All eyes will be on the Reserve Bank's perilous juggling act with the twin opposing threats of a high dollar and a heating domestic housing market when the central bank makes its latest judgement call on interest rates next Wednesday.
It is a slam dunk certainty that the RBNZ will leave the Official Cash Rate unchanged at 2.5%, where it has been since March 2011.
The concern for the marketplace, however, will be what the bank chooses to say about houses and the dollar. Rising house prices, particularly if combined with strong borrowing and spending, carry the threat of higher inflation. A high dollar presses down on the exporters.
In layman's terms it is in something of a pickle. Raise interest rates to hose down the housing market and foreign investment money will flood into the country, pushing the dollar even higher. Leave interest rates low and potentially the public goes on a spending spree, buying up houses and forcing the prices even more upward.
So, the country's economists in previewing the latest OCR decision (which is a day early due to Anzac Day) have largely focused on the dollar vs housing dilemma.
ASB senior economist Jane Turner and economist Christina Leung say the "key tension" between the houses and the dollar the RBNZ faced when it made its OCR decision in March had "intensified" since then.
"Recent communications from the RBNZ highlight its growing discomfort with the continued pick-up in housing market activity and housing credit growth. However, the continued strength in the NZD in recent weeks presents further headwinds for the tradable sector, as well as having a dampening effect on tradable inflation," they say.
Westpac chief economist Dominick Stephens describes the RBNZ's current position between the dollar and the housing market as being "uncomfortably perched on the fence".
"In the March Monetary Policy Statement the RBNZ noted that if the exchange rate were to stay high and continue to suppress inflation, OCR cuts might be on the agenda. But last week Deputy Governor Grant Spencer said in a speech that if the housing market were to stay strong and provoke consumer spending, the OCR may have to go up early. There is no contradiction between these two statements. They simply reflect the fact that the central bank faces two diametrically opposed risks," Stephens says.
"At next week’s OCR review, we expect the RBNZ will remain perched on the fence, but will express its increasing discomfort with the risks on either side."
In his March MPS outlook statement the RBNZ Governor Graeme Wheeler said: “There are both upside and downside risks to this outlook. At this point we expect to keep the OCR unchanged through the end of the year.”
Stephens says it would be no surprise if the governor repeats the same statement again verbatim next week.
"That said, the Reserve Bank’s summary of the outlook will have to be updated to reflect the fact that if anything, the economic dichotomy has become starker."
He says the central bank may back up a little on its March comment that global “risks have receded”, following the bailout crisis in Cyprus.
Also, wording around the local economy will have to become more "bullish".
"GDP growth in the December quarter was much stronger than the RBNZ expected, and recent survey data suggest that the buoyancy has rolled on into the new year.
"The link between rising house prices and consumer spending may be singled out for special mention. Private consumption expenditure grew 1.4% in the December quarter, possibly signalling a return to our borrow-and-spend ways of last decade."
Stephens says the RBNZ will mention both the drought, which will hit agricultural production hard, and the recent 66% increase in dairy export prices that will soften the blow.
Railing against the dollar
"As always, the RBNZ will rail against the high exchange rate. Given that the Trade Weighted Index has risen to a new all-time high, the RBNZ might even invoke language associated with exchange rate intervention, such as labelling the New Zealand dollar 'unjustified' and 'exceptional' (these are two of the RBNZ’s four criteria for intervention)."
Stephens says if the OCR turns out the way "along the lines we are suggesting" then nobody will be surprised and the markets will not react.
"Even so, the nature of the dichotomous risks facing the RBNZ means there is scope for markets to move if the RBNZ unexpectedly emphasises the risks on one side more than the other."
Deutsche Bank chief economist Darren Gibbs says the "main interest" will be to see whether the upside and downside risks cited by the RBNZ in March have changed enough to cause the RBNZ to signal a significant change in that stance.
"...We think that the statement will read a little more upbeat than the policy assessment issued with the March MPS (produced overleaf), with the Bank likely to acknowledge recent stronger domestic activity and confidence indicators. We also expect that the statement will strongly reinforce the Bank’s concerns about stability and inflation risks associated with the rebound in house prices, especially in Auckland."
But Gibbs says the RBNZ will likely note the present benign inflation environment, reflected in the first quarter inflation figures and future challenges posed by the recent drought (notwithstanding recent rains and firmer spot dairy prices), sustained fiscal consolidation and the appreciation of the exchange rate.
"On balance we expect the RBNZ will share our view it will likely be well into 2014 before the economy is generating sufficient sustained upward pressure on prices to drive annual inflation towards the mid-point of the inflation target range (let alone the top of that range). Therefore, we expect the RBNZ will again note expectations that the OCR will likely remain at its present level for the balance of this year, whilst acknowledging both upside and downside risks to inflation that could alter that outlook."
Gibbs says following next week's OCR announcement attention will turn to the release of the RBNZ’s Financial Stability Report on May 8.
The news conference accompanying this is very likely to discuss the RBNZ’s concerns about the housing market in some detail, he says.
"The market will be looking to see, in particular, whether the RBNZ is any closer to implementing macro-prudential instruments that might at least temporarily dampen activity in the housing market. Whilst such instruments would be implemented primarily due to prudential concerns, they would likely delay the need for conventional policy tightening to address broader inflation concerns."