Since the Reserve Bank of New Zealand’s last formal Monetary Policy Statement in February, the Bank has engaged in a full suite of crisis response measures, similar to those undertaken by the Federal Reserve, RBA, and Bank of England.
The Bank has cut the Official Cash Rate to a historic low of 0.25% , opened a $33 billion Large Scale Asset Purchases Facility, loosened macro-prudential restrictions on housing lending, offered longer term liquidity to banks through the Term Lending Facility. In addition to this, dollar liquidity has been made available to the domestic financial system via swap facilities with the US Federal Reserve. In conjunction with the effectiveness of early lockdown measures, New Zealand’s economy now seems to be in a relatively enviable position. However, it is far from clear that the RBNZ is finished loosening monetary policy, and this week’s Monetary Policy Statement, on Wednesday, is unlikely to be a simple victory lap. In addition to the addressing the possibility of negative interest rates, the RBNZ must grapple with the uncertain duration of the overall covid-19 shock, weak external demand, and several other considerations.
Addressing expectations of negative rates will be a high priority for the RBNZ, even if policy remains unchanged on Wednesday. In an extraordinary meeting on March 16th, the RBNZ cut the OCR 0.75 basis points to its current historical low. The statement accompanying the decision made it clear that if further stimulus is required, asset purchases would be preferred to further OCR reductions. However, since then, speculation has begun to build that the RBNZ may not only cut rates further, but may even move into negatives. In the past, RBNZ Governor Adrian Orr has spoken favorably of negative rates, even saying in August 2019 that they would be more effective than asset purchases.
It is important to note the RBNZ’s policy considerations were considerably different in August 2019 to today, explaining the discrepancy between Orr’s earlier statements and more recent official RBNZ communication.
Regardless, Orr was careful not to rule out the possibility of negative rates in his most recent comments on the topic, during a web based seminar on the 21st of April, although repeating the line that “aren’t the best tool” for the current situation. The more recent comments were off hand and probably not intended to give a hint of any policy changes, but simply to keep the Bank’s options open – during the same webinar he also did not rule out the far more unconventional option of direct monetary financing. However, this has not prevented speculation that the RBNZ will lower rates further. Analysts at large regional bank Westpac downgraded their expectation of the OCR into negatives at the end of April, forecasting a rate of -0.5% by the end of the year.
Between the comments from Orr and Westpac’s predictions, expectations of future RBNZ policy have begun to price in further cuts. The OIS curve is fully pricing in fall in the OCR over a 12-month horizon, compared to a relatively flat structure as recently as a month ago.
At the margin, we think the RBNZ is more likely to opt for an expansion of asset purchases and further lending and liquidity measurements on Wednesday.
However, like Governor Orr, we rule nothing out from the central bank, which has been famously willing to take innovative and proactive policy measures in the past.
Korean won may have room to rally on fiscal and monetary support after containment success story
The South Korean won’s sensitivity to global trade volumes and growth conditions in Asia meant it was heavily impacted by the outbreak of the coronavirus in Q1.
The won depreciated nearly 2% in February against the dollar, before market turmoil began as the virus spread to Europe and North America. With China’s economy in a state of lockdown and the virus reaching Korea, Japan and other nations in Asia, the won followed Asian currencies in depreciating over the course of the month. In February, the won tracked virulence metrics and the estimated economic impacts of the governmental response. By the end of February, Korea had the most Covis-19 patients in Asia outside of China, with new confirmed cases doubling every few days. However, just as the virus began to appear in mainland Europe in the first few weeks of March, new daily cases fell from 800 to fewer than 100. The government’s swift containment of the outbreak and widespread testing program stemmed the humanitarian crisis and meant the Korean economy avoided economically damaging policies currently enforced in Europe and North America.
While the measures sheltered the domestic economy, the battle scars of Covid-19 were still visible
The advanced reading of Q1 GDP data showed the economy contracted by 1.4% QoQ, mainly due to a plunge in household spending. Household consumption fell 6.6% from Q4 2019, marking its steepest collapse since 1998 when consumption slumped 14% during the depths of the Asian Financial Crisis. Even though the spread of the coronavirus has practically ground to a halt in South Korea, we expect the Q2 GDP reading to be even worse than the first quarter as trade and investment also take their toll and global demand conditions contract. This was evident in the early trade data for April, which highlighted a 26.9% YoY contraction in exports compared to just a 0.2% contraction for the full month of March.
With the global economy heading for a deep contraction due to coronavirus, the won wasn’t sheltered by Korea’s containment success either. The currency was still hit by the global fight to US dollars, with USDKRW hitting 1296.750 on the 19th March; its lowest level since the global financial crisis. While some of the ground has been reclaimed, as fiscal and monetary stimulus provided a floor for risk sentiment and the depth of the economic contraction, the won is still trading around 4% lower than it did prior to the outbreak.
Korea’s containment success story didn’t give the won a get out of jail free card as the currency hit fresh decade lows
However, there are glimmers of hope for the South Korean economy. The current fiscal stimulus package from the Moon Jae-in administration is comprehensive to say the least, and is likely to be expanded following the ruling party’s win in the April 15th legislative elections. Moon’s KRW7.6trn extra budget proposal seeks to add to the initial KRW11.7trn stimulus package, targeting emergency relief payments totaling 14.8m low and middle-income households. This should provide a layer of support to household consumption as the measures focus on those with higher marginal propensities to consumer. Additionally, the downward pressure on inflation from the pandemic and a collapse in oil prices will likely see the Bank of Korea cut rates further in their upcoming meeting on May 28th. While the BoK already cut rates to a historic low of 0.75% in March, the race by developed market central banks to the zero lower bound has in turn lowered the BoK’s effective lower bound.
Level of fiscal stimulus is copious to say the least in South Korea
With policy support still forthcoming in Korea and global conditions showing signs of tentative improvement as pandemic curves begin to flatten, we expect the Korean won to begin trading back to its pre-virus range of 1150-1200.
While we expect a rally in the won, especially towards the back-end of the year as global trade volumes and growth recuperates, the journey is unlikely to be smooth. This stance is shared in options markets, where implied volatility in the pair remains at elevated levels.
Options markets are also pricing elevated volatility in USDKRW over the coming month and year
Ranko Berich, Head of Market Analysis
Simon Harvey, FX Market Analyst
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