Reserve Bank says Trump presidency will be marginally inflationary; Governor warns the world is past peak trade

Reserve Bank deputy governor Christian Hawkesby says the impact of the Donald Trump presidency will be manageable, but there are risks. Photo / Mark Mitchell

Reserve Bank of New Zealand deputy governor Christian Hawkesby says a Donald Trump presidency in the United States will be inflationary at the margins, but manageable.

Addressing Parliament’s Finance and Expenditure Committee to discuss the central bank’s latest biannual Financial Stability Report, Hawkesby was asked about the impact of the US election.

He recognised a Trump presidency would see tariffs on goods imported to the US hiked, taxes for American people cut, regulation loosened, and immigration to the US reduced.

“On the margin, it’s a higher inflation package than the alternative, but one that’s very much manageable in the world of operationally independent central banks,” Hawkesby said.

“That’s the central case. It’s manageable. There are risk scenarios around that, and that all relies on whether the tit-for-tat escalation [occurs], who does what in response, and whether things sort of broaden out from there.”

In its Financial Stability Report published on Tuesday, the RBNZ said New Zealand banks were acutely aware of the escalation of geopolitical risks in recent years.

So it’s preparing to stress-test them next year to see how well they’d weather various scenarios.

Addressing the parliamentary committee, RBNZ governor Adrian Orr elaborated on the accumulation of risks facing the global economy.

“I’m recently back from IMF [International Monetary Fund], World Bank meetings, and sanguine was not a word. There is a palpable challenge globally that’s going on at the moment,” Orr said.

“We’re past, and may never see it again in our lifetimes, peak global trade.”

He noted the escalation of “tit-for-tat protectionism” and the re-emergence of “industrial policy”, last prevalent in the 1980s.

Orr said the concept of building a wall and putting a factory behind it, rather than buying goods from offshore, had become “the topic of all major economies around the world”.

He recognised Hawkesby’s comment around a Trump presidency being a little inflationary, saying “landing the inflation story” was another big issue globally.

“That is unfolding as anticipated, touch wood.”

Then there is fiscal management – or the state of government finances.

While the New Zealand Government issued an unprecedented amount of debt in response to the pandemic (which is currently being rolled over, rather than repaid), Orr recognised New Zealand was in a better position than many other countries.

He said the challenge was paying down debt without hurting future generations, given the amount of investment required in different areas.

Climate change was the other issue front of mind for Orr.

Given New Zealand is a “small, open economy”, he said stress-testing banks to see how they’d pull through different geopolitical scenarios was essential.

The RBNZ elaborated on this in its Financial Stability Report.

It said loan arrears could rise if economic activity plummeted. Interest rates could spike if shocks to financial markets raised funding costs.

“Under severe circumstances, banks’ access to funding could be restricted, hampering credit supply and increasing refinancing risks for borrowers,” the RBNZ said.

“In the long term, financial markets may become more fragmented as investors reallocate capital away from countries that are less geopolitically aligned to their own ...

“Deglobalisation could gradually result in more concentrated investment linkages with fewer financial partners. Asset prices and funding conditions may become more volatile over time.”

Should the RBNZ make banks strengthen by holding capital?

While talking about risks to the banking sector as part of their appearance before the Finance and Expenditure Committee, Orr and Hawkesby were also asked by a couple of National MPs about the impact of the RBNZ’s requirement for banks to hold more capital to prevent them from collapsing during crises.

Catherine Wedd and Ryan Hamilton pushed Orr and Hawkesby on whether banks were passing on the costs associated with the rules to their customers, to the detriment of the economy.

The questions followed Finance Minister Nicola Willis in August telling the Herald she was open to possibly requiring the RBNZ to ease its rules, which have been several years in the making and are still being phased in.

Orr continued to strongly defend the rules.

He characterised the requirements as being “incredible value for money” in terms of strengthening the financial system, and reminded the committee there would be “utter chaos” if one of New Zealand’s major banks failed.

Hawkesby drew on what the RBNZ outlined in its submission to the inquiry into banking competition, which the committee is heading up.

In its submission, the RBNZ explained banks need to make allowances for unexpected losses they may suffer due to a major shock. Its rules specify how much capital banks need to put aside to withstand this.

If there were no rules, banks would still assign more capital to loans subject to higher unexpected losses.

So, while this has some effect on the interest a bank charges a particular type of borrower, rates are also influenced by other factors, such as the interest banks pay to secure funding from wholesale markets or depositors, their operating costs, the allowances they leave to cover more predictable losses, and the margin they seek to add.

Orr said there was competition between banks and the single biggest difference between the big and small banks was their cost-to-income ratios.

In other words, the large banks have the scale to keep their costs down.

Jenée Tibshraeny is the Herald’s Wellington business editor based in the parliamentary Press Gallery. She specialises in government and Reserve Bank policymaking, economics and banking.