By Alex Tarrant
Reserve Bank Governor Alan Bollard is set to leave the Official Cash Rate on hold at 2.5% next Thursday, according to New Zealand's bank economists, while financial markets are pricing in a 25% chance of a 25 basis point cut.
The two groups have been at odds with one another for months as to the next move in the OCR. Bank economists are all expecting the next move will be up, in March 2013, while markets have priced in cuts within a year of around 40 basis points.
Bollard's comment about possibly reassessing where rates were headed when he last reviewed the OCR on April 26 kicked up talk of the Reserve Bank positioning itself to cut the OCR in the face of a stubbornly high New Zealand dollar while export commodity prices were falling, and a deteriorating global economic outlook.
At the time, Bollard said that, should the exchange rate remain strong, without “anything else” changing, the Bank would need to “reassess the outlook for monetary policy settings.”
The 'monetary policy setting' the Bank referred to was its 90-day bank bill interest rate track. The 90-day rate effectively tracks the Official Cash Rate, and generally sits 25-30 basis points above where the OCR is expected to be during the forecast period.
The Bank's latest set of forecasts in its March 2012 Monetary Policy Statement showed minor rate rises priced in, with the OCR set to rise to 3.25% by the March 2015 quarter.
Since those comments in April, the New Zealand dollar has fallen as much as 5.7% on a trade-weighted basis and the TWI currently sits 3.4% below its April 26 level, at 70.0. In early May, Bollard said the falling currency since his April comments was in line with fundamentals.
In mid-May, markets were pricing in an 85% chance of a 25 basis point cut on June 14, which has since retreated to about a 25% chance.
So all eyes will again be on the Reserve Bank's forecast 90-day bank bill track in Thursday's quarterly Monetary Policy Statement accompanying the OCR review to see where the central bank expects monetary policy settings to go over the next three years.
What the economists are saying
Westpac chief economist Dominick Stephens said on June 6 that Bollard would not cut the OCR on Thursday for two reasons. One was monetary conditions had already eased over the last six weeks, while the second was the uncertain economic environment meant maintaining flexibility to cut was paramount.
"Sharp declines in swap rates and the exchange rate over recent weeks have done much of the work for the Reserve Bank, and will cushion the economy. Falling (wholesale) swap (interest) rates have translated into lower fixed mortgage rates," Stephens said.
Any market reaction to an on-hold decision on June 14, which could see interest rates and the exchange rate rise slightly due to some expectations for a cut, would pale in comparison to the gyrations that could occur after Greece’s elections on June 17.
"The wild uncertainly of the international situation – and the fact that at least one defining event will occur shortly after next week’s Monetary Policy Statement – incentivises the Reserve Bank to adopt a wait-and-see approach. The Greek election might set off a chain of events that leads to a GFC-style banking crisis in Europe," Stephens said.
"Failure to recapitalise Spain’s third-largest bank might do the same. But the most likely scenario is that Europe engineers another muddle-through rescue plan which calms markets for a while at least," he said.
The Bank might also decide to emphasise that it was willing and able to cut the OCR in response to a deepening crisis.
"The final paragraph might include a phrase along the following lines: Should global financial and economic conditions deteriorate further, the Bank has latitude to reduce the OCR. For now, it is appropriate to keep the OCR at 2.5 percent."
Stephens said Westpac expected the Reserve Bank's 90-day track forecasts to predict no rate changes for the next year or so. For 2014, the Reserve Bank may forecast gently rising interest rates, if only to remind markets that the OCR is currently below its long-run sustainable level, they said.
Risk of borrowers moving to fixed rates
BNZ economists also noted the falling dollar and interest rates were easing monetary conditions. They said it would be unwise for the Reserve Bank to cut on June 14.
"Some would argue that an insurance easing to protect against the ravages of Europe might be warranted but we would argue that the current behaviour of the NZD suggests that the currency itself is the insurance. Every time European risk rises the NZD falls. We have no reason to believe that it will be any different going forward," BNZ's head of research Stephen Toplis wrote on June 7.
