A round-up of leading economists' views on the RBNZ decision to leave the OCR unchanged.
The RBNZ left the OCR unchanged at 2.5% at the July OCR Review, as widely expected. However, the accompanying statement suggests the RBNZ would like to remove the 50 basis point ‘insurance' cut soon, provided it saw an easing in global risks and a continued recovery in the NZ economy. Recent domestic developments have been encouraging, and the RBNZ is now more confident that the recovery is back on track. We now expect a 50 basis point OCR increase in the September meeting.
Beyond this, the RBNZ has indicated that the timing and extent of further OCR increases will be largely influenced by the level of the NZ dollar. Given we expect the NZD to remain elevated for much of this year, we expect the RBNZ will leave the OCR on hold at 3% until January next year. Further OCR increases will likely be in 25 basis point increments as the RBNZ looks to tighten monetary policy steadily over 2012.
The RBNZ kept the discussion on the growth outlook deliberately brief to avoid confusing the message. The important thing to note is the conditionality of the increase of the OCR on the continuation of the NZ economic recovery and the global economic risks subsiding.
The RBNZ acknowledged the stronger economic outlook, and noted the key role the high terms of trade is playing. On this note, the outlook for the global recovery is crucial, and the current risks, particularly stemming from uncertainty in the US, are a concern to the RBNZ. As a result, the removal of the emergency cut is highly conditional on these risks receding. That means the RBNZ will be assuming there is little impact on NZ from the US debt ceiling negotiations and a possible US credit rating downgrade.
The discussion on the exchange rate was also pared back. The RBNZ was very specific that further increases in the OCR (i.e. beyond the removal of the 50bp insurance cut) were dependent on the level of the exchange rate (the Trade Weighted Index is likely to be the most appropriate measure to consider).
In regards to inflation, the RBNZ focused on its expectation that underlying inflation will be below 2.5%. Unlike the June MPS, there was no reference to its discomfort with the signs of growing inflation pressures in the NZ economy. This statement was clearly aimed at watering down inflation expectations in light of the high annual headline inflation rate seen in Q2.
What is apparent is the RBNZ wants to take back the March 50bp ‘insurance' cut very soon. That suggests a September hike is very likely, and in our view a 50bp is more probable than a 25bp. The RBNZ sees "little need for the March 2011 ‘insurance' cut to remain in place much longer", and our interpretation is that means an imminent move and also reversing the March cut in one hit.
Beyond that we see the RBNZ pausing until January, then resuming steady 25bp OCR increases. Further hikes, beyond removing the ‘insurance' cut' are conditional on the level of the NZD, ongoing NZ economic recovery, and the fluid global situation. We expect the NZ dollar will remain elevated, and "likely to reduce the need for further OCR increases in the short term". This means NZ interest rates are going to be trading as if the MCI was still in use. Furthermore, NZ commodity prices (and the Terms of Trade) are likely to moderate, reducing the income boost to NZ. These are reasons, we believe, for the RBNZ to pause (after removing the insurance cut) for the rest of the year.
The market reaction to the statement was muted, with the NZ dollar easing slightly in the half hour following the release. Markets brought forward its expectations of an OCR increase with short-term interest rates rising accordingly. Markets have now fully priced in a 25 basis point increase by September. Meanwhile, longer-term domestic interest rates declined slightly, given the uncertainty around further OCR increases beyond the 50bp increase by the end of the year.
RBNZ Governor, Alan Bollard, left the official cash rate (OCR) steady this morning, as was unanimously expected by all economists surveyed by Bloomberg, but issued a concise, hawkish statement. In the previous June statement, the RBNZ foreshadowed a "gradual increase in the OCR over the next two years", with the OCR remaining on hold "for now". The dataflow since then has shown that "the economy has grown more strongly than was expected", which clearly has made the Governor nervous about keeping the cash rate at such lows for a prolonged period.
This morning's statement was unusually brief, which only serves to highlight the very clear message about current policy settings: the RBNZ cut the cash rate by 50bps in March as an "insurance" measure, to shore up confidence following the second devastating Canterbury earthquake. As with many central bank calls across the globe at the moment, the timing of policy moves is heavily conditional on a normalization in market sentiment, and ebbing of risks around the US and Euro area fiscal situation. But provided such risks "recede", and the domestic dataflow stays on its current trajectory, "the Bank sees little need for the March 2011 ‘insurance' cut to remain in place much longer".
The risks have been stacked toward earlier tightening than our March 2012 forecast for some time. That call was predicated on earlier commentary suggesting that the RBNZ would wait until the earthquake rebuilding process (which has yet to kick-off due to continued aftershocks) was producing clear economic dividends. Now, it appears the Bank is drawing a clear line between the cyclical component of accommodation which must be removed, and the prior "insurance" cut. The fact that the growth impulse from rebuilding to GDP, which in the June statement was estimated at 2%-pts, was not mentioned today, further underlines that the Governor's near-term focus is on recalibrating policy.
Insurance is costly, and your willingness to pay will change with your assessment of risks. With the prior statement noting that, in fact, the "negative confidence" effect from the earthquake "has been limited", we expect the RBNZ to remove the insurance cut in one fell swoop in September, hiking the OCR by 50bps. There is an argument for the RBNZ treading more lightly, perhaps moving with a 25bp hike initially, given that the recovery has been punctuated with disappointments over the last couple of years. But today's statement sends a fairly clear message that "the March 2011 ‘insurance' cut" - singular, i.e. the entire 50bps - should be removed.
