Thursday, December 11, 2014

RBNZ December Monetary Policy Statement

There was the proverbial “no surprises” from the Reserve Bank of New Zealand (RBNZ) this morning.  They left the Official Cash Rate (OCR) unchanged at 3.5%, pushed out the next rate hike to the back end of next year, reduced the total quantum of tightening and acknowledged both upside and downside risks.

The key point is that despite recent low inflation outcomes it is the RBNZ’s judgment that continued strong growth and the recent decline in the exchange rate will likely see inflation move higher next year and that in order to keep inflation and inflation expectations contained near the 2 percent target midpoint “some further modest tightening is likely to be required”.  I concur.

The RBNZ is expecting continued robust 3.0%-plus growth in the period ahead.  Near term forecasts are broadly the same as ours but we have growth coming off a bit faster in the back end of the projection period.

The Bank also see’s potential growth holding up better than I do.  It’s certainly the case that potential growth is strong right now at around the 3.0% level for all the reasons I’ve written about before.  The RBNZ sees this level being sustained through the projection period.  I’m not convinced.

But the key questions for today are when will the RBNZ start hiking rates again and how high will they have to go?  This tightening cycle was always going to carry more than the usual degree of uncertainties.  Key questions for the post-Global Financial Crisis environment  were, and to a large extent still are, where the neutral cash rate is, the level of potential growth and how households would responding to higher interest rates and new Loan to Value Ratio (LVR) restrictions.

In the Monetary Policy Statement today the RBNZ flagged three important considerations in determining how quickly and how far rates would need to rise: how actual pricing decisions interact with measures of capacity pressure and inflation expectations; how house price inflation develops in the face of still-low interest rates, strong net migration, restrictions on high loan to value ratio mortgage lending, and supply shortages; and how reduced dairy farm incomes affect spending.

The upside risk from housing and the downside risk to rural incomes and spending was reinforced this week with strong REINZ housing data out this weeks and the downward revision to the Fonterra payout.  And of course oil prices are lower since the RBNZ finalised their forecasts.

The RBNZs interest rate projections show interest rate increases beginning again from December next year.  The projected track has the 90-day bank bill rate rising gradually over the projection period to 4.5% at the end of 2017, a level that’s 30 bps lower than their September projections.  And of course with both upside and downside risks to the outlook, the RBNZ states that further policy adjustments will depend on data emerging over the assessment period.

For our take on the outlook for the New Zealand economy and monetary policy, have a look at our December edition of New Zealand Insights which you can find here.