There are two fiscal costs to the earthquake. One cost is the estimated $15b drop in GDP over the next five years – and the OCR drop is in recognition of this.

The other cost is the actual cost of rebuilding which may be up to $20b. As the construction gets underway, then it will put inflationary pressure on the economy and I suspect we will see interest rates rise rapidly – but not until probably 2012.

Bernard Hickey has a good piece on why the Reserve Bank dropped the OCR, despite inflationary pressures looming.

I tend to think a 0.25% drop would have been adequate, as it sends the signal, but then means a less drastic escalation in future.

However as I have around a $500,000 mortgage which is mainly floating, I at least benefit from the Reserve Bank dropping 0.5% – saves me a couple of thousand dollars.

Corin: On the cost, 15 billion dollars now Treasury is saying, and 1.5% of GDP, does that make a cut in the official cash rate, some help for monetary policy, pretty much essential this week?

John: Well that’s a matter for the Reserve Bank Governor, and it’s for him to decide and him alone to decide what happens on Thursday …

And that’s where ideally the sentence should stop. But the transcript continues:

but certainly the markets have factored in a likely cut in the official cash rate, and you’ve gotta say lower interest rates probably help the country, but that ultimately is a matter for the Governor

That is a subjective view that lower interest rates help the country. They don’t help long-term if they lead to excessive inflation.

On this case I agree with the PM, but the difference is I am not the PM. By making those comments, we have a possible headline that if Bollard does not lower interest rates that the “PM thinks Governor is not helping New Zealand”.

I’m a bit of a purist. I beleive there are only four people in New Zealand who should not express a view on what the Reserve Bank Governor should do – that is the Minister of Finance, the Prime Minister, the Leader of the Opposition, and the Shadow Finance Minister. They are all his current or future effective bosses, and any comments from them puts pressure on the Governor – even if unintended.

Also politically commenting is not wise. If the Governor happens to do what you say, then there is a suspicion he was pressured to do so. If the Governor does not do what you say, then the media will paint it as a row.

The bottom line is that while the public like having a Prime Minister who will answer questions on almost every issue and subject – potential changes to the official cash rate should be one you don’t answer except to say :”It is a matter for the Governor”

Cash-strapped homeowners will see some relief this year, with experts predicting the Reserve Bank will keep official interest rates low until at least September.

However, some experts say even that may be too early.

After two rises of 0.25 percentage points in June and July, the Reserve Bank has held the official cash rate steady at 3 per cent, as economic growth stalled.

Economists still expect a recovery this year, but there is a growing view that Reserve Bank governor Alan Bollard will leave rates on hold for another eight months.

Works for me, as from today I am once again burdened with a mortgage. My disposable income has shrunk by around 75%!

Money markets expect this tightening by way of small steps to prompt an official rate of 4 or 4.25 per cent by this time next year, and further increases to about 5 per cent by the end of 2011.

We should not, says Governor Alan Bollard, expect the rate to rise as far as the 8.25 per cent peak of the previous cycle.

Hopefully not, but several things could knock the ship off course. One is rising inflation, the central bank’s core concern.

I think the OCR will increase beyond 5%.

The Press also talks OCR:

Now, however, as recovery begins to look more robust here and among New Zealand’s main trading partners, the central bank must consider again the prospect that inflation will spike outside its target 1 to 3 per cent range. The move yesterday was modest – only a quarter of a percentage point – but it is an indication that the bank is determined to keep inflation expectations under control.

Some manufacturers and exporters have suggested that moving now on interest rates is premature. Manufacturers and exporters, like politicians and indeed all borrowers, never welcome interest rate rises, but the criticism in this case is unwarranted. The Reserve Bank under Alan Bollard has hardly been hawkish on inflation. A sign of this is the fact that, in an effort to balance competing forces during the boom years, the bank allowed inflation to nudge outside its prescribed limits three times in the space of six years. At the moment, inflation in the future is a possibility.

I still think the range should be 0% to 2%, so a midpoint of 1% is targeted.

