Thursday, June 14, 2012

No surprises from the RBNZ

As expected the Reserve Bank of New Zealand (RBNZ) left the Official Cash Rate (OCR) unchanged at 2.5% this morning.  The outlook, however, very much hinges on how Europe plays out from here.  The Bank is clearly ready to act aggressively if things go from bad to worse in Europe, but based on the central scenario of a continued muddling through the New Zealand economy will continue to grind slowly upwards.  That has the RBNZ continuing to project less stimulatory monetary condition from mid-next year.

The Bank lowered their growth forecasts to be more in line now with market consensus.  They are forecasting GDP growth of 1.9% in the year to March 2013, followed by 3.0% and 1.6% in the subsequent two years.  Our forecasts are 2.0%, 2.8% and 2.0% respectively. 

The RBNZ has also lowered its estimate of potential GDP.    The change in potential growth explains how the bank is able to construct an outlook that has both lower growth and higher inflation.  All else being equal, one would assume lower growth would lead to lower inflation.   The higher inflation track is also due to future planned tobacco excise increases.

The Bank believes potential GDP is 1.2% in the current year and that it will rise only gradually to 1.4% and 1.8% over the following two years.  That compares with estimates of 1.5%, 2.1% and 2.3% in the March Monetary Policy Statement.  We have consistently argued that New Zealand potential growth is now significantly lower than it was pre-GFC and that estimates of current spare capacity would likely prove to be over-inflated.  The upshot is that inflationary pressure is likely to emerge earlier in the cycle than it has historically.

That means, absent any more or less knowledge than we have on the outlook for Europe, the Bank is right to continue to flag a bias to tighten.  Their initial tightening has been shifted out to June 2013.  That’s in line with our expectation on the back of our revised GDP forecasts discussed in the post below: Lower NZ near-term growth, OCR hikes pushed out.
While retaining a bias to tighten, the RBNZ has lowered the trajectory of the projected increases over successive Statements.  We continue to believe the tightening cycle will be more aggressive than the Bank is projecting, although not as aggressive as previous New Zealand interest rate cycles, partly because fiscal policy will also be contractionary.  We continue to expect an OCR peak of around 4.5% in the second half of 2014, again assuming Europe muddles through.