Reserve Bank claims it has beaten freeze

Press, 13 March 1985, Page 33

Reserve Bank claims it has beaten freeze

By

MICHAEL HANNAH

in Wellington

The Reserve Bank maintains it has “broken the back” of the monetary squeeze with a package of measures which brought down short-term interest rates yesterday. But in the process, the Government has gambled the opportunity to finance its estimated $2.7 billion deficit completely from domestic savings. There was also a warning from money-market dealers yesterday that the Reserve Bank will have to move more quickly this morning to maintain the impact it achieved on interest rates yesterday. By mid-afternoon yesterday, overnight interest rates had already firmed to about 200 per cent after dropping earlier in the day.

Overnight rates eased initially yesterday morning as the Reserve Bank:

• Injected another S2OOM into the money supply by buying bank TCDs and commercial bills; • Cancelled the expected March 21 Government stock tender, effectively relinquishing its call on an estimated S3OOM of bank assets this month; and

• Fixed an interest rate of 19.5 per cent on compensatory deposits, which banks obtain from the Reserve Bank to offset the drain on funds from the present tax take.

A market source said that the fixing of an interest rate of 19.5 per cent, on top of the injection of S2OOM which was spread around the institutions more evenly than earlier injections this week and last week, had an immediate effect. Rates on 90day securities dropped from 36 per cent to about 22 per cent, and overnight rates eased.

However, the source said the move came too late in the day to affect all overnight arrangements, and overnight rates firmed again to about 200 per cent later in the day as merchants scrambled for overnight funds to balance their books.

The source suggested an earlier move today would rates further.

The cancellation of the Government stock tender was still being digested, however, the source said.

The tender had been expected to call for S3OOM from big institutions, according to Mr Peter Ledingham, deputy chief economist at the Reserve Bank. Its cancellation raised questions in the money market about whether the Government had forgone its target of funding its Budget deficit totally from internal savings.

If this were the case, the Government would have to fund any shortfall from overseas loans, but a highlevel source yesterday suggested there was probably little risk of this being needed. This source said there was not much risk of the deficit’s being higher than the $2.7 billion estimated in last year’s Budget. But there was a chance that it could be lower than this figure. Stock tenders so far had raised SI4OOM of the SI6OOM the Government had targeted for deficit funding this year, the source said.

The Government was “comfortable” with this level of funding, he said. These comments suggest that the Governments hop-

ing to record a deficit of only $2.5 billion by March 31, the end of the fiscal year, or at least come so close to this figure that the need for overseas borrowing would be minimal.

Any such overseas borrowing would amount to an expansion of the money supply, but another official source suggested the Government may be happy with the small amount of borrowing needed as it would help encourage some expansion. Another effect of a shortfall

in funding of the deficit from internal savings would be an easing of interest rates, a market source said. This was because the Government’s internal borrowing requirements were less than expected, so reducing its need to enter the market for funds and compete against market interest rates.

The source said yesterday’s measures were accepted by the market “with a sigh of relief."

Mr Ledingham, deputy chief economist with the Reserve Bank, said the bank wanted rates to return to the same level they stood at “before this little burst.” He gave warning, however, that the bank did not have “an open cheque book” to fund its injections into the money supply.

“We want to intervene as much as is necessary to bring the market back to where it was,” he said. He also rejected suggestions in the market that institutions may raise their interest rates on longer-term loans and house mortgages because of the prolonged spate of high rates on overnight and 30-day loans. “It would take more than one or two weeks of heat to do

that,” he said. “It would take a month or two with rates at this level to do that, I would think.”

Announcing the package of measures yesterday, the Governor of the Reserve Bank, Mr Spencer Russell, said they were aimed at settling conditions in the financial markets. He said that current shortterm interest rates were very high because of exceptional circumstances, and that market rates could be lowered substantially without sacrificing firm monetary control. The cancellation of the stock tender would help to rebuild liquidity and reduce interest rates. In addition, the bank would continue to inject liquidity through its market operations until an appropriate level, in terms of the new operating environment for the institutions, had been reached

Mr Ledingham added later that he could not put a figure on what an “appropriate level” was. Mr Russell continued that, once the financial markets had settled down, with interest rates at more appropriate levels, the bank would be in a position to resume Treasury Bill tenders, and market operations would revert to a more neutral position. He emphasised that the cancellation of the stock tender did not represent a weakening in the Government’s monetary policy. He noted that an active stock tendering programme would be resumed in the next fiscal year, and that an announcement on debt sales objectives would be made later this week. On the compensatory deposit interest rate, he recalled that the intention had been to set the rate in relation to the

average interest rate for nonbank, 60-day commercial bills over the pay-out period. However, in the exceptional circumstances prevailing at present, he did not view it as appropriate to lock in the present high interest rates, which were no more than a temporary phenomenon, for the whole compensatory deposit repayment period, which runs to the end of May. Accordingly, the rate set had been pitched at a level related to market rates before the recent surge, which was likely to be similar to the level which would be restored when the current disorderly conditions had dissipated. This would also be a level consistent with broader monetary policy objectives. He expected the measures taken would combine quite quickly to bring greater certainty, and thus help restore more appropriate interest rates in the short-term money markets. The Reserve Bank would continue to monitor the situations closely, and Mr Russell felt sure that the various institutions in the market would welcome these moves, and react sensibly to them.