Case for Reserve Bank to cut Official Cash Rate mounting, BNZ's Toplis says; But NZ$ will first have to rise further, and housing market stall

Case for Reserve Bank to cut Official Cash Rate mounting, BNZ's Toplis says; But NZ$ will first have to rise further, and housing market stall
New Reserve Bank Governor Graeme Wheeler is due to make his first OCR decision on October 25

The case is growing for the Reserve Bank to cut the Official Cash Rate (OCR), although the New Zealand dollar will first have to rise further and the housing market stall, BNZ head of research Stephen Toplis says.

Markets were this morning pricing in about a 90% chance of the Reserve Bank cutting the OCR from its record low 2.5% sometime within the next year. Despite this, BNZ economists put the chance of a cut at 35%, reinforcing their view the OCR would stay on hold until December 2013.

While the vast majority of economists at the major banks and economic forecasting agencies are picking the OCR to stay on hold until the end of 2013 or early 2014, more talk is emerging of a possible cut before then.

The high New Zealand dollar, while hurting export returns, has kept pressure off the prices of imported goods. Consumer Price Index inflation figures to be released on Tuesday are expected to show a 1% rise in the year to September, according to a Bloomberg poll. That would be the same reading as in the year to June, and be right at the bottom of the Reserve Bank's 1-3% CPI target band.

However, most economists point to emerging price pressures from the Canterbury rebuild, rising commodity prices, and a resurgence in the housing market as reasons why the next move in the OCR will be a hike, not a cut.

The Official Cash Rate is closely correlated with floating mortgage rates and a cut in the OCR should be followed by a corresponding cut in these rates (although perhaps by not as much - see Gareth Vaughan's June article, Reserve Bank gives banks carte blanche to 'decouple' floating mortgage rates from the OCR; Says bank funding costs no longer tied to OCR and swap rates).

Banks have been fighting hard to undercut each others' fixed rates recently as they compete for market share. However, a quiet spot has been with floating rates, which have averaged about 5.75% all year.

Cut more likely

BNZ economist Stephen Toplis said on Monday that as each day passed, the green light allowing the Reserve Bank to lower the OCR grew ever brighter.

A very weak Performance of Manufacturing Index last week, followed by today’s weak Performance of Services Index, intimated that GDP figure for the September quarter might print very poorly indeed, he said.

"Consensus forecasts for global growth remain under pressure and, importantly, the demise of the western world is now having a very clear impact on emerging markets. The Australian economy is looking demonstrably shaky, resulting in grief for domestic manufacturers, and the RBA is easing," Toplis said.

"The NZD TWI sits stubbornly 1.4% above the RBNZ’s assumed Q4-average. And the annual CPI is about to print below the bottom edge of the RBNZ’s 1-3% target range. We, thus, now put the probability of an easing as high as 35%."

Toplis highlighted a number of factors currently stopping the Bank from cutting the OCR: 

-   While the global environment looks ugly, there are indications that Europe is stabilising and the first signs that the Chinese expansion may be rejuvenating; 
-   The currency might be higher than assumed but dairy prices are again rising and the overvaluation (relative to the Reserve Bank’s assumptions), is, at this stage, modest; 
-   The housing market continues to gain momentum; 
-   The medium term outlook remains for heightened inflation; 
-   The Christchurch earthquake rebuild appears to be starting in earnest; 
-   There are the first signs of credit growth; and 
-   The new Reserve Bank Governor has barely got his feet under the table and will not be keen to wave his wand until he knows exactly what he is waving it at. 

"So we stick with our view that rates are on hold for some time to come but warn that the downside risk should not be ignored. The market certainly isn’t ignoring it, now pricing in around an 85% chance of a cut over the coming 12 months," Toplis said.

"It’s been pricing in a reduction in rates consistently for much of the last year and we have railed against it. While we think the odds are overdone, the situation has certainly changed sufficiently for us to be much less aggressive in our dissension," he said.

NZ$ will have to rise, housing market stall

For BNZ economists the catalyst for an easing was continued appreciation in the New Zealand dollar, accompanied by a stalling in the domestic housing market. 

"Symptomatic of our softer view of the world, we have used this morning’s Performance of Services Index as the catalyst to lower our Q3 GDP forecast to 0.3% from 0.5%. The PSI slipped to 49.6 from 50.0 at a time when the PMI remained well into negative territory," Toplis said.

