RBNZ seen as having to do 'even more' to achieve its inflation target

ASB economists say the Reserve Bank will now need to do "even more" to achieve its inflation target of 1% to 3%.

The chief economist for ASB Nick Tuffley says the the odds "have now tipped towards a 1.75% low in the OCR".

"Events since the March Monetary Policy Statement [released on March 10] show the RBNZ is not likely to get the stimulatory response to the OCR cut that it would have hoped for," Tuffley said in an 'OCR Outlook Update' issued by ASB today. 

"Several benchmark lending rates have not fallen as much as the RBNZ clearly expected them to. Moreover, the RBNZ again runs the risk that the [New Zealand dollar] holds up at a higher level than it has assumed, continuing to undermine the extent to which inflation will pick up in the future."

Tuffley said ASB's now expecting two "final" OCR cuts, at the June and August Monetary Policy Statements, though the April meeting is "a very lineball call for the next move".

He said, however, that the housing market’s response to lower interest rates will remain a consideration for the RBNZ in terms of “how much” and “when”.    

One factor in the ASB economists changing their assessment, Tuffley said, has been the lack of "pass-through" of the RBNZ's March cut (to 2.25%) of the OCR to bank lending rates. 

"Rising risk premia for banks, particularly this year as European banks have come under pressure, have impacted the costs of raising funds in international markets.  But it is clear the RBNZ wasn’t anticipating that three of the major banks would only pass on 10bp of its 25bp OCR cut.  (Note that ASB is the only major bank so far to pass on a 20bp floating mortgage rate cut and comprehensively cut its fixed-term mortgage rates, and is the only one – so far – to cut its rural floating rate [by 20bp])."

In respect of the Kiwi dollar, Tuffley said despite the RBNZ cutting the OCR earlier than expected, there had been "minimal easing of monetary conditions through that channel".  

"Last Thursday morning, the US Federal Reserve undid all the RBNZ’s handiwork in shoving the NZD down. The Fed kept interest rates unchanged, but dialled back its expectations for future interest rate increases by more than expected. The promise of delayed action spurred a dip in the USD to the point where the NZD/USD ended the week higher than it was before the RBNZ’s surprise OCR cut.The trade-weighted NZD is back around the level it sat at in the week ahead of the OCR cut.

"It is clear the RBNZ can’t expect the Federal Reserve to come to its rescue. But beyond the Federal Reserve, continued policy easings by other major central banks mean NZ remains a place of relatively high returns in a world of low and even negative interest rates.

"Increasingly, the risks are the NZD continues to hold up by more than both we and the RBNZ had been thinking. Consequently, tradables inflation – the main driver of higher inflation over the next couple of years – is likely to be more muted than both we and the RBNZ have been anticipating."

Tuffley said all this presented "a creeping conundrum" for the RBNZ, with the NZ dollar strongly risking continuing to blunt the extent to which tradables inflation picks up. 

"To make up for that lack of inflation boost the RBNZ would need to tug the interest rate lever harder, to get more inflation from the non-tradable sector.  But the challenge of generating added stimulus from that source has been made harder by the muted pass-through of the last OCR cut," he said. 

One "perverse" risk was, Tuffley said, that the lack of traction in lending rates discourages the RBNZ from cutting to the extent ASB economists now envisage. 

"But to assess that risk we ultimately have to fall back on the message from our inflation outlook. That is, action is required if the RBNZ is to have confidence it will meet its inflation objective with an acceptable safety margin."