There were no real surprises from either central bank today. It is simply a question of when: for the Fed when to start tapering its asset purchase program and for the RBNZ when to start raising interest rates. Both probably erred on the side of being slightly less dovish than the average market expectation.
After deciding not to taper in September,
October was always going to be too soon to see the required improvement in
economic growth and the labour market the FOMC wants to see. That made December the next most likely date
for an announcement on the tapering of their asset purchase program. With the disruption from the recent partial
government shutdown and the debt ceiling debate, expectation had started to shift
to a March start date. Today the Fed was
less explicit in signalling a delay than the “doves” were expecting. That said, the minutes of the meeting will be a fascinating read in a couple of weeks time.
The bottom line is this: tapering of the
Fed’s asset purchased program is coming, it’s just a question of when. And the answer to that question will be
dependent on the data flow over the next few months. We agree with the statement that “taking into
account the extent of federal fiscal retrenchment over the past year, the
Committee sees the improvement in economic activity and labour market
conditions since it began its asset purchase program as consistent with growing
underlying strength in the broader economy.”
The FOMC is still looking for more evidence that underlying progress
will be sustained.
Given likely data disruptions over the next
few months (see the note on consumer confidence below) it seems to us to be
unlikely the FOMC will have sufficient evidence of the sustainability of the
pickup in growth before the end of the year.
That means a March 2014 start to tapering, with the program ending towards
the end of 2014, is now the most likely scenario.
The delay to Fed tapering and the
implications for the New Zealand dollar is one of the changes the RBNZ had to
incorporate onto their OCR Review comments today. The other is of course the fact that growth
is looking a tad higher (at least in the short-term) than their forecasts
released in the September Monetary Policy Statement. The Bank today referred to September year
growth as estimated to be “more than 3%” which suggests a September quarter
growth estimate closer to our 1.1% than the 0.8% they forecast in September.
The bigger question for today was how the
Bank was going to deal with the recently stronger New Zealand dollar. The Bank acknowledged that development by
commenting that “(s)ustained strength in the exchange rate that leads to lower
inflationary pressure would provide the Bank with greater flexibility as to the
timing and magnitude of future increases in the OCR.”
Despite the important qualification
(“that leads to lower inflationary pressure”), that comment means there are risks
to my view that the Bank starts to tighten in March next year. Indeed it appears other economists are
already shifting their rate hike expectations out to April or June. As regular readers would no doubt expect, I’m
not shifting yet.
Signals are pointing to sharply higher
growth in the period ahead. Likely growth
of 3.5% by the middle of next year is well ahead of potential and the output
gap is as good as closed. That means capacity
constraints and upward pressure on prices while the OCR remains at record
lows. The real risk is that in waiting
for the exchange rate to behave the Bank gets behind the curve on domestic
inflationary pressures and we create a bigger problem down the track.