"In combination these indicators, by themselves, foretell annual GDP growth falling to near zero before year’s end. We simply don’t believe this but are loath to disregard the indicators completely – hence, our downward adjustment. We’ve also taken a point out of Q4 GDP bringing it back to 0.6% from 0.7%," he said.. 

"Be that as it may, this has limited immediate implication for our short term interest rate view. Cumulatively, we still have growth of 0.9% for the second half of this year compared with the Reserve Bank’s 0.8%."

Govt surplus under threat

"It’s also not that different to Treasury’s view of the world though we still believe that medium term growth will fall short of Treasury’s expectations leaving revenue flows shy and the 2014/15 surplus objective under threat," Toplis said.

"Tuesday’s Q3 CPI report may well announce the first time that annual CPI inflation has ever fallen below the bottom edge of the Reserve Bank’s target band. We are forecasting 0.4% for the quarter, 0.9% for the year," he said.

"We expect significant downward pressure on prices (or outright deflation) from the clothing and footwear group, household contents and services, and telecommunications. In contrast, prices in the food group and housing are expected to be up relatively sharply. 

"The RBNZ has 0.5% for the quarter so a reading akin to our own will, again, have little impact on the Bank’s view of the world."

Dairy prices rising again

One of the factors preventing the RBNZ from easing had been the recent resurgence in dairy prices.

"Generally, we expect dairy prices to rise further, over time, driven by ongoing issues around the US drought. However, any move in world prices need to be weighed up against currency fluctuations to assess domestic cash flows," Toplis said.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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21 Comments

Cuts, cuts, cuts.
Keep the OCR & Mortgage cuts coming .....
They're on a downward trend ....

Raise, raise, raise.
Let's get rid of the manipulation and use of band aids on sliced arteries.
Who cares about trend (except sheeple)?

are u struggling to make ends meet at the current record low rates?

We are doing just fine. Always want to do better, and since the banks are coming off record profits and new borrowing a little muted I'm hoping for more deals down the line. Still 100% floating with kiwibank at 5.25%. Apparently we are not in the hole enough to warrant a bigger discount? Comfortably over 30% equity and debt ~ 200K. Anyone got a better deal on similar terms?
 

Mr Wheeler, this does look like your marching orders from the first of the banks; the rest to follow shortly one imagines.
Reading the narrative, the BNZ seems to be admitting that things are considerably worse than they thought. In terms of the proposed action, there seems a considerable disconnect. Presumably they didn't get the okay from upstairs for an immediate cut, even though the narrative seems to call for one. Why on earth would we wait for yet further appreciation in the NZD? Does the BNZ want to sneak in another billion or two of very damaging foreign currency before the drawbridge finally gets pulled?
Mr Wheeler, I don't really think you have much of a honeymoon period. A good number of people have a view that the government and your predecessor have very warm hands (from being sat on); and that a current account deficit growing at $30 million a day is doing irreparable damage to New Zealand every single day we continue to do nothing.
Some early action; and clear articulation of why, would be a very good start. "I'm new to the job, and still getting my feet under the table" won't cut it.

Agree, things must be very bad indeed for a bank economist to (almost) call for/predict a (horror) rate cut.
Normally, the bank economists are jumping up & down shouting that a (steep) rate hike is just around the corner.  Hike, hike, hike - they normally say -  while the reality is flatline or cuts.
Therefore, a very big set of cuts must be on the way if we add the normal downside to the economists predictions.
Another interesting phenomenon:   the longer rates are low, then the longer banks really need to keep them low(ish).  The proportion of new borrowers is growing who have set their household budget on the basis of a new 5.5% mortgage, then they are unlikely to handle a hike to 7-8+% in the near future until incomes grow.
So, BH is right again  ---- lower for longer.   

The households that have their budget only handling a 5.50% mortgage rate are in serious strife I think a couple of years down the track. I feel for them as many will be young ones with their first house, but youre no doubt right about their budget Mortgage Belt - I can only  hope that they've gone for a 5.90% 4-5 years rate because they are the ones that can't stand an even half modest rise in rates

The Christchurch earthquake was a high price to pay for the RBNZ to finally appropriately cut the OCR to economic conditions.  Imagine the hard landing NZ would have had in the last 18 months if the OCR had carried on at 3.5 to 4% trajectory that the RBNz was blindly following & believing that an economic recovery was kicking in.

