Our Head of Investment Strategy, Jason Wong, drew the short straw this morning and consequently spent a fruitful morning at the RBNZ lock-up for the June Monetary Policy Statement. These are his comments on the Statement:
The RBNZ left the official cash rate at 2.5% as widely expected. Those who just read the press release could be forgiven for thinking it was a pretty uneventful statement, with the policy message of “the pace and timing of increases will be guided by the speed of recovery, but for now the OCR remains on hold”. However, those who read the whole statement got a much clearer picture of the likely tightening in monetary policy over coming quarters.
The Bank’s 90 day bank bill track showed rates rising from 2.6% currently to 3.0% by December , then onto 4.6% by December 2012, and even higher towards 4.9% by the end of the period. This is more aggressive than previously projected. Just to spell it out, the Bank basically thinks it’ll have to raise the OCR by circa 200bps by the end of next year. This is about double what the market had priced in before the Statement.
The Bank thinks that the outlook for the NZ economy has improved since the March Statement, hence the higher projected interest rate track. In addition, the NZ dollar has been stronger than expected, and with only a mild depreciation factored in from this higher level, the currency will be doing more work in reducing growth and inflation pressures compared to previously expected.
The bottom line is that the projections outline a pretty firm track for monetary policy in the period ahead – in excess of that previously projected by the Bank and firmer than the market has priced in. While some might be surprised by this stance our projections have, for some time, factored in a significant tightening, with the OCR at 4.5% by the end of September 2012. We believed that the emergency rate cut back in March was unnecessary and that inflation pressures were already building in the economy to warrant a tighter policy stance.
It is somewhat interesting that the Bank isn’t tightening policy already. It highlights in the Statement that its estimate of core CPI inflation has been above 2% over the last two quarters and that underlying inflation is expected to rise as GDP growth picks up. Isn’t the Bank meant to be aiming for 2% inflation, the mid point of the target range, not the top of the range? When asked why the Bank wasn’t tightening now, the answer was that it wanted to see further evidence that a sustainable recovery was underway and commented that it tightened prematurely back in the middle of last year.
In our view the RBNZ might already be “behind the curve” and waiting another six months raises the risk of the Bank struggling to reduce inflation down further down the track. Recall that 2-year inflation expectations recently reached its highest level since the low inflation era began. The Bank is assuming that the recent increase in inflation expectations is temporary. We hope the Bank is right otherwise NZ could be in for another monetary policy cycle where rates need to go a lot higher compared to taking a more pre-emptive policy stance.
The possibility of the Bank raising interest rates more than the market currently projects suggests upside risk to NZ bond yields and further upward pressure on the NZ dollar over the balance of this year. For a weaker NZ dollar to ensue we really need to rely on global factors, such as weaker global growth momentum continuing and weaker commodity prices.