The Press focuses on the Foreshore & Seabed negotiations:

Last year, the Government announced it wanted to restore the right of Maori to seek customary title in court, and acknowledge the foreshore and seabed not already in private title as public domain. It held nationwide hui, with Treaty Negotiations Minister Chris Finlayson at each one. Though that impressed Maori, they did not like the “public domain” concept. They want ownership in iwi hands, the foreshore and seabed being inalienable.

Again I remind people that the Court of Appeal merely said that an Iwi could try and claim title in court, not that they would get it. They also said one would have to show unbroken usage since 1840. That is a world of difference away from saying Iwi own the entire foreshore & seabed.

What the Maori Party thinks at this point is not clear – it definitely wants the Foreshore and Seabed Act repealed but might be having to weigh up pleasing the ILG against pleasing an increasingly implacable prime minister.

As Mr Key found over the Tuhoe/Urewera matter, it is hard to placate Maori without upsetting many Pakeha or to ameliorate Pakeha fears without upsetting many Maori. He might have to reluctantly accept that the Foreshore and Seabed Act has to stay on the books.

That is an option. Another is to simply repeal the FSA and let Iwi test their claims in court.

And the ODT chides North Korea:

The jury appears to be out on the exact state of mind of the North Korean dictator Kim Jong-il, variously regarded when healthy as either cunning like a fox, borderline mad or just pathologically nasty.

It is rumoured that he suffered a destabilising stroke some 18 months ago and, at 68, is ailing. Consequently, the world’s only hereditary communist dictatorship seems to be gearing up for succession to the “Dear Leader”.

Cuba is looking hereditary also. Ironic that communism was meant to be a fight against inherited privilege.

Had there been serious evidence anywhere else in the world that a submarine of one sovereign nation had arbitrarily sunk a warship of another, in what appears to be an entirely unprovoked incident, the clamour for retaliation or justice would have been deafening.

This is my concern. You reward North Korea for being well mad.

An expert in banking has rubbished a planned inquiry and says banks are being treated as scapegoats.

Massey University Centre for Banking Studies director David Tripe said the inquiry should not be taken seriously.

Little danger of that.

What I find amusing is the opening statement on the inquiry site:

Many New Zealanders are concerned about the high level of interest rates

The floating mortgage rate averaged 6.44% in June 2009. In June 2008 when Labour were in office it was 10.9%. So they were not concerned about 10.9% but are concerned about 6.4%?

That reduction means a $250,000 mortgage homeowner is paying $11,250 a year less interest or has an extra $215 a week in the hand.

MPs yesterday attacked banks for not passing on interest rate cuts to customers while turning in high profits during a recession.

The rebuke came a day before the Reserve Bank reviews its official cash rate, which stands at 2.5 per cent, and days after some banks increased their long-term fixed interest rates.

Parliament’s multi-party finance and expenditure committee said in a hard-hitting report that it was “concerned that some banks have not passed on the latest … cut to the official cash rate in their interest rates for floating mortgages”.

Not surprised MPs were unanimous on this. Attacking banks is almost as popular as attacking paedophiles!

It does four things:

1. allow pawn brokers to charge administration fees, thereby removing any need for high interest rates
2. require lenders to seriously consider the actual means of a prospective borrower and their ability to service the debt
3. allow for the prescription of maximum annual percentage rates of interest payable in respect of consumer credit contracts
4. restrict the right for a creditor to recover from a debtor any amount beyond the value of the goods sold subject to a security agreement.

Taking each in turn

Pawn Broker Admin Fees

I’m not sure what the original rationale for pawn brokers not being able to charge an admin fee, but seems to me flexibility is a good thing.

Lenders to assess ability of borrowers to service debt

I should start off by saying that I am well aware there are many very scummy companies that exploit people with cashflow problems by taking advantage of their desperation to get them to agree to loans that with compounding interest are crippling.

But I am hesitant about putting the burden of assessment on the lender, rather than the person borrowing the money. The borrower does have some responsibility themselves to judge their own capacity to replay. And you could end up with a lot of uncertainity as to what steps lenders must take to assess repayment. I don’t see this as being practical or necessarily desirable – lenders do have an incentive already to check repayment ability – so they can get repaid.