Indeed, there are clear echoes in today's statement of RBA Governor Stevens' characterization of inappropriate "emergency" cash rate settings in Australia following the financial crisis settings in late 2009, where the emergency component was swiftly removed, with six rate hikes in seven meetings.
Thereafter, as today's statement notes, the cyclical fundamentals come back into play. The Bank will be guided by the dataflow, both domestically and offshore, and of course, the "very high value of the New Zealand dollar", which is "acting as a drag on the New Zealand economy". NZD has risen 15% since February (i.e. before the "insurance" cut), which is imposing a meaningful tightening of monetary conditions, particularly given that the economy is rebalancing with a greater weighting toward the traded sector. This reduces the required pace of tightening beyond the first 50bps.
Indeed, the statement today was also quite clear on this point, with elevated NZD "likely to reduce the need for further (i.e. beyond the insurance component, emphasis added) OCR increases in the short term". We expect the RBNZ to hike the cash rate by 25bps a quarter from 1Q12 to 3Q12, with the OCR ending 2012 at 3.75%.
The RBNZ announced this morning that the OCR would remain at 2.5%, an outcome that was widely expected. Of much greater importance was the accompanying statement, which was very brief. In our view the statement signalled clearly an intention to take back the 50bp "insurance" post-earthquake rate cut at the policy review that will accompany the publication of the September Monetary Policy Statement meeting provided that the domestic recovery remains on track (which we think is very likely) and that global financial risk recedes (an assumption that is far more contentious). Thereafter, the RBNZ appears to be signalling that policy will remain on hold for the remainder of the year due to the elevated level of the NZ Dollar. We now see a 50bp hike at the 11 September meeting as the most likely outcome but we caution that developments offshore could readily undermine the case between now and then.
The Reserve Bank kept the OCR on hold and issued a mixed outlook for future monetary policy.
The Reserve Bank's plan appears to be 50bp worth of hikes over the next couple of meetings, followed by a pause if the exchange rate remains high. However, the statement was highly conditional. If any of the global financial conditions, domestic economy, or exchange rate evolve in surprising ways, the plan will change.
Before today, our OCR call was for a December start date to the hikes. There is now a clear risk that the RBNZ will move earlier than that, and we are reviewing our call. However, we do regard market pricing for almost 50bp of hikes over the next two OCR meetings as excessively certain, given the uncertainty of the world. We remain concerned that the high exchange rate and slowing global growth could reduce the RBNZ's current enthusiasm for near-term hikes.
The final paragraph of the statement appeared to warn that the March 2011 50 basis point "insurance cut" may soon be reversed, providing risks around US and European sovereign debt issues recede. There was no clear indication of the timing of these hikes, nor whether the move would come as a single 50bp hike or in two 25bp increments.
By contrast, the final paragraph went on to note that if the exchange rate remained high, it is likely to reduce the need for further OCR increases in the short term. So there could be a pause after the first 50bp worth of hikes, if the exchange rate remains high (and one would naturally expect the exchange rate to remain high if the central bank had just hiked early).
None of this alters the long-term plan to hike the OCR gradually over the next two years.
The body of the statement was short and dovish. Better domestic data was contrasted against fragility in global financial markets, and downside risks to global growth. The second paragraph dismissed any near-term concern about inflation, noting that underlying inflation was below 2.5%.
Market implications and reaction
Markets were confused at first, but eventually interpreted the statement as hawkish and moved to fully price a September OCR hike, with a 50% chance of a 50bp hike. The NZD rose 20 points, and the two-year swap was up two basis points.
RBNZ kept rates steady today at their emergency low, of 2.50%, as was expected.
The Governor gave a strong indication that rates will need to rise soon, flagging that the
RBNZ sees ‘little need' for the ‘insurance' cut to remain in place much longer.
Much as we expected, global uncertainties seem to have kept the RBNZ sitting on their hands today: lifting rates at a time when global financial markets are dislocated is tricky.
As we have long argued, we think the March rate cut was a mistake and that cutting rates was the wrong response to a negative supply shock. Negative supply shocks typically drive inflation up, not down.
The RBNZ today acknowledged that the cut was an ‘insurance' policy, presumably against the possibility that the earthquake severely reduced demand, via weakened confidence. But, as we all know, insurance costs something. This cost may be that rates need to rise more and faster than otherwise to get inflation expectations under control.
Today's statement sought to condition inflation expectations by pointing out that underlying inflation was below 2.5%. But with headline inflation at 5.3% and rates at emergency lows, this effort may require action, rather than words. We still think that inflation and inflation expectations are uncomfortably high and that the risk is that the
RBNZ is already behind the curve.
Of course, the current strength of the exchange rate is doing some of the work for the RBNZ. The Governor acknowledged today that the high NZD is ‘acting as a drag' on the economy and that if this persists it may reduce the need to OCR moves in the ‘short term'.
The key caveat to all of this, of course, is that global financial markets do not see a significant meltdown, which we view as a very small risk. The RBNZ acknowledged this in today's statement, suggesting that removing the ‘insurance' cut would occur on the proviso that ‘current global financial risks recede'.