Roger J Kerr sees the RBNZ holding the Official Cash Rate at 2.5% this year and says global oil prices will recover eventually, while inflation - possibly stronger than the RBNZ forecasts - will emerge in NZ

Roger J Kerr sees the RBNZ holding the Official Cash Rate at 2.5% this year and says global oil prices will recover eventually, while inflation - possibly stronger than the RBNZ forecasts - will emerge in NZ

By Roger J Kerr

Despite the first increase in US short-term interest rates in December for a decade, long-term US bond yields have decreased sharply over the last two week from 2.25% to 2.03%.

As a consequence our, 10-year swap interest rates have returned to their lows at 3.50%. Global investment funds have temporarily been returning to the security and safe-haven of US Treasury Bonds as equity markets have taken fright from China and geo-political developments over recent weeks.

Whether US bond yields can remain at these lower levels depends on how quickly international investment and financial markets settle down after the tumultuous start to the year. If the markets follow what they did in August/September last year, the uncertainties and volatility should abate rather quickly as the Chinese also move quickly to allay fears on their economy and stimulate through a lower currency value and/or lower interest rates.

On a number of economic measures of good GDP growth, related inflationary pressures and rising wages, US bond yields should be increasing as investors require a return above inflation. In addition to the economic drivers, US bond yields are also predicted to move higher on increasing US short-term interest rates this year and the Chinese switching from buyers of US Treasury Bonds to being sellers of those bonds. For the first time in more than 15 years Chinese foreign reserves did not increase over the last quarter of 2015. The days of large Chinese buying of US Treasury Bonds pushing the yields lower are well and truly over.

All these interest rate market equations are clouded by the recent tumble in the oil price to below US$30/barrel. Yet again inflation will be subdued in the short term in both the US and New Zealand, despite the normal demand/supply pressures you normally expect to see when the economy is expanding by more than 3.00% pa. It looks like the NZ economy expanded by 1.00% in the December quarter, so we are really cooking with gas here with the annual growth rate being closer to 4.00% over the second half of 2015.

With a lower exchange rate and super low interest rates there is no reason why the NZ economy does not continue along in 2016 at that same robust pace.

As has been widely reported, the Auckland housing boom is spreading into the regions as residential property owners see the Bay of Plenty, Waikato and the Hawkes Bay as cheap buying compared to the inflated prices in Auckland. Understandable rational economic behavior by these folk to get a better house, improved community environment and a lower mortgage by shifting out of Auckland that can be of no great surprise.

All these economic and market developments leave the Reserve Bank of New Zealand doing absolutely nothing with interest rates in 2016; i.e. the OCR stays at 2.50%.

Eventually oil prices will go back up, imported goods into NZ are going up now and housing rental costs are also increasing sharply.

The annual inflation rate can still move upwards this year at a faster clip than the RBNZ are forecasting, however it will need a reversal in the current oil price trend for that to occur.

It seems to be forgotten that the RBNZ are meant to “look through” movements in global oil prices in terms of inflation control and monetary policy management. It also seems to me that the recent reductions in crude oil prices to below US$30/barrel was the oil markets anticipating in advance the ending of the Iranian trade sanctions and Iranian oil supply coming on to the globally traded market again. The price movement occurred in advance, so maybe we do not see much further weakness in oil prices from here.


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Roger J Kerr is a partner at PwC. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com

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20 Comments

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"With a lower exchange rate and super low interest rates there is no reason why the NZ economy does not continue along in 2016 at that same robust pace"

...whew!

Everything will be fine, it's not like there will be a year of bad financial news.

The construction sector is strong, which is understandable given banks are getting competitive over mortgages again. With bubbles bursting in export markets I have doubts about the rest of the economy this year.

You could be right to have doubts. Have a look at this World Bank %GDP oil rent chart (2013) then consider what a two thirds drop in the price will be doing to imports and stability in the oil dependent countries.
http://data.worldbank.org/indicator/NY.GDP.PETR.RT.ZS?order=wbapi_data_v...

"Given the focus on China at the moment, it is tempting to assume that the price falls in the financial and oil markets reflect serious concerns about weakening in the Chinese economy. This analysis is too simplistic. Although it is a big consumer of commodities, China buys only about a tenth of the global supply of crude.

There is not much sign of sharply slowing economic growth, and hence demand, from the US and Europe which between them make up around 40 per cent of worldwide oil consumption. A much more likely reason for falling prices has been the buoyancy of supply owing to US shale and also the decision by Saudi Arabia and other producers to keep pumping out crude rather than restricting output.

