By Roger J Kerr
It is another situation of “will he, or won’t he cut interest rates?” this week as the markets anticipate the RBNZ’s OCR review on Thursday April 28.
Based solely on the exchange rate level and their consistency of messaging/actions the RBNZ should reduce the OCR to 2.00% this Thursday.
The local moneymarket’s pricing of interest rates is sitting at only a 30% chance of a 0.25% reduction with the banks becoming unnecessarily cautious as the March quarter’s CPI inflation result of +0.20% was above their forecasts.
The inflation increase, however, was bang in line with the RBNZ’s forecast and therefore the only thing that has changed from their early March signal that they would cut rates again is that the exchange rate has appreciated.
The rise in commodity prices and a weaker US dollar value over recent weeks has thwarted Governor Wheeler’s desire to push the NZ dollar lower so that he gets inflation back into the 1% to 3% band.
Since December the RBNZ have, rightly or wrongly, been perceived as too changeable with their monetary policy signaling and actions. Now is the time to show consistency and follow through on warnings made earlier.
The RBNZ stated in early March that they would cut the OCR again dependent on the economic data and subsequent financial market developments. The overall exchange rate value as measured by the TWI Index at 72.30 is significantly above the RBNZ’s assumed level of 68/69 to get the inflation outcomes they forecast.
Why would the RBNZ wait a few more months before cutting the official interest rates when the inflation outcome for the March quarter was in line with their forecasts and the currency is much higher?
In many respects reducing interest rates again at this time is the lesser of two evils as the subsequent decrease in mortgage lending interest rates will only pour more fuel onto the residential property market fire. The RBNZ should cut rates to get the NZD down to immediately assist the beleaguered dairy sector and hope that further macro-prudential measures and Government actions control the real estate bubble.
Governor Wheeler will know only too well that if he pontificates this week and does not cut the OCR, the NZ dollar will move back up above 0.7000 again and he will be under even more pressure and scrutiny with inflation staying below the 1% minimum for longer.
The RBNZ will be very conscious of the milksolids payout forecast for the new 2016/2017 dairy season being made at the end of May.
A third year of very low milk prices that produce negative cashflows and financial losses for dairy farmers is very negative and damaging for the economy. There is more immediate urgency for the RBNZ to address the exchange rate level for the dairy industry to avoid widespread receiverships/banking bad debts than holding interest rates at current levels to attempt to keep the housing market in check.
A lower NZD/USD exchange rate back to the mid 0.6000’s and improving wholemilk powder prices towards US$2,500/MT are crucial to restore the milksolids payout to above $5 for the dairy industry.
A recovery in the US dollar on global FX markets and a realisation in the bond market that Federal Reserve Janet Yellen may have gone too far with her over-cautiousness on US interest rate increases has lifted US 10-year Treasury Bond yields to 1.91% from 1.75%. Further increases over coming months seem likely as US economic data and inflation rates print on the stronger side and world financial/investment markets remain relatively stable.
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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