Govt changes may lower interest rates

Press, 4 December 1985, Page 1

Govt changes may lower interest rates

By

MARTIN FREETH

in Wellington Big changes in the Government’s liquidity management policy have been welcomed in the money market with some predictions that a decline in short-term interest rates might ensue. The changes, unveiled last, evening by the Reserve Bank, make it clear there is no deviation from the Government’s tight monetary policy. The policy review first indicated by the Minister of Finance, Mr Douglas, in late October has produced a technical refinement in the Government’s methods of controlling the level of liquid funds within the financial system at any one time. Reserve Bank officials and money market dealers suggest the public will feel no impact from the changes. The Government debt

sales programme, which is the main thrust of the tight monetary policy, now being reflected in high interest rates, will continue unchanged. However, the liquidity management changes are important for the financial system. They are intended to “smooth out” fluctuations in liquidity and so avoid unnecessary leaps in shortterm interest rates. Last evening’s announcement had been eagerly awaited in the money market. Several dealers told “The Press” the changes could cause an easing of rates by removing uncertainty about future fluctuations in liquidity. The changes alter the system of weekly Treasury Bill tenders which have been the main instrument in the Reserve Bank’s liquidity management operation.

Bank officials say that longer-term bills will still be sold by tender, although these may be less frequent from now on, and bills with a maturity of less than 30 days will be sold by the bank in daily business. The policy change has three components: • First, the terms for discounting Government securities - the selling of them back to the bank at a time before their maturity — will be restricted. The period for discounting will be reduced to within six months of maturity to one month. This involves a narrowing of the bank’s definition of primary liquidity, the control of which is central to the Government’s short-term monetary policy. • Second, trading banks will receive a higher rate of interest on the funds they hold on account with the Reserve Bank. The rate has been 5 per cent but from today will be tied to daily changes in the market To-

day’s rate will be about 13 per cent. • Third, the bank will be more active in the money market as a dealer itself. This will happen through greater flexibility in tendering and through so-called open market operations where the bank trades in existing securities. The changes will be phased in in such a way that the narrower discounting provisions take full effect from next April 1. The discounting rate, which is a penalty for relinquishing the stock before maturity, will stay the same. Reserve Bank officials see the changes as an integral package which has evolved out of experience this year when the Government has radically changed the ground rules for financial institutions, and let interest rates move entirely with the demand for money and the quantity available. One official said that change was needed because of the complexity of the management system until now “and the difficulty people have had in under-

standing what is going on.” The bank hopes that the new policy will make it easier for the market to interpret Government intentions for the level of liquidity, and so let traders contend better with the seasonal fluctuations in liquidity that must inevitably occur.

Mr Douglas described the changes as a “continuing process of refinement and we plan to look at the revised system after it has been in operation for a year. “At that point we will consider further possible refinements, including for example, whether a “cash only” definition of primary liquidity is appropriate,” he said.

Market dealers were pleased with the announcement, saying it represented no sudden shock and would continue the present trend in the market. It had been more stable since mid-Octo-ber when the bank had started to work a “de facto” version of the policy now announced, one commented.

Short-term rates have •eased in that time, from

previous rates on 90-day commercial bills of about 27 per cent to a comparable rate yesterday of 20.5 per cent.

The dealers pointed to the higher rates not being justified by either corporate or consumer demand for funds, and simply reflecting rigidity in the financial system. The new liquidity management policy would do much to bring rates into line with real demand for money. The dealers also saw the new policy as making the Reserve Bank more accountable for the impact its moves had on liquidity levels.

There is some feeling that the bank has been remiss at times, as when funds were very short in September and overnight interest rates briefly hit up to 100 per cent.

One dealer said, ‘Til be very surprised if we don’t see interest rates fall as a result of this.” Another was more cautious in describing the policy change as simply “very positive” for a fall in rates.