BNZ economists see potential for one-off 50 basis points hike to OCR, as it's pushed up 1.25% by year's end

By Kymberly Martin

Yesterday the RBNZ left rates unchanged as expected. NZ swap and bond yields closed down 3-7bps across the board. Overnight US 10-year yields rose to 2.72%.

The RBNZ left rates unchanged this week as we expected. However, in our view, the Bank gave the clearest possible indications that it anticipates raising rates in March. It said “there is a need to return interest rates to more-normal levels. The Bank expects to start this adjustment soon”. In our view “soon” is as close as it gets to code for “the next meeting”.

In addition, the reference to “more normal” levels is a reminder that the OCR is currently at an abnormally low level.

The RBNZ’s own analysis shows the neutral cash rate as being around 4.25%. We would concur with this view.

Questions around the OCR will likely now move to whether the Bank will ultimately move back to neutral or have to overshoot to the high-side, as is historic precedent.

While our official forecasts see a 4.5% peak in the OCR in late 2015, we see upside risk to this view. A peak above 5.0% is certainly plausible.

Market pricing is now closely aligned to our view of a 25bps hike in March and 125bps by year-end. However, we are increasingly mindful that at some point this year the RBNZ may feel compelled to undertake a 50bps move. We will be alert to the potential to trade such an opportunity, though at this point we do not think it will occur at the March meeting.

NZ 2 and 5-year swap closed down 6bps at 3.78% and 4.48% respectively. The market responded in the first instance to the ‘no hike’ decision, as opposed to the fairly hawkish message of the statement. In our view, hedging value is beginning to reappear at these swap levels.

NZ 10-year bond yields closed down 7bps at 4.52%, now within a whisker of the bottom of the 4.50-5.10% range we had highlighted for the year ahead. However we would not yet be aggressive sellers as NZGB supply is constrained until the next nominal bond tender on 27 February. In addition, we think spreads to US and AU equivalents could still compress further (from 185bps and 65bps respectively).

Overnight, US 10-year bond yields pushed a little higher, to 2.72%, after US Q4 GDP came in line with expectation at 3.2%q/q ann.

Today, the domestic focus will be on the scheduled speech by RBNZ Governor Wheeler at the Canterbury Employers Chamber of Commerce. We expect he many have opportunity to elaborate on yesterday’s rate decision during Q&A.