Friday, June 14, 2013

RBNZ June MPS - a well-executed communications strategy

There must be the odd occasion where the RBNZ wishes it wasn’t obligated to produce a quarterly Monetary Policy Statement (MPS).  With things going exactly the way the RB wants them, at least with respect to the trade weighted exchange rate, yesterday’s MPS became an exercise of producing 38-pages of commentary and forecasts without giving any opportunity for anybody to interpret anything in the document as being in any way remotely close to hawkish.  They did a great job.

The outlook for the economy is broadly in line with our own.  In particular they are forecasting a modest pick-up in growth despite the headwinds of the recent drought, the firm exchange rate and fiscal consolidation.  They see GDP growth peaking at around 3.5% next year, only modestly ahead of our 3.3%.  That level of growth relative to potential GDP generates eventual upward pressure on prices and a gradual move in inflation back to the mid-point of the target band. All sound and reasonable stuff.

The only question for me was how they were going to deal with the recent decline in the exchange rate.  In the end they took the prudent approach of largely ignoring it, although admittedly much of the decline in the TWI came after the Bank would have finalised their projections and much of the commentary in the document.

Such an approach is prudent for two reasons.  Firstly, and most simplistically, a lower exchange rate means higher inflation (all else being equal) and a higher interest rate track.  Such a track in yesterday’s MPS would have been received as hawkish.

Secondly, the recent decline in the NZD versus the USD is to do with a stronger USD in anticipation of the US Federal Reserve starting to reduce the pace of its asset purchase program.  We expect the FOMC at its meeting next week to comment that the market has got too far ahead of itself in that expectation.  In that respect we don’t view the recent decline in the TWI as the beginnings of a trend decline over time.  That means that at this point there is just as much chance of Kiwi heading higher again as there is of it moving lower.  It remains the case that we only expect the trend decline to begin once the Fed starts tapering, and we don’t think that is imminent.

I’ve recently characterised the Bank’s current challenge as being between a rock (the exchange rate) and a hard place (the housing market).  With respect to the housing market the Bank acknowledges the ongoing strength.  The central projections do not assume any introduction of macro-prudential tools, which the Governor commented in the post-MPS media briefing could be deployed as early as next month.  However I continue to believe the risk is that the Bank believes the deployment of such tools will do more to cool the housing market than they actually will.  While the strong housing market is predominantly a risk to financial stability, we believe higher interest rates are part of managing that risk.

The upshot is I don’t buy the RBNZ’s view that interest rates will remain unchanged until the middle of next year.  I’m happy to remain at the hawkish end of spectrum in assuming that while there is a chance of the Fed reducing the pace of its asset purchase program this year, there is the chance of a more sustainable move lower in the NZD which would open the window of opportunity for a 25bp rate hike this side of Christmas.  However, I freely acknowledge there is a reasonable chance that I join the forecasting throng and move that first hike into early next year.