Maximum rates of interest

The proposal is that the Reserve Bank Governor can set a maximum rate of interest for borrowing. This is well intentioned but may have unintentional side effects. Let’s say you can currently get unsecured borrowing from scummy lenders for between 35% and 75% interest. And let us say the Reserve Bank says that the maximum you can charge os 50%. Now yes that will stop money being lent at 75% interest, but may push the 35% rate up to 50%. A ceiling often becomes a target. And you may also get scummy lenderss claiming greater respectability as their interest rates are “approved by the Reserve Bank”.

Creditor Recovery

I’m not quite sure how this clause will work in practice, so will update when I have worked it out. As I understand itm, this is a more minor part of the law change.

I have doubts over the practicality and desirablity of parts of the bill, but neither do I think the current law is working particularly well – many families are getting exploited.

If the bill gets selected from the ballot, I think it should definitely be supported to select committee so they can consider the issues and proposed solutions. Any support beyond that would depend on what changes get made there.

Generally I support most private members bills going to at least select committee for hearings. My exceptions are those that are:

1. Obnoxious (EFA type laws) and so bad not possible to make into good law.
2. Directly contrary to the Government’s policy (designed just to score political points)

This graph used the Reserve Bank data and shows the difference between what banks are charging for floating mortgages and what they pay for six month term deposits.

The big spike at the end is the credit crisis at work, but also maybe showing that the banks are not doing too badly.

But what I found interesting is there has also been a gradual increase since 2000 in the margin.

I remember the days when a 50 basis point drop was a big thing. Now we have 150 point drops that are in line with expectations.

This should start to push mortgages back into the affordable category for more people.  Of course depends where retail rates go.

Look at that baby drop. The Governor is not giving much away about further drops, but I think we can expect at least 50 more basis points next year.

“We’ll be looking, like others, to see what the Reserve Bank governor does on Thursday but we would be anticipating significant rate cuts,” he said.

I’ve noticed that as Opposition Leader, John would often predict or even suggest what the Reserve Bank will do with the official cash rate. It was an annoying habit in Opposition, but a bad habit to keep going in Government.

In some ways the PM is just stating the obvious. Even the stupidest first year economics student knows that the Reserve Bank will cut the cash rate on Thursday. The only debate is by how much.

So, to be fair, when the PM says he is anticipating significant rate cuts – he is speaking literally – he is anticipating cuts, like everyone else.

But he is not like everyone else. He is the Prime Minister. And it is unwise to carry on a commentary on what you think the Reserve Bank Governor will do, when you hold that job. Because sooner or later it will be interpreted as pressure. It will be seen as trying to indirectly instruct the Reserve Bank – even if that is not the intention. It will one day generate negative headlines when the PM predicts one thing, and the Reserve Bank goes the other way.

Here’s my preferred responses for a PM on what the Reserve Bank will do:

Well the Reserve Bank makes it own decisions on the cash rate, and I don’t think it is helpful for me to speculate – I’ll leave that to the bank economists.

As I said above, it isn’t a big issue this time, because it clearly wasn’t a comment to pressure the Reserve Bank – it was stating the obvious. But in future the circumstances may be different, and best to bury a bad habit early – in my opinion.

This is the biggest ever single movement – previous moves had been as high as 50 basis points but never a 75 or a 100 before.

The Governor says:

“With weaker short-term growth and sharply lower oil prices we now expect that annual CPI inflation will return to the target band of 1 to 3 percent around the middle of 2009. However, we still have concerns that domestically generated inflation (particularly in labour costs, local body rates, electricity prices and construction costs) is remaining stubbornly high.

The domestic inflation is what causes the risk of stagflation.

“Consistent with the Policy Targets Agreement, the Bank’s focus will remain on medium-term inflation. Should the outlook for inflation evolve as projected we would expect to lower the OCR further. However, the timing and extent of OCR reductions over the coming months will depend on evidence of actual reductions in domestic cost pressures as well as how the global financial developments play out.”

I can think of some domestic costs that could be reduced!

