Capital Markets report: Liam Dann - Reserve Bank putting wind in market sails

Reserve Bank Governor Adrian Orr. Photo / Mark Mitchell

COMMENT:

Monetary policy continues to provide fair winds for capital markets.

Actually, make that gale force winds - bringing with them their own risks of share market wreck.

Super-low interest rates have seen investors pour back into equity markets since the Covid crash in March.

With bank rates moving ever closer to zero anyone with hope (or need) for a real return has had to look at other options and equities seem to be top of the list.

That's despite a grim global economic outlook which suggests corporate returns will struggle to justify valuations for some time to come.

Central banks around the world have slashed rates and pumped cash into the system to stabilise financial markets and ensure the Covid-19 downturn doesn't become a credit crisis.

It has worked.

Not only have we avoided the kind of credit market freeze we saw in the global financial crisis, but investor confidence has remained strong enough to allow companies facing short term pandemic issues to raise new capital.

In New Zealand, the Reserve Bank and Governor Adrian Orr moved early to cut rates and inject cash with a bond-buying programme.

The official cash rate was slashed to 0.25 in March and the monetary policy committee committed to keeping them there until at least the end of the year.

A Quantitative Easing programme, which gives the Reserve Bank scope to buy up to $60 billion in government bonds, was launched to stop market rates rising.

That's bought the RBNZ some breathing space.

Economists are now debating whether that $60b QE limit will be enough.

There is an expectation more will be needed eventually.

But with a strong domestic spend-up since lockdown keeping New Zealand's economic performance ahead of all but the most optimistic forecasts, the RBNZ now appears to be under little pressure to hurry its next move.

That puts the Bank exactly where it needs to be.

Reserve Bank governor Adrian Orr has options and continues to keep them open.

"How much easing is enough is still to be determined. Both on size of economic challenge and how much more stimulus is needed and on how it is working," he told the Herald last month.

After the controversy that's surrounded Orr and his RBNZ leadership for the past two years, the effectiveness of the Covid-19 response has markedly cooled debate.

There's always room for discussion and disagreement about the timing and scale of monetary moves, but the economic discourse has shifted to less abstract issues - like wages subsidies and border control.

Bigger questions - such as how we get rates back to what were once considered "normal levels and whether we can do it without crashing equity markets - remain on the back-burner.

Clearly not enough progress was made after the global financial crisis to get rates back comfortable levels.

Now we face a complex and confusing world of negative rates and the worrying question of where monetary policy goes when we face our next credit crisis.

The reality, though, is the RBNZ has limited scope to push back against a global trend set by the US Federal Reserve.

And while the Fed is supposed to be above direct political influence, it consistently buckled to the economic might of Wall Street and pulled back from lifting rates significantly between 2016 and 2020.

While the US dollar remains the global reserve currency, the world remains at the mercy of the country's political and economic challenges - that's not new.

How New Zealand deals with the challenges that creates remains an issue.

Orr understands the social cost of asset bubbles and widening inequality that low rates can cause.

He isn't shy of discussing them.

These were global challenges that New Zealand was a part of, he told the Herald last month.

"Without doubt those who have assets generally benefit at times of very low interest rates," he said.

But these were secondary issues for central banks, with the primary task being to ensure stability of the financial system.

Without that stability our economic choices would be severely limited, he said.

That's an entirely appropriate response for a central banker.

Perhaps it's also a reassuring one for some who felt Orr's reformist zeal was stretching beyond his mandate.

There's no doubt Orr remains committed to creating a more open Reserve Bank and one that is more relevant to the lives of everyday New Zealanders.

But the Covid-19 crisis has seen him hone his focus and proved that, when it comes to monetary policy basics, we are in safe hands.

Meanwhile, equity markets look set to sail on, with little prospect of rising rates anytime soon.

Investors may just need to put their heads down, keep life jackets handy - and enjoy the ride.