The Reserve Bank will not only have to cut rates in August but leave the door wide open to one more cut thereafter if it wants to gain some traction over the currency and to maintain its own credibility, BNZ head of research Stephen Toplis says.
Toplis said the BNZ economists "yet again" found themselves in "the somewhat hypocritical position" of calling for the RBNZ to cut rates, from a consistency perspective, while being of the view that doing so is not optimal for the long term stability of the economy.
"....Unfortunately for the RBNZ it is finding itself in a deeper and deeper hole from which it shows not only little sign of escape but also very little sign of taking control of its own destiny.
"On the one hand it has an out of control housing market that it has contributed to by lower interest rates and by reducing LVRs to non-Auckland buyers but which is fundamentally driven by population growth (in part migration driven) and a paucity of supply. Neither of which, the RBNZ can deal to.
"On the other hand the strength of the NZD largely makes New Zealand a victim of its own success. New Zealand simply looks a better place to store your hard earned cash than just about anywhere else in the world so folk keep buying New Zealand dollars. When the next inevitable economic downturn occurs this money will leave our fair shores but that looks a while away. The RBNZ can’t do much about this either," Toplis said.
He said that over the past week or so financial markets became completely distracted by the state of the housing market and its implications for prospective interest rates. Their attention on inflation as the primary driver of RBNZ monetary policy actions became greatly diminished.
"This process was exacerbated by the macro-prudential policy speech delivered by Deputy Governor Grant Spencer, which markets interpreted as saying that housing market concerns and their impact on financial stability would subjugate inflation (read: deflation) concerns for the time being. This was not our interpretation of the speech but we warned that by not correcting this misapprehension the RBNZ was lending tacit approval to the market reaction which resulted in a surging NZD and reduced market pricing for an August rate cut."
Toplis said he believed that in its economic update this coming Thursday the RBNZ will, indeed, try to correct that apparent misapprehension.
"And certainly the market has come around to this way of thinking with the NZD falling around 2.5 cents against the USD and the market raising the probability of an August rate cut to around 75%.
"The market reaction so far should, of itself, be a clear indication to the RBNZ that simply letting folk know that currency appreciation is not a one way bet can have a significant impact."
But Toplis said it was now up to the RBNZ to follow through.
"We believe Thursday’s statement will reiterate strongly the fact that the NZD, even after its recent depreciation (which was given another shove by the news that the CPI had come in below expectation), remains well above the levels assumed in the Bank’s June forecasts. Indeed, at a TWI of 75.6 it still sits 5.5% above the level it was assumed to average through the September quarter of this year. This will unequivocally reduce the RBNZ’s forecast track for CPI inflation over the next twelve to eighteen months."