NZIER released their quarterly survey of business confidence yesterday. On the basis of it they predict the recession will last for at least another two quarters. A net 32% of firms have reported a decline in trading activity and a net 13% expect trading activity to fall further in the next three months.

It is in that context, and the decade of deficits announced by Michael Cullen on Monday, that National have modified their tax package which will be announced later today. This is both necessary and responsible. The public want a tax package that takes account of the last few weeks, let alone the last few months.

The scary thing with the PREFU numbers is they were finalised five weeks or so ago, so do not include the latest shocks from the US. As the Herald says:

Party leader John Key yesterday admitted that the pre-election opening of the books by the Treasury showed a picture that was much worse than he had expected.

“We’d always expected a slowdown, but I don’t think anyone saw deficits for 10 years and such a deterioration in the accounts.”

The economic and fiscal update showed cash deficits forecast to reach $7 billion and budget deficits for the next 10 years. …

No-one at all was expecting it to be that bad.

Also behind the decision is the fact that the forecasts revealed by the Treasury this week do not take into account the tumultuous events of the past month, in which banks have collapsed, the US Government has approved an enormous bail-out deal for Wall Street, and the flow of credit internationally has virtually seized up.

Who knows where it will end. Now this is no reason not to have tax cuts at all – they are important as one factor in lifting economic growth. But some caution around size and timing is essential.

Prime Minister Helen Clark yesterday cast doubts on National’s statement that it had scaled down its tax cut plan.

“I believe they over-promised on their tax package and they are now using the excuse of the books to try and talk down expectations,” she said.

I am tempted to call the PM a moron for that comment, but I know she is not a moron so all I’ll say is she is playing dumb. If she really thinks a decade of deficits is simply an “excuse” then she is in la la land.

But here is what is really interesting. We have seen National says “Yes we will modify our plans in wake of the financial crisis” while Labour says it is not going to change anything. Dr Cullen ruled out any change to tax or spending in the PREFU lockup. At most they might delay some of WInston’s new bureaucrats. Labour are happy to have ten years of deficits and debt rising from under 20% to 30% of GDP.

Labour have had it easy for the last nine years. They have never had to make tough decisions, and now the economy is in reecession they have no idea and no plan as to what to do to prevent a decade of deficits. Their biggest problem for the last decade has been what new schemes to dream up to spend our money on – hey lets put a billion more into Working for Families, no no lets buy some trains for a billion, no no let’s give pensioners free bus trips, no no let’s give public servants a pay rise but only if they join the PSA etc etc.

Because the economy, helped by strong commodity prices, has been so strong they have been able to say no to measures that would boost labour productivity and economic growth. Many of these measures (such as RMA reform) will be unpopular with some lobby groups, so why bother to take the heat, when hey we have enough money without such reforms.

But now Labour has run out of money. They are content to run ten years of deficits. They are not willing to take any hard decisions about lifting our economic growth, let alone paring back any of their spending schemes.

We’ll hear later today what National’s plan is. I think it will be measured, significant and popular. It will of course be attacked by Labour and the unions. National could announce the second coming, and Labour and the unions will attack it. Hopefully at some stage, somone may ask Labour what their plan is? Their plan is to not change tax rates and not change spending significantly. Their plan is a decade of deficits.

Reserve Bank Governor Alan Bollard said: “The New Zealand economy is experiencing a marked slowdown, led primarily by the household sector. The outlook for the global economy has deteriorated further in the wake of continued financial market turmoil. In addition, the New Zealand business sector is coming under pressure from both rising costs and falling demand. While domestic activity is likely to pick up late this year as a result of personal tax cuts, increased government spending and rising rural incomes, we expect a prolonged period of household sector adjustment and below-average growth.

I almost feel sorry for Bill English, if he becomes Minister of Finance in a few weeks.

I also remain concerned that inflation will remain too high for years to come.

I can just visualise Helen Clark and Michael Cullen doing a little jig in their Beehive offices this morning. A further lowering in the OCR is just what the doctor so desperately wanted. And the more aggressive stance that Bollard seems to be taking to cutting hopefully means more money in homeowners’ pockets before the election.

