Wednesday, July 16, 2014

RBNZ: more cause for a pause

Today’s June quarter CPI came in a tad softer than expected at +0.3% q/q.  Average market expectations were for a quarterly increase of +0.4%.  The annual rate came in at +1.6%.

As expected the Housing and household utilities and Food groups provided much of the upward contribution over the quarter rising 1.2% and 0.9% respectively.  That said the increase in the former was a tad lower than we were expecting and was in fact driven mostly by an increase in electricity prices.  Indeed non-tradable (i.e. domestic) inflation came in at just 0.4% while the Reserve Bank was expecting +0.7% so this result isn’t going to spook the RBNZ.

And this data came in on the same day we saw another large fall in dairy prices in the global dairy trade auction.  Prices came off another 8.9% overnight, with the cumulative decrease since the start of the year now indicative of a dairy payout of around $6.00- 6.50 per kilo and a reduction in dairy farmer incomes of around $4 billion compared with last season.  While that’s consistent with our expectation that GDP growth has probably peaked, the dairy price decline is larger than we had expected to see.

What does this mean for the RBNZ?  The expectation has been they will tighten at the OCR review next week and then pause for a while.  We still think that’s the case.  The reality is we still expect growth to be running ahead of potential which will necessitate interest rates back towards neutral at some point so we think the Bank would prefer to get another one done before pausing.

That said the cause for a pause in the tightening cycle just increased.  We have said all along that it was particularly the trajectory of the exchange rate that would determine both the phasing and the ultimate peak in the tightening cycle.  That’s still the case.  The reality is the combination of dairy prices falling more than expected, continued strength in the exchange rate and continued interest rate increases just don’t add up.

So expect another 25bp hike next week and then a pause.  The only question now seems to be the length of the pause…