The Reserve Bank's introduction of limits to low-equity mortgage lending last year had a similar impact on inflation as raising the official cash rate by as much as 50 basis points, governor Graeme Wheeler told a global banking conference in Wellington.
The loan-to-value ratio policy had "a dampening" impact on house price inflation and credit, "and the diminished 'wealth effects' on spending associated with it have reduced consumer price inflation pressures by an amount similar to a 25-50 basis point increase in the OCR," Wheeler told the Bank for International Settlements' BIS Conference on Cross-border Financial Linkages.
"In essence, the reduction in housing pressures allowed us to delay the tightening in interest rates, thereby reducing the incentive for any additional capital inflows into the New Zealand dollar in search of higher yields," Wheeler said, according to speech notes on the Reserve Bank website.
Wheeler began hiking the OCR from a record-low 2.5 percent in March, before pausing at 3.5 percent in July to assess the impact of the tightening round. Economists say he's unlikely to raise rates again until 2015, with expectations growing that any increase may be delayed until mid-year or later. The LVR policy and rate hikes contributed to a slowing of house price inflation to an annual 5 percent currently, from about 10 percent, "despite high levels of net immigration," he said.
The future of the LVR policy will be reviewed in the Financial Stability Report that the central bank is releasing next month. Wheeler said the policy isn't intended to be permanent and will be removed "once housing market pressures have moderated and when we are confident there will not be a resurgence in house price inflation."
Wheeler pointed out to the conference that the New Zealand dollar boxes above its weight in terms of foreign exchange flows, given the relatively small size of the nation's economy and exports.
Citing the BIS triennial foreign exchange survey, Wheeler said the kiwi is the world's tenth most traded currency, with daily turnover of about US$105 billion - "250 times our daily external trade flows." The New Zealand dollar was part of an Asia-Pacific region whose currencies have grown to account for 40 percent of global trades, up from 30 percent in 2007, he said.
Wheeler said while there is much known in theory about what drives exchange rates, such as their link to interest rates, "empirically, the connection is weak."
"Internationally, we see markets adopting risk-on and risk-off strategies that are often linked to expectations of the timing of monetary policy decisions by the Federal Reserve," he said. "And sometimes capital flows seem to matter. We see flights to quality and to more liquid markets accompanied by large exchange rate movements when risk and uncertainty increase."
In New Zealand's case, factors driving the currency included movements in commodity prices, the direction of interest rates and appetite for New Zealand dollar risk.
"But without a strong empirical understanding of what determines the exchange rate there is considerable uncertainty regarding the efficiency of the exchange rate transmission channel," he said.