Thursday, December 6, 2012

RBNZ retains tightening bias

The Reserve Bank of New Zealand (RBNZ) left interest rates on hold at the December Monetary Policy Statement (MPS) today and retained its bias to tighten.  I think that’s entirely appropriate. 
The key question for this MPS was the extent to which the Bank would see recent soft economic data (particularly September quarter HLFS, retail spending and inflation) as a sign of general or likely-to-be-sustained weakness in activity and inflation.  The answer is not at all, other than to alter the starting point.  While the Bank has lowered its GDP growth forecast for the second half of the year to +0.6% from +1.1% previously, they have not changed their view of annual GDP growth rising to between 2.5% and 3.0% over the next two years.  They see this leading to a gradual elimination of spare capacity in the economy and an increase in the inflation rate towards the 2% target mid-point over time.  That is consistent with our own view.
Balancing the recent weakness in some domestic data, the Bank sees the global economic outlook as “less threatening” but still “soft”.  In particular the risk of a significant deterioration in euro zone has diminished and they recognise the recent improvement in the data out of China.  With respect to America they acknowledge the growth-constraining impact of the fiscal uncertainty, but also the recent improvement in the housing market.
The only concession to recent calls for interest rate cuts was the acknowledgment that retail interest rates have fallen recently so that monetary conditions have effectively eased recently without the Bank needing to reduce the OCR.  This has enabled them to come up with a set of projections that builds in the recent data weakness, sees inflation returning to the mid-point of the target band and leaves the projected interest rate track largely unchanged from that in the September MPS.
I’m in broad agreement with most of the Bank’s forecasts, although I think they will prove to be a bit light on their current account deficit projections.  The Bank sees the current account deficit at -5.5% of GDP by March 2015.  My own forecasts are closer to 7%.  Importantly, the Bank also expects the NZD to remain strong over the foreseeable future. Yep. 
The Bank continues to flag the first interest rate increase for the end of 2013/beginning of 2014.  I recently shifted my expected tightening out from June 2013 to the somewhat less definitive “second half of 2013”.  I’m still happy to be expecting an earlier tightening than the Bank largely due to the fact that I think inflationary pressures will emerge somewhat earlier in the cycle, especially in the labour market.