradables and wage inflation remain moderate, but are expected to increase gradually. This will bring future headline inflation to the midpoint of the target band over the medium term. Longer-term inflation expectations remain well-anchored, at around 2 percent.
The New Zealand financial system remains sound and continues to perform its functions effectively. New Zealand banks maintain capital and funding buffers in excess of minimum requirements, and profitability, which has fallen modestly as a result of declining net interest margins, remains robust.
A key domestic risk continues to be the performance of the housing market. House price growth has slowed over the past eight months, but the outlook for the housing market remains uncertain. Mortgage interest rates remain low and while building activity has continued to increase, the rate of house building is insufficient to accommodate rapid population growth and address existing housing shortages.
The loan-to-value policy has improved the resilience of the banking system to a correction in the housing market. However, many households have taken on loans at high debt-to-income ratios and are vulnerable to an increase in interest rates or a decline in income. The Bank is consulting on whether a debt-to-income policy instrument should be included in the set of macro-prudential instruments.
The Bank’s economic forecasts in the May 2017 Monetary Policy Statement show the New Zealand economy expanding at an average of around 3 percent annual growth over the next three years, with CPI inflation at the mid-point of the target range in the outer two years. These forecasts are based on several key assumptions, including that the global economy grows at around 3.5 percent per annum over the forecast period and that New Zealand house price inflation continues to moderate.
Strategic priorities
The SOI outlines the Bank’s nine strategic priorities for 2017–20.
These strategic priorities, which are described in more detail on pages 12-14 in the PDF, continue to be framed around three broad themes:
- enhancing the Bank’s policy frameworks;
- continuing to strengthen the Bank’s internal and external engagement; and
- improving infrastructure and reducing enterprise risk.
These strategic priorities contain responses to new initiatives such as addressing outcomes of the International Monetary Fund’s (IMF’s) Financial Sector Assessment Programme (FSAP) review. A new strategic priority – to improve the resilience of the Bank’s operations – highlights the on-going commitment to business continuity and cyber-security, both of which are important to enhancing and securing the resilience of the Bank’s business.
Informing government
The Bank keeps the Minister of Finance regularly informed about its thinking on significant market and policy developments, especially where Cabinet decisions, legislation or regulation may be required. This involves providing substantive information on and a discussion of the rationale for any changes and their potential economic and fiscal impacts at an early stage of policy development. The Bank also provides assessments of the expected regulatory impacts of proposed policy developments.
Relevant to the 2017–20 SOI, this would include information on:
- how key macro-economic relationships and behaviours have changed, and the implications for the operation of monetary policy;
- the effects of any economic or environmental changes on the practical application of the Policy Targets Agreement, ahead of a new agreement being agreed by the Minister of Finance and the Reserve Bank Governor next year;
- assessments of financial system stability risks and the suitability of policies to reduce the likelihood and impact of a bank failure in New Zealand, including the potential implications for the Crown’s balance sheet;
- assessments of the effectiveness of the macro-prudential tools outlined in the Memorandum of Understanding agreed in 2013, and views on including a debt-to-income-ratio tool in the macro-prudential policy toolkit; and
- progress with key policy developments and reviews – including the Insurance (Prudential Supervision) Act 2010 review, the Bank’s review of bank capital, and responses to the IMF’s FSAP review.
Graeme Wheeler
Governor
Grant Spencer
Deputy Governor
16 June 2017