Thursday, October 29, 2015

RBNZ leaves options open and FOMC keeps December "live"

After three successive cuts in the Official Cash Rate since June, the Reserve Bank of New Zealand (RBNZ) left interest rates unchanged today.  However they signaled “some further reduction on the OCR seems likely”, though this will depend on the emerging flow of economic data.

The Banks reading of economic developments is much the same as ours: global growth is below average with concerns about future prospects centered on China and East Asia.  At the same time global inflation remains low.  Dairy price weakness continues to weigh on domestic farm incomes and it remains to be seen how sustainable the more recent increase in prices will prove to be.  House price inflation remains a financial stability risk and while residential building is accelerating, it will take some time to correct the supply shortfall.

On a brighter note the Bank notes the recent robust growth in the services sector and construction driven by strong net migration, tourism and low interest rates.

The Bank expects inflation to return to “well within” the 1-3% target band by early 2016.  We concur.  That’s in response to the weaker exchange rate and as the earlier impact of lower petrol prices fall out of the annual calculation.  However they also note the more recent appreciation in the exchange rate which, if sustained, would require a lower interest rates path than would otherwise be the case.

I still think there’s another 25bp cut in the OCR on the cards and that this will be delivered at the December Monetary Policy Statement.  That’s based on an expectation the recent strength in exchange rate will prove to be more sustained than desirable.  But if we take anything from today's Statement its that a December cut is not a done deal.

Earlier this morning the US Federal Reserve left interest rates unchanged and, if anything, surprised markets by keeping “live” the prospect of an interest rate hike in December.

As you know we’ve been reluctant to completely dismiss the chances of a rate hike this year – though acknowledged this would require some stronger labour market data, better news on global growth (particularly China) and less general angst in financial markets.

Indeed today’s Statement appeared less concerned about global developments with the Committee removing the reference in the September Statement that those developments could restrain retrain economic activity somewhat and put further downward pressure on inflation in the near term.

So December “lift-off” is still on the table, though as with the RBNZ, their next move will depend on the data before the meeting in mid- December.  Markets are now pricing in a slightly less than 50% chance of a rate hike at that meeting which is probably about right.  But some stronger domestic data suggesting the likely low print for Q3 GDP (our forecast 1.2% saar) is just a blip will see that probability move to over 50%.