Agree this is good for the Government, even if bad for NZ.

There are a couple of other reasons why Clark is smiling at the moment. National confirmed its industrial relations policy this morning, which changes little except for introducing a 90-day trial period for workers, cleverly dubbed “fire at will” by Labour. I think this will haunt National during the campaign, and for little political upside. If employers won’t be unscrupulous and sack people after the three-month trial is up, then why have one at all?

I guess Colin has not been an employer. Sacking someone not up to the job is not being unscrupulous. Employers generally want to retain staff. But if a staff member is costing them money rather than earning them money, then a small business has to do what is necessary. And the reality is that a small business has great difficulty in sacking someone just because they are incompetent. They do have have the resources larger firms do.

Colin is right that Labour wil try and scare people off with this policy. But National’s job is to make sure people realise it applies to small businesses only and just for 90 days.

The other reason, curiously, is the Winston Peters donation scandal. I’m not so sure this is bothering Clark terribly much. Why do I think this? Well, for one thing, when junior partners in a coalition or confidence and supply arrangement get into trouble, it’s almost always the smaller party that suffers – the Alliance, for example, in 2002.

I think Colin is very wrong here. First of all he overlooks that every day the headlines are about the Foreign Minister’s secret donations, they are not about stories that are more favourable to the Government. They face weeks and weeks where the main political news is Winston.

Secondly Colin should look back to 1996 and 1997 and Tuku’s Undiegate. Yes NZ First lost support, but so did National – greatly so.

The second reason is that the irony of the donor scandal is that it once again raises the whole issue of anonymous rich people trying to buy elections. And while the heat is currently on Peters, I wonder how long before it will again turn back to the National Party, which has more experience with secret trusts hiding large corporate donors than any other party.

There is a risk there, but the key difference is National has not spent 15 years condemning such trusts and demanding they be ended. Also the latest revelation from Bob Jones suggests a level of secrecy well beyond anything National has done – at least their trusts are known about, commented on, and declare their donations to National. The Spencer Trust appears to pays bills off secretly on behalf of NZ First.

It also limits National’s ability to go quite so hard on the Electoral Finance Act in future. Granted the law is complicated, virtually unworkable, and probably unfair. But it does limit the ability of parties to slip donations under the carpet in the way NZ First is being accused of doing, and as National (and Labour) have done in the past.

I don’t think it does. While the EFA does have better provisions relating to donations (and I am on record support some of them) this is showing the false confidence one can gain from such a regime.

Secret donations to MPs and/or their expenses are allowed under the EFA.

Secret donations to trusts associated with a party are allowed with the EFA.

Donations from different family members and companies associated with them are not discloseable under the EFA so long as each is under $10,000 and each family member and associated company is not proven to make the donation on behalf of someone else.

One can still donate $66,000 in a year without disclosing your identity.

One could donate $250,000 over a year through anonymous $1,000 donations a day if the party doesn’t know they are from the same source.

So don’t think the EFA solves all this.

And National knows it can’t go after Peters too hard in case it needs him after the election. The temptation must be there, though, given if it did manage to finish Peters off an early election would be in its favour. The fear, however, is that if the attempt backfired and Peters survives, National can kiss goodbye to any post-election deal with NZ First.

Indeed. But both Clark and Key will be wondering how long a post-election deal would last, if there are more revelations like this week to emerge, and if Peters is never going to retreat from his stance of never admitting any fault at all, and blaming the media for exposing his secret donations.

So provided Peters doesn’t completely throw his toys and march out of the government, therefore prompting an early election, I don’t think this week has done Labour any harm at all.

Which is why the Prime Minister is still smiling.

The PM will be happy with the cash rate announcement. I don’t think she is at all smiling over the antics of her Foreign Minister.

I have absolutely no view on the suitability of Dr Eichbaum’s appointment. I do note however that the Minister forgot to mention that Dr Eichbaum worked in the Ministerial offices of Steve Maharey, Mike Moore and Geoffrey Palmer. That would have been useful to disclose.