Inflation is rampant at 1.1% annual! 
http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=1084...
This story must be written by ghost writers (aka Westpac) plugging for rate hikes to suppress this runaway inflation!

No inflation for the next 12 months, possibly 24, but look further ahead than that. If a couple buys a house based upon a floating rate that's probably good for a couple of years, but have a 25 year mortgage, they're at risk.  Why are US rates so low ? because of a big output gap ?, yes, but then Greece's is even larger and look at their rates (and Spain's etc) i.e. rates don't always have to do with inflation, but that will be the killer here. Money printing, Operation twist, verbal guidance (something that they can only promise until they can't) is what's keeping them down in many countries around the globe.
Yup it will do the job for a while, maybe its 2-4 years out, but they are in no position to be able to stop the printing, and  ultimately, and no one knows when, it will start to become inflationary - and when it does, and when its recognised by the public, look out, high inflation, imported here through oil prices etc, eventually followed by floating rates way above 5.50%. Inconceivable right Mortgage Belt, just like the GFC to so many on here ? Sudden the world changes and it all so obvious ?   
If you don't undestand that this is a big risk, and some of the accurate forecasters globally over the last 6-7 years would say its a certainty, you're probably in for a big shock. Be prepared unless yours is due to paid off, or insignificant,  in a couple of years or so?

Consider,
1) You and the inflationistas have been plugging inflation for 4 years, its not even in sight 2 years off...so thats 6 years you have been wrong, so far....
2) The Fed I think is saying no rises til 2015....so the carry trade looks "safe".
IF they start to rise in 2015 that means we will have had/having a recovery and wages should be rising as well as prices.
3) That will be long signalled, ie 6+months of the core inflation rate rising and un-employment dropping will give warning.
No one knows, well plenty of time and that's if it goes well....fat chance personally.
In terms of oil imported via inflation, the core measure takes out fuel as its volitile and seasonal...so sure our exchnage rate drops say 15%, thats not really inflation and the RBNZ can look through that.  On top of that if ppl are not earning any more the higher price means other things wont be bought or will have to deflate to compensate for more expensive petrol to get a sale....thats less productive and deflationary.
In terms of,
Inflation being a big risk, personally I dont see it as a significant risk for 5 or 6 years maybe even a decade...we've had 10% rates 5 or so years ago....
Accurate forecasters, maybe point me at them, Ive seen none who are now saying inflation is a risk....the best seems to be Steve Keen and his ilk....and I odnt see them saying inflation is a problem.
Big shock, well most seem to have coped with 10% let alone the 7 or 8% thats possible...even the RB I think sees an OCR of 4.5% a s peak?  so say 7% retail? hardly earth shattering.
regards
 
 
 
regards
 

Scoop !!!The RBNZ Governor Graeme (the wheedler) Wheeler announced to his wife over breakfast, there will be no change to the official cash rate, citing the continued targeting of inflation as the ongoing focus of the Reserve Bank.
Waking his wife a number of times during the 30 minute speech , he reassured her that while the policy would appear to be the same as during the previous Governor's tenure , they now would indeed be be delivered with a more dynamic style and better dress sense.
When aroused once more from her state of unconsciousness, his wife said she now felt rested, and further that insomniacs N.Z. wide should tune in for this announcement.

She showed a lessening of interest, then?
 

No, I wouldn't say that PDK ,...Mrs Wheedler demonstrated the consistency with which such announcements will be recieved.....signaling to economic press reporters a pillow and blanket should remain part of their standard attendance kits.....perhaps an IPhone with Angry Birds for some light relief during passages of consciousness.
For a transcript of the pre announcement announcement, download the previous 6 announcements and shuffle the running order, insert new Governor's picture, and compliment the tie as a footnote. 

They're showing a little reserve then

I am keeping my lip tight on this one about which way rates are going..  Next year we might find that we have all been hoodwinked !

So if it drops, stays the same or rises....you will be...uh right....
Tell you what go for it, take a punt....
My best guess is ocr about here or even lower...maybe even rock bottom (<1%) if it goes as badly as its looking.
regards
 

I suspect rates will stay the same for now.  There is not enough case to drop at the moment.  Next year will will see a few surprises on the rate front and and maybe not what everybody is expecting.

...who will be hoping their income is somehow insulated from low rates.

So that's all the important hardworking people that deserve a break, then.

Whilst all the indicators support a drop this will not happen until the shit hits the fan and it is too late