That may not be good for the prospects of reducing carbon emissions in the near term, but it is certainly of significant net benefit for the global economy and employment. Broadly speaking, a fall in the oil price transfers income from economies more likely to save it to those more likely to spend it, and from capital-intensive industries to ones that are labour intensive."
FT.com

One of the problems at the moment is that a lot of people are in substantial amounts of debt. They will either marginally increase spending or put the money towards reducing debts. Either way there are a lot of people with less money to spare each month. For some lower oil prices just stop them from going backwards so fast financially.

"sharply slowing economic growth" that is because there is no economic growth, so it cant slow can it.

Not so sure on the NET benefit either, ie I'd expect to see some real growth after 2 odd years and there seems to be none.

"Roger J Kerr sees the RBNZ holding the Official Cash Rate at 2.5% this year and says global oil prices will recover eventually, while inflation - possibly stronger than the RBNZ forecasts - will emerge in NZ"

Are you still on holiday on a remote island cut off from all world news ???
1) Inflation is still dead and not rising at all (been going on for 2 years)
2) Oil is plummeting lower & lower
3) The RBNZ will be forced to reduce the OCR
And for good measure the NZ OCR is not low, it is very high compared to most developed countries. (it does not matter where the OCR was historically, we're not trading with "10 years ago" we 're trading now, with other nations that have much lower National bank interest rates)

Exactly. This is the misinformation "interest rates in NZ are low" that the banks/media repeat.
Interest rates are still relatively high in NZ.

Lock me into the super trade - have to offset waning NZD/USD book losses. Read more

1) more like 7 years

3) The OCR is for our CPI/core inflation simply too high and has been for 2 odd years.

dp

With Iran increasing oil supply I don't see any recovery in oil prices any time soon. Maybe after 2020?

Crude futures are less than $50 out to 2025. The doomsters are going to make killing on that trade.

Conventional oil is about peak and has been since 2006. There is an argument about condensate,

http://peakoil.com/production/the-great-condensate-con-is-the-oil-glut-j...

as its not crude but the price still reflects excess supply the only unknown is how much, ie 1mbpd or 2? or 3?

Then there is shale which also isnt conventional crude.

Bear in mind that $30 is due to mostly US shale, Iran's 3mbpd does not yet have an impact on price. So the other Q is how low can it go, $20 seems not un-realistic.

Yes, the time frame of 2020 for total output drop seems a bit more likely than 2 or 3 years ago when only conventional crude said 2018. Shale has indeed thrown 4.8mbpd into the model, plus then If china really is melting down, then with Iran as well a low price for a few years seems quite believable.

"oil prices will recover eventually". What a penetrating insight that is.As a statement of the obvious,it would be hard to beat. As Keynes once said;"In the long run,we are all dead".
If I were one of Roger Kerr's clients,I think i would be expecting a little more for my money.Speaking of money,I would be prepared to have a wager with him,that our OCR will be cut again this year.

"oil prices will recover eventually". What a penetrating insight that is.As a statement of the obvious,it would be hard to beat. As Keynes once said;"In the long run,we are all dead".
If I were one of Roger Kerr's clients,I think i would be expecting a little more for my money.Speaking of money,I would be prepared to have a wager with him,that our OCR will be cut again this year.

Still bleating about inflation 8? odd years, on, still wrong.

I too would bet on a decrease in OCR before any increase. On a global basis the decline in oil price is a net zero effect. The oil producing nations will see negative effects to revenue and oil importers an equal decline in oil import costs. The down side is in investment where declines in oil prices will see, if prices remain suppressed for a long period, a lowering of oil asset values, bankruptcies and a write downs in the value of loans to the industries. Except where we have the intervention of the Fed in telling banks not to write loans to market value to falsify the cost of losses to lenders.

To say there is no inflation is to ignore raising asset values the consequences of such is plainly visible in the oil sector and in NZ the dairy sector. For dairy farmers, as has been discussed in these forums inflation has been running at 8%.

I have to laugh at Roger Kerr's statement that due to low interest rates NZ should boom. Boom in what way more borrowing, more asset inflation, more future consumption today at the expense of tomorrow?

NZ has become a very expensive place to live, every time we return home we always feel like our bank account has a hole in it. The cost of food compared to even Europe is startling, I did an exercise about 18 months ago compare the staples we buy in Europe to the prices of on-line supermarkets in NZ and found NZ was 34% more expensive than those of the Dutch supermarket we shopped at. I used online prices for the Dutch supermarkets too.

We live in wacko economic times. I cannot understand why so many are blind to it

The time is ripe for a good rise to the minimum wage. This will create some needed inflation. from my quick calculations the average annual minimum wage rises over labours last 3 terms was 6% and has been half of that under national since. I have 15 staff so I wouldn't be a direct beneficiary of that either. The new rates are usually published around February to take effect from 1st April. How about putting up a survey on that DC 0%, 3%, 6% or 9%? http://employment.govt.nz/er/pay/minimumwage/previousminimum.asp