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Roger J Kerr on today's GDP surprise, the Fed's potential QE tapering, the OCR outlook, NZ$ outlook and why borrowers should fix their mortgages
Reserve Bank Governor Graeme Wheeler might increase the Official Cash Rate (OCR) within the next few months if the New Zealand dollar drops below US75 cents, according to Roger J Kerr.
Kerr, a partner at PwC specialising in treasury advice, told interest.co.nz in a Double Shot interview the most likely scenario, however, was for OCR increases to start sometime between March and May next year.
"The risk is, and this is the risk he (Wheeler) is prepared to take at the moment, housing market and inflation turn out to be higher than what they think. And when he does start to raise the OCR next year he has to raise it quicker and in bigger jumps than what many might expect," says Kerr.
Wheeler is currently "playing the game" of buying time, looking at using his new macro-prudential tools to constrain the growth of banks' housing loans.
"He knows if he raises rates now, or in the next couple of months, it's just going to push the Kiwi dollar back up because no one else in the world is raising rates so we'll stand out. The Kiwi dollar goes up and our export growth, competitiveness and profits and investments and jobs and everything else doesn't happen," Kerr says.
"As always they (the Reserve Bank) walk the tightrope, but I think he (Wheeler) is doing the right thing at the moment."
That said, Kerr suggests if the NZ dollar - at around US78.8c this afternoon - fell to US73c or US74c, that would give Wheeler room to raise the OCR from its record low of 2.5%, if housing market data remains strong.
"(If) all the data was still strong in three or four months time, yeah I could see that scenario," says Kerr.
'Fix your mortgage'
Meanwhile, he suggests any borrower who hadn't fixed their mortgage ought to.
"If you're not fixed already you should be."
That's because both risks - the OCR at the short-end of the rate curve, and 10-year US Treasury bonds at the long end, are going up, Kerr adds, with OCR hikes next year potentially being in 50 basis point jumps.
But for Wheeler, with the percentage of fixed-term home loans by value already back above 50% and rising, there's potential for OCR increases from next year to not have much short-term impact.
"The risk is like Alan Bollard found out in 2006-07, you could be raising the OCR really aggressively and it has no impact because everyone has fixed their mortgage and that might be the same situation again. So he (Wheeler) might be raising interest rates and not having too much impact on the housing market," says Kerr.
Bernanke taking foot off the accelerator
Meanwhile, with Federal Reserve Chairman Ben Bernanke suggesting the Fed might start tapering off its quantitative easing (QE) from later this year, Kerr says the US dollar is now firmly on the rise.
"In terms of the US economy, and their (the Fed's) reading of the US economy, what they're saying is the risks are less of it falling back down and he (Bernanke) has set out a whole range of conditions of when they might take their foot off the accelerator."
"I think what Bernanke made very clear, and the market has got to understand this, is they're not tightening policy now. Tightening monetary policy is putting your foot on the brake. All he's doing is taking his foot off the accelerator, as he said in the press conference, a little bit."
For the foot to come off the accelerator a bit US economic data needs to remain positive, with Kerr believing it will.
"At a household level in the US things are going really well now, - jobs, retail, housing," Kerr says.
"The US bond markets and the foreign exchange markets are always pricing the future in a long way in advance so what they're pricing today is what's going to happen in 2014 and 2015, particularly in foreign exchange markets."
The Fed's QE programme currently has it buying US$40 billion worth of mortgage-backed securities per month, and US$45 billion worth of longer-term Treasury securities a month. The Fed's benchmark interest rates, the federal funds rate, remains between 0% and 0.25% where it has been since December 2008. The Fed's current QE programme is its third one over the past few years, with these having seen the Fed's balance sheet rise to a record high of US$3.41 trillion.
US dollar on a strengthening path
"Our view on the NZ-US$ (cross) rate, because of generally a stronger US dollar in global foreign exchange markets, is we're going to spend some time in the US70c (range between US70c and US79c) now," says Kerr.
"The question is do we get to the low US70s or not? I'm not so sure about that but certainly in the high US70c (range) because of a stronger US dollar and what has happened in Australia. The Aussie (dollar) was way over valued and it needed a major correction and it's now having that."
"Eighty percent of the time the Kiwi-US rate follows the Aussie so the most important thing when you're talking about NZ-US rates is probably what's going on in Australia. Secondly is what's happening to the US dollar globally, and certainly our view is the US dollar is now on a strengthening path against all currencies having weakened from 2003 to 2011," Kerr adds.
"It's a big sea change in global currency markets. The US dollar generally is strengthening. That should hold the Kiwi-US rate below US80c but the other cross rates up. And the other cross rates up because the New Zealand dollar's probably going to outperform other currencies against the US. Why would we outperform? Because eventually our interest rates are going up and our economy's doing pretty well despite today's GDP figure."
Kerr acknowledged surprise at today's Gross Domestic Product data, which showed growth of just 0.3% in the first quarter.
"We thought agricultural production would've been up with the drought and the live stock going to the works early. They (Statistics NZ) clearly count the numbers a bit different to what we thought. We thought there could've been a number above 1% actually, on top of the 1.5% we had in the December quarter, largely based on the ANZ regional growth survey," Kerr says.
Nonetheless, he still has an upbeat outlook for GDP.
"Three percent per annum is what the New Zealand economy did last year and we think that's what it'll do this year and next year," says Kerr.
"All the domestic economic numbers have been strong in recent months (and) the dollar coming back is good for the export sector. If it stays in the US70c range they (exporters) are competitive and can make money, make profits at those levels. It's hard to find any negatives, even the Government's finances are coming back into order so it's all pretty good."