This has the dual impact of helping the New Zealand economy rebalance by supporting exporters to the detriment of domestic demand, which was exactly what is required. Cutting interest rates would have the opposite effect in discouraging household saving and encouraging consumption.
"The Reserve Bank also has to be cognisant of the shape of the yield curve for borrowers. With global bond yields pushing down through record lows and banks competing relatively aggressively in the fixed mortgage space, we are threatening to create an environment where there is a significant shift from floating to fixed mortgages," Toplis said.
"If that occurs then the leverage the Reserve Bank has from the cash rate will be reduced. This could prove problematic in the event that the housing market does pick up in the manner we expect," he said.
"Putting all this together, we believe the New Zealand economy is set for a period of modest growth. Modest is the key word here. The growth path is certainly singularly unspectacular. We are forecasting the economy to expand just 1.9% this year, rising to 2.8% next and then 1.3% the year after.
"This is not a strong argument for interest rate increases and we concede that the first rate hike may be delayed relative to our March 2013 forecast. We also concede that the current peak we have in the cash rate of 4.25% may be too lofty. However, we remain very concerned that New Zealand's current potential growth rate is probably very low," Toplis said.
Any cuts to be emergency cuts
On June 5, ANZ economists said if the Australian Reserve Bank decided that day to cut its rate by 50 basis points (it ended up cutting by 25 bps) then that might put more of a focus on New Zealand interest rate markets.
The catalyst for a cut in New Zealand was now the global scene rather than the level of the New Zealand dollar, they said.
"Strictly speaking, we don’t think the RBNZ is in the rate cutting space – the currency and lower mortgage interest rates are doing the work for them. Moreover, there is a rebuild effort eventually around the corner, which ironically might hit the economy at an extremely fortuitous time," ANZ economists said.
"At this juncture, however, there seems very little upside drawing too much attention to it when the global scene is dominating today and OCR hikes look to be a very long way away," they said.
The hurdle to OCR cuts was high.
"New Zealand has yet to really feel the macro economic impact of events in Europe. However, there has been a market impact with fixed mortgage rates having eased and the NZD markedly lower. The offshore cost of funding may be rising, but NZ banks have pre-funded much of their 2012 borrowing needs," ANZ economists said.
"The NZD should weaken further in response to slowing global growth and end-demand for our exports, and in this respect, the outlook for China and Australia remains crucial. In the interim, the RBNZ’s best option is to sit tight, even with a relatively benign inflation profile. We still believe that should any cuts be delivered, they will be emergency in nature," they said.
Rate track might be pushed out, but shape to stay the same
Meanwhile, ASB economists said on June 7 that an extreme deterioration in Europe could spur OCR cuts, but this was not their central scenario.
"Economic developments have been, on balance, weaker than expected. Income growth and retail spending have been weaker than expected, commodity prices have continued to fall and there is increasing evidence global growth is losing momentum," ASB economists said.
"However, much of the weaker economic outlook has been offset by looser monetary conditions via the weaker NZD and declines in fixed interest rates. We expect the RBNZ to push out the timing of OCR increases to the first half of 2013. But, with a lower NZD providing the majority of additional stimulus needed, we expect a fairly similar 90-day projection beyond this," they said.
Offshore risks had once again come to the fore over the last month or two.
"The Greek election resulted in additional uncertainty following the failure to establish a new coalition government. A second election is now set for 17 June. Concern is also growing over the extent of losses amongst Spain’s banks," ASB economists said.
"It is likely that external, possibly Europe-wide assistance will be necessary to shore up the financial system (in Spain and more widely)," they said.
"Should Europe continue to muddle through in this fashion, we would not anticipate a cut to the OCR. However, should a more significant disruption eventuate (such as a Greek exit from the euro) an OCR cut would be very likely. We currently put the odds of this at one in three."