Thursday, January 30, 2014

No surpises from the RBNZ or the Fed

The Reserve Bank of New Zealand (RBNZ) left interest rates unchanged today, but signalled the tightening cycle will begin soon.

There was no knee-jerk reaction today to recent higher-than-expected growth and inflation data.  The press release was a continuation of their recent measured and calm communications strategy.  The Bank acknowledged the “economic expansion has considerable momentum”, indeed we expect the Bank will raise its growth forecasts at the March Monetary Policy Statement.

They also acknowledged the improving global growth environment, but also the uncertain impact on emerging markets of the timing of the withdrawal of the exceptional monetary accommodation that has been required in the major economies.  (More on emerging markets tomorrow.)

The high exchange rate gets a mention again but this is limited to its dampening effect on inflation in the traded goods sector and a reiteration of their view (which is consistent with ours) that the level of the NZD is unsustainable in the long run.  However, they don’t mention the strength of the NZD as a headwind to growth.  That perhaps signals the Bank is now more accepting of the point that the exchange rate is strong for a reason – the strength of commodity prices and the terms of trade.

The key paragraph in the release is as follows:
While headline inflation has been moderate, inflationary pressures are expected to increase over the next two years.  In this environment, there is a need to return interest rates to more-normal levels.  The Bank expects to start this adjustment soon.

That’s entirely appropriate. The case for a tightening is compelling indeed we think it’s been compelling for a while.  Growth is strengthening and inflation is rising yet the Official Cash Rate (OCR) remains at the historical low of 2.5%, some two percentage points below (new) estimates of the neutral rate.  If I were the Bank right now I’d prefer to be a lot closer to neutral!

The first hike will more than likely come in March when we expect the RBNZ to raise the Official Cash Rate 50bps from 2.5% to 3.0%.   We expect successive 25bp hikes at each Monetary Policy Statement after that for a total of 125bps of tightening in 2014 and an OCR of 3.75% by year end.  Further tightening next year will see the OCR at the (presumed) neutral rate of 4.5% by mid-2015.

That is, however, mostly a working assumption (albeit a thoughtful one!).  A number of factors will come into play that will determine the pace and quantum of tightening over this interest rate cycle.  At this point we are only estimating that neutral is 4.5%, let alone whether that will prove to be enough to keep inflation in check.

While we think the Bank has been at risk of over-playing concerns about the exchange rate, how the NZD tracks in the period ahead will still be a determining factor in the interest rate cycle.  So too will decisions by firms about the balance of hiring and investment they undertake to resource increased demand for their goods and services.  And while it looks like LVR speed limits are having an impact on activity in the residential property market, the same cannot yet be said about house prices.  (More on all those things soon too.)

As was widely expected in the US the Federal Open Market Committee announced a further trimming of its asset purchases today.  They announced a further reduction of US$10 billion per month (split between Treasuries and MBS) following the reduction of the same magnitude in December.   Monthly purchases will now be US$65 billion per month from the start of February.

There was little to get excited about in the Statement, although changes from last month were generally biased to the positive.  Rather than growth being “moderate” they said it has “picked up in recent quarters”.  On fiscal policy they stated the degree of restraint on growth “is”, rather than “may be” diminishing.  On the negative side there was a nod to December’s wayward payrolls report.

The FOMC is at pains to stress reductions in its asset purchase program are not on a pre-determined (although I'm sensing a pattern already!).   So long as conditions with respect to growth, the labour market and inflation continue broadly in line with expectations, we expect the FOMC to continue to reduce the program for asset purchases to be finished before the end of the year.