Thursday's Official Cash Rate (OCR) review is less a case of what would prompt the Reserve Bank to increase the OCR, and more a case of would make it pause, ASB's economists say.
In their preview of the upcoming OCR review on Thursday, July 24, ASB's economists, led by chief economist Nick Tuffley, say they expect the Reserve Bank to lift the OCR another 25 basis points, taking it to 3.50%. That would be the fourth such increase so far in 2014.
ASB's economists then expect the Reserve Bank to hold fire in its September 11 and October 30 OCR reviews, before resuming increases at its last OCR review for 2014 on December 11.
"The Reserve Bank faces choice between dragging the NZ dollar up with the OCR or pausing and triggering an unwanted drop in term (interest rates) rates, ASB's economists say. "We expect the Reserve Bank to lift the OCR 25 basis points on July 24 and then pause until December. But communicating a pause may be a challenge for the Reserve Bank."
"July’s OCR decision has evolved to be less a case of what would prompt the Reserve Bank to lift the OCR to more what would make it pause. By and large the Reserve Bank’s outlook is on track enough for it to follow through. While we expect the Reserve Bank will raise the OCR by 25 basis points next Thursday we acknowledge the central bank is stuck a bit between a rock - risk of the NZ dollar lifting further - if it hikes and a hard place - risk of term rates falling and undermining Reserve Bank’s actions - if it stays on hold," Tuffley and co. say.
Their comments come after Westpac chief economist Dominick Stephens yesterday said he also expects the Reserve Bank to increase the OCR on Thursday, but to then hold off further increases until 2015.
The migration effect
ASB points out the first quarter 1% increase in Gross Domestic Product was just under the Reserve Bank's forecast, and the second quarter Consumers Price Index points to a benign inflation environment.
"Migration is still on the high side, and an important point given the Reserve Bank’s focus on demand side impacts on inflation," the economists say.
ASB suggests the central bank's outlook for peak annual working age migration of 37,000 at the end of this year is on the low side.
"The Reserve Bank's migration scenario in the June Monetary Policy Statement implied an additional 4,300 migrants over the next three years was worth around 50 basis points in higher interest rates."
Meanwhile, escalating geopolitical tensions in Ukraine and Gaza are clearly unsettling global developments, they add.
"For now, it is too early to tell whether the situation will have a lasting impact on financial markets. Other recent events that will be key concerns for the Reserve Bank to keep an eye on include the continued drop in global dairy prices, mortgage rate movements and the high NZ dollar. The recent global dairy price declines point to a downward revision to Fonterra’s current milk price forecast. Meanwhile, fixed mortgage rates have lifted and the NZ dollar Trade Weighted Index remains higher than the Reserve Bank’s assumption despite the recent pull-back from record highs."
"The higher than expected NZ dollar puts the Reserve Bank between the rock and a hard place. Interest rate differentials are still supporting the NZ dollar at a high level. The Reserve Bank has a tough choice between going 'soft’ on the OCR to reduce pressure on the NZ dollar against keeping up some transmission of a higher OCR to term rates. In the current environment it can only choose one, and we expect the Reserve Bank to choose maintaining a floor under mortgage rates," ASB's economists say.
"Along with the softer tone of recent data, this dilemma reinforce to us that the Reserve Bank will pause after July. With 100 basis points of tightening done by the end of this month, and looming uncertainties from the upcoming election, it is an opportune time to sit back and assess how the economy is responding. It is possible the Reserve Bank gives a bit of a hint it will pause. But giving such a hint risks having the market push wholesale rates back down and undermining the Reserve Bank’s intent of tightening policy."