The Government has been busy with over a hundred appointments in recent times – they also just appointed four Labour/left people to the new Land Transport Board.

Anyway back to the official announcement:

“Recent oil and food price increases mean that annual CPI inflation should peak around 5 percent in the September quarter of this year. However, we expect that inflation will return inside the target band in the medium term. The weaker economy is expected to reduce pressure on resources, making it more difficult for firms to pass on costs and for higher wage claims to be agreed.

So the cash rate dropped 25 basis points to 8.00%. I would like to know exactly when the Reserve Bank thinks inflation will drop back to under 3%? 2009? 2010? 2011?

TVHE comments:

Even ignoring inflation, it appears that the Reserve Bank values the livelihood of those who have mortgages above people who are struggling to pay their food and fuel bills (which will go up, as a lower exchange rate will increase the New Zealand price of both).

I predict inflation will remain outside the target band for some years.

The most hilarious part was this:

On Sunday, Dr Cullen accused banks of talking up tax cuts as inflationary out of self-interest …

Is this the same Dr Cullen who for several years attacked tax cuts at every opportunity as being inflationary?

The same Dr Cullen who cancelled the chewing gum tax cuts last year on the basis of them being inflationary?

You can’t have it both ways.

My position remains the same – it is the combination of both government spending and tax cuts which has an effect on inflation – and spending tends to have a greater effect as a portion of tax cuts will be saved.

The amount of political pressure on Alan Bollard will be immense in the next few months and it will be a test of his independence whether he ignores the clear wishes of the PM to cut rates before the election, even if it means he breaks his legally binding target of inflation under 3%.

A few journalists are saying it is only tax cuts that could keep interest rates high, and this is silly. It is the combination of both tax cuts and extra spending. If you replace a billion of spending with a billion of tax cuts, then in fact it will be reduce inflationary pressures as a proportion of tax cuts are saved not spent.

Martin Kay in the Dom Post reports on Cullen:

Finance Minister Michael Cullen has accused money markets of over-reacting to his tax-cut programme after a blip in the interest rate at which banks borrow for mortgages.

The two-year wholesale rate jumped from 7.7 per cent to 8 per cent after Dr Cullen announced his $10.6 billion, three-stage cuts on Thursday.

Well I know who I trust to be right!

Now Labour in the 1990s tried to blame all of that downturn on the then National Government. I prefer a more rational analysis, and both National in 1997 and Labour in 2008 can’t be primarily blamed for what is essentially a global problem. However both Governments do have responsibility to have the economy as free and resilient as possible to mitigate the effects of global events.

So what has happened in the last quarter:

• Those in employment have dropped on a seasonally adjusted basis by 29,000, wiping out the gains since December 2006
• The number of people unemployed rose by 4,000 – a 5.2% increase from 77,000 to 81,000
• The number of people not in the labour force increased by 35,000 – so these are people no longer looking or available for jobs. The labour force participation rate has dropped to 67.7% – at least a two year low.
• Most of the fall in employment has been amongst under 25s
• Unemployment rates (non seasonally adjusted) by ethnicity are Europeans up from 2.2% to 3.0%, Maori from 7.2% to 8.6%, and Pacific from 4.8% to 8.2%
• Wellington appears to have the largest rise in unemployment – from 2.5% to 5.0%
• The total number of jobless people (this includes those not available or looking for work) rose from 145,900 to 181,800
• The number of actual hours worked in the quarter is the lowest since March 2005

Now I think the HLFS has exaggerated the decline somewhat. The HLFS is basically just a big opinion poll. It has a large sample (17,000 off memory) but that still leaves a sampling margin of error. I don’t think there has actually been 29,000 jobs go in the last quarter. But certainly there has been some decline.

The above graph, at The Visible Hand in Economics, shows the market reaction. The concern is not over the decline, as much as the size of the decline.

The only good news is that the chance of a lowering of interest rates this year is now higher. But food and fuel inflation will still make this a risky call to make too early.

The target is 2% (it should be 1%) with the allowable range being 1%  to 3%. Bottom line is no drop in interest rates for a while.