Treasury lowers forecast interest rate track over next four years; Expects first OCR hike at start of 2013, and for OCR to rise higher than Reserve Bank thinks

By Alex Tarrant

Treasury is the latest to succumb to a ‘lower for longer’ view of where interest rates are headed, but is still more optimistic than the Reserve Bank on how high the Official Cash Rate will be in four years’ time.

Budget 2012 forecasts showed Treasury expects the 90-day bank bill interest rate to rise from an average 2.7% in the March 2012 quarter to 4.1% in the March 2015 quarter, suggesting an Official Cash rate then of about 3.75%.

In contrast, the Reserve Bank’s latest set of public forecasts released in March show the 90-day rate rising to 3.6% in March 2015, implying an OCR of 3.25%.

The OCR is currently 2.5%. Most bank economists expect the Reserve Bank to resume hikes in the first quarter of 2013.

The 90-day bank bill rate has in fact fallen in recent weeks to just above 2.5%, indicating markets are expecting a 25 basis point cut in the Official Cash Rate to 2.25% by the end of the year.

The 90-day rate is generally 25-30 basis points above the Official Cash Rate.

The numbers:

RBNZ March 2012 Monetary Policy Statement 90-day rate forecasts.

March 2012: 2.8%

March 2013: 3.1%

March 2014: 3.3%

March 2015: 3.6%

Treasury Budget 2012 90-day rate forecasts; (BPS expectations in brackets)

March 2012: 2.7% (2.7%)

March 2013: 2.9% (3.3%)

March 2014: 3.6% (3.7%)

March 2015: 4.1% (4.4%)

March 2016: 4.4% (5.2%)

“The forecasts assume that monetary policy does not tighten to offset the temporary effects of the higher excises on the CPI,” Treasury said.

“However, strengthening demand in the economy and diminishing spare capacity are forecast to lead to a gradual withdrawal of monetary stimulus. The withdrawal of this support is forecast to begin in early 2013,” it said.

However, the pace of tightening was uncertain.

“The pace and extent of interest rate rises are dependent on the strength of the exchange rate, the strength of domestic demand, and conditions in financial markets; a stronger exchange rate would also lead to tighter monetary conditions,” Treasury said.

“Banks continue to find the cost of funds elevated relative to their pre-global financial crisis levels, which is increasing the margin between the Reserve Bank’s Official Cash Rate (OCR) and retail interest rates,” it said.

“These higher costs are assumed to persist over the forecast horizon; international funding markets are expected to improve but to remain impaired; and upward pressure on domestic funding costs is expected as domestic deposit growth slows and credit demand rises.

“Further increases in the cost of funds would, if passed on to borrowers, reduce the extent of increases in the OCR required to meet the Reserve Bank’s medium-term target of inflation between 1% and 3%,” Treasury said. 

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OCR of 3.6% in 2014 is extremely unlikely.
Any rises over the next 3 years will have exaggerated and immediate depressing effect on the economy.

I'm not so sure future rises will be so dramatically effective given the way banks are discounting fixed rates and leaving floating hanging out to dry presently. The gap between the rates is making fixed increasingly attractive and is likely to attract a good number of takers. 

Well lets sit and watch, for myself I think I'll trust the Fed's projections flat and low OCR well into 2014 and probably 2015......right now I think the OCR is  going to go Grexit occurs and RB and BE try and stop NZ nose diving....and I cant see any improvments inside 2 years to justify >3% .......

Be interesting to see the proportion of the 60% floating that move to fixed over next few months. And to which term length.

Grexit, or the inevitable fall in US GDP as debt levels continue to rise with a continuing total lack of effort to stem it, means more and more money printing. Steven, do you know the consequences of that with Govt's that love the good feeling we all get from money pushed into the system, compared to the same Govt's who uniformally hate the bad feeling (read loss of elections) when they have to pull the money out  (i.e. delay doing so) - and read, pull the money out to stop high or hyperinfaltion that ALWAYS leads to higher rates - the only question is obviously have that nailed so myself and others would love to hear when that will be
Or maybe you just think "this time will be different"...someone should write a book on it

Actually, I think the next 5 years will be quite "different" from the normal economic cause & effects experienced over the last 50  years.  Where is inflation currently?  Maybe rising in local body rates, insurance, petrol, power - but there are no price hikes similar to the '70s.  Prices of anything driven by disposable income are going down -  so some deflation, some inflation   -   net effect zero inflation, zero growth, .... zero budget.

Zero OCR hikes

Net deflation for those with tons of disposable income havin' a great time spending it; neutral for those with their books in order; net inflation for those struggling with the basics IE Inflation for the young and their families. Net effect:  more social dislocation. Just because you don't see something doesn't mean it's not there.

Prediction from late 2011:
"Westpac chief economist Dominick Stephens said ... Rates would rise by 150 basis points in 2012 and "definitely more" in the following year, but the peak for the official cash rate had been cut down to 4.3 per cent, rather than 4.9 per cent as previously expected."  
Okay - so we are expecting 150 basis points in 2012........   OK, it's May 2012 and so far we have had Zero basis points in 2012 .....   Uhm  we are 'peaking' at 2.5 so far......

Given Dominick is about 12 years old, he hasn't yet learned that economists should never use words like "definitely".
It's been clear to me and most other readers on this site that predictions for the economy have been particularly unrealistic for some time (as opposed to the norm of being unrealistic).
The present time is no exception.  Reliance on a ChCh rebuild is just a delusion.  Most commercial property owners either had only indemnity insurance (which has actually left most adequately off but with insufficient to actually rebuild), or they had full replacement and their insurer has made generous offers either in cash or immediate replacement with existing buildings - which is enough to dissuade most from bothering with a drawn out rebuild.
The fact is CERA and the Govt have absolutely no idea what's going on, because as Central City land owners, they've NEVER contacted us to ask our plans or had any discussion about what needs to be done.
A top down approach will never work.  There should have been discussions with property owners from day one, not the antagonism that has gone on.
Now nearly all hope of any real boom is completely gone, Treasury miraculously pin their hopes on it eventuating.
As Bill E and JK do the CH CH CHA CHA, I can see the fancy footwork turning into a foot tripping fiasco and everyone landing hard on the floor!!!

So Mortgage Belt, your time horizon extends no further than 12-24 months (yes there will likely be modest inflation in that time), and what's the point of quoting some bank economist's forecast from a year ago in this market ?
Good to know you've got it sorted, so in writing now, so that I can record it and copy this back later, please give me your timeline for interest rates movements 1-2 years, 2-3 years, 4-5 years and 5 years plus, just like they have to.
Thank you.

It is good to know I have it sorted - in fact I am a genius. If only the 4 pillar - economists would contact me before their abysmal predictions.   
Here goes:  
2012 June OCR 2.25
2012 Dec  2.0
2013 Feb 2.0
2013 June 1.5
2013 Dec 1.5
Somewhere in here we have the full global currency crisis  resulting in firstly the EU placing a global straitjacket / global currency etc ...
So beyond 2014 we may have a completely revised system  ...... 
What is interesting is that for 4 years now, conventional bank economists have got all their predictions badly wrong -   they are still making assumptions that it is/or will soon be "business as normal".  We are in a completely new paradigm  -   things will never go back to a free market system again in the same way.

Thanks Mortgage - I can't express much of an opinion about your first 18 months, basically youre suggesting that the central banks will stop printing money, I'd question that, but if they don't, I strongly doubt we'll see below 2%, if that. However, it won't continue forever, and I'm very much of the same mind as you on the rest of your comments, but again, don't know that its 2014 but its as good a guess as any I least you've given the timeline, well done