Thursday, June 12, 2014

RBNZ hikes a third time - more to come

The Reserve Bank of New Zealand (RBNZ) raised the Official Cash Rate 0.25% to 3.25% today, the third consecutive hike.  Most of the interest prior to this statement was the extent to which the RBNZ would lower its projected interest rate track in light of recent falls in dairy prices and the continued higher-than-desirable level of the currency.  In the end the interest rate track was largely unchanged – which is in our view the correct course of action.

That means today’s Monetary Policy Statement (MPS) was more hawkish than market expectations.  Market reaction therefore has been to take interest rates and the New Zealand dollar higher.

The reality is there have been both positive and negative developments in the economy since the March MPS.  Dairy prices are lower, the New Zealand dollar has been a touch lower but remains unsustainably high, recent housing market data has been softer-than-expected (which we put down to the way Easter and Anzac day fell this year), fixed mortgage rates have declined, and net inward migration has continued to rise.  On balance that still leads to a picture of an economy that is still growing considerably faster than potential and in which spare capacity is being absorbed.  That means “Inflationary pressures are expected to increase”.

The RBNZ’s real economy forecasts are broadly similar to our own.  That means they have revised up their growth forecast for the year to March 2014 (reflecting a higher March quarter forecast of 1.1% q/q), but lowered their year to March 2015 forecast.   Inflation is expected to gradually head higher towards 2%.

The RBNZ appears to be forecasting another two rate hikes this year, in line with our forecast of 25bp hikes in both September and December.  At this point, especially given the tone of today’s MPS, I won’t completely dismiss the possibility of a further hike in July (or possibly instead of the September hike).  But at the moment we are happy with our forecast of an OCR of 3.75% by the end of this year and an eventual peak of 5.25%.

The only interesting change of wording in the Statement was the sentence “The speed and extent to which the OCR will need to rise will depend on future economic and financial data, and its implications for inflationary pressures.”  Rather than “financial data” the RBNZ had previously referred to the exchange rate.  That does not signal any diminution of the importance of the exchange rate going forward.  That, and whole range of other known unknowns, and no doubt along with a few unknown unknowns, will ultimately determine the phasing and extent of the hiking cycle.

What that wording does signal is a new concern for the RBNZ: the recent decline in fixed mortgage rates which risks (re)stoking the housing market.   That reflects the current and likely ongoing challenge for the RBNZ in desiring higher interest rates and lower exchange rate.