Keep rates low for up to 18 months: Moodys

Photo / Sarah Ivey

Reserve Bank Governor Alan Bollard should ensure New Zealand has "accommodative" monetary policy settings for up to another 18 months as the economy gradually recovers from its deepest recession in two decades, according to Moody's Investors Service.

New Zealand's banking system outlook is still stable and should be supported by the slow grind out of recession, but delays to the reconstruction effort in Canterbury and the threat of another global downturn should keep the central bank's monetary settings accommodative in the coming 12 to 18 months, Moody's said in a report on the nation's banking system.

The report comes just four days before Bollard reviews the official cash rate, and analysts expect he will keep the benchmark interest rate at a record-low 2.5 per cent.

The rating agency reaffirmed the financial system's stable outlook in contrast to the sector-wide downgrades issued by rival Standard & Poor's last week. S&P changed its methodology to rate banks earlier this year.

"While we see potential vulnerabilities in the system's exposures to rural sectors, household leverage and household leverage and wholesale funding, they are mitigated by the system's overall low-risk loan portfolio and high capitalisation," the report said.

Moody's said it expects New Zealand's bank profitability to remain stable as lenders benefit from accelerating loan growth and lower impairment charges, though that may be offset by increased funding costs. New Zealand's lenders source about 35 per cent of their funding from foreign markets, and have been resisting the need to tap overseas lenders amid the recent threat of a European sovereign debt crisis.

Assistant vice president and analyst Marina Ip said the lenders' dependency on foreign funding is a concern, "which we think could become a vulnerability over the horizon of our outlook as the current euro-zone crisis could deteriorate beyond our baseline scenario."

Still, Moody's stress tests found New Zealand's lenders are relatively resilient to external shocks, and able to withstand both a base-case scenario and a severe recession modelled on the early 1990s downturn.

Last month, the Reserve Bank gave lenders more time to beef up their core funding ratio, which dictates how much short-term money banks can borrow from foreigners.