Monday, December 7, 2015

RBNZ: To cut or not to cut

The RBNZ releases its December Monetary Policy Statement (MPS) this Thursday with the big question being whether there is another interest rate cut in the bag.  Our view is that having signalled another cut at the last MPS, there is no compelling reason not to deliver.

Sure some of the growth indicators are looking better.  In particular both business and consumer confidence appear to be on the mend after a mid-year slump on over-inflated concern and hyperbole around the imminent demise of the Chinese economy.  At the same time dairy prices have waxed and waned but appear to be trying to form a base at a level that suggest the RBNZ will be able to revise up its forecast for the terms of trade.  And net migration inflows continue to hit new record highs.

But it’s the labour market that I think should still see the RBNZ deliver on an interest rate cut this week.  Our views on monetary policy have evolved with the labour market.  As I’ve said many time before the big surprise for me this cycle has been the extent to which increased labour supply via net migration and a high participation rate have conspired to keep wage increases and therefore domestic inflationary pressures in check.   Non-tradeables inflation was 1.5% in the year to September, a 14-year low.  At the same time unit labour costs (as measured by the private sector Labour Cost Index) are again ticking lower. 

Headline inflation will rise over the next few quarters as big declines in fuel prices drop out of the annual calculation and as (at least some of) the recent decline in the exchange rate feeds through into retail prices.  But importantly, while some of the growth indicators are looking better, we still expect the unemployment rate to rise over the next few quarters.  Outside some notable sectors (e.g. construction in Auckland) we expect this to keep wages and underlying inflationary pressures in check. 

So in short – we see no compelling reason for the RBNZ to back away from or even delay its already flagged interest rate cut this week.