Sunday, September 11, 2011

RBNZ on hold...for now.

It was only a matter of a few weeks ago that a 0.5% hike in the Official Cash Rate (OCR) at the September Monetary Policy Statement (MPS) looked like a done deal. Following the July OCR review it became universally expected the RBNZ would remove the March 2011 “insurance” interest rate cut in this week’s MPS.

The key phrase in the July statement was: “Provided current global financial risks recede and the economy continues to recover, the Bank sees little need for the March 2011 “insurance” cut to remain in place much longer.”

This sentence highlights the challenge for the Bank. Global financial risks have not receded; in fact they have increased since July. There are renewed concerns about the growth outlook in the United States and Europe and the risk of a return to recession in these key economies has increased in recent weeks. Financial risk is also elevated given increased fears of sovereign default.

At the same time, however, the New Zealand economy is continuing to recover and appears to be gathering momentum. At the same time the inflation risks are increasing. Most worrying of all is the rise in inflation expectations which will be a problem if they become entrenched.

Given the international backdrop, and the risks that entails for the New Zealand economy, it is prudent for the Bank to stay on hold on September 15th. But we don’t think they will stay on hold for long. The New Zealand economy appears to be withstanding recent global jitters well with business confidence at healthy levels. Of course that would change should the US and Europe return to recession, but that is not our expectation.

We have shifted the first interest rate increase back to December (where it was prior to the July OCR review). We still expect a first move of 0.5%. Some will still see that as too early, but if the Bank is to be sufficiently pre-emptive, then it probably should feel early!

From there we continue to expect a relatively aggressive tightening cycle that will take the OCR to 4.5% by late 2012. All that’s really changed for us is the start of the tightening. When the time is right, there is still a lot of work for the Bank to do.