By Alex Tarrant
What will new Reserve Bank Governor Graeme Wheeler do with the Official Cash Rate (OCR) at his first review next Thursday? Will he be cutting the OCR sometime during the next year as markets expect, or will it just stay 'lower for longer' as local economists expect?
The consensus amongst the local brigade is that Wheeler will leave the OCR on hold until the end of 2013 or early 2014. But they do say the case for a cut is growing.
That follows figures released on Tuesday morning showing annual Consumer Price Index inflation fell to 0.8% in the year to September, below the Reserve Bank's 1%-3% target band for the headline CPI (the Bank's mandate is to keep the CPI within that band, on average, over the 'medium term').
This led financial markets to price in a 140% chance of a 25 basis point cut over the coming year - they expect 35 basis points of cuts over that time. Seeing as the Reserve Bank only really moves in lots of 25 basis points, that implies an OCR of 2.25% or 2.0% by October next year.
The Reserve Bank's latest public forecasts, in its September quarter Monetary Policy Statement, show it expects to keep the OCR on hold until the start of 2014, going by its 90-day bank bill track. It expected annual CPI inflation to return to the middle of its target band in the June 2013 quarter, and stay within a 1.7%-2.3% range from then until early 2015.
A number of economists on Tuesday afternoon questioned whether the latest CPI figures, which were below the RBNZ's expectations for the quarter with ANZ noting this was the fifth successive negative surprise for the Bank, would lead the RBNZ to revise its inflation forecasts down.
That could see the RBNZ lengthen out its 'lower for longer' stance when it releases its next set of forecasts in December, and analysts will be looking out for a possible fall in the forecast 90-day rate sometime over the next year.
Home grown triggers for cut talk
BNZ economists noted on Tuesday that the markets had been pricing in more than 25 bps worth of cuts to the OCR earlier this year.
"Since April the market has fairly consistently priced in some chance of a RBNZ cut. In late May/early June more than 40bps were priced. The catalyst at that point was heightened European concerns that impacted on global risk appetite. A surprise 50bps rate cut from the RBA also contributed, as did a tick up in the NZ unemployment rate to 6.7%," BNZ economists said.
"This time, the triggers are a little more ‘home grown’ in nature. Global sentiment is actually fairly solid at present (though risks certainly lurk). This time the market is more focused on recent uninspiring domestic data, and now a low-side inflation reading," they said.
BNZ economists said while the market expects 35 basis points worth of cuts over the coming year, they placed that likelihood at 40%. Wheeler was unlikely to cut next Thursday (markets were pricing in a 25% chance of a cut).
"We see this as very unlikely. Today’s data may force the RBNZ to probe its convictions on its forecasts for a rising inflation trajectory from Q3," BNZ economists said.
"However, it does not provide any smoking gun for an immediate cut. We continue to believe the meeting will be a fairly low key affair. As the first meeting under the new leadership of Governor Wheeler we expect a fairly neutral statement. If cuts are not directly referenced in the statement, market pricing could rebound from this week’s lows," they said.
"We also remain unconvinced by the argument that the RBNZ should follow the Reserve Bank of Australia’s course lower. Without detailing the differences in the outlooks for each economy it is also worth remembering the starting point. The RBA cash rate remains 75bps above the RBNZ’s. On average since inception the RBNZ’s OCR has sat 40bps above the RBA’s target rate."
On Monday, BNZ head of research Stephen Toplis said for the chance of a cut to increase, the New Zealand dollar would have to move higher while the housing market recovery would have to stall.
BNZ economists expect the RBNZ to leave the OCR on hold until December 2013.
'Cut would be housing market sugar rush'
Westpac economists said while Tuesday's figures stoked expectations for a rate cut, they viewed a reduction as a risk scenario rather than a likelihood.
"The RBNZ’s inflation target is framed in terms of its inflation forecasts, and in terms of the average rate over the medium term. The most recent forecasts in the September Monetary Policy Statement had annual inflation averaging 1.9% over the next two years, comfortably close to the middle of the target range," Westpac senior economist Michael Gordon said.
"So the first question to ask is whether there is anything in today’s release that would prompt the RBNZ to revise its inflation forecasts significantly lower. We suspect not: the greater surprise for the RBNZ was on the tradable goods side, which probably reflects a mix of idiosyncratic factors (such as used car prices) and the lingering effects of the NZ dollar, which is not forecast to rise further," Gordon said.
"As for domestic price pressures, the RBNZ is assuming that construction costs will remain relatively contained throughout the Christchurch rebuild; today’s figures seem more in line with our view that construction cost inflation could be substantial.
"Of course there is always a risk that the RBNZ may feel the need to buffer the economy against global risks, in spite of an on-target inflation forecast. Our view is that the weak global environment is a good reason for keeping interest rates low, as indeed they are; we’re not sure it presents a case for taking them lower. Especially when we have a housing market that is all too receptive to the sugar-rush of lower mortgage rates," Gordon said.
Westpac economists are currently picking the next move in the OCR to be a hike in July 2013. However, Gordon told interest.co.nz that Westpac was currently in the middle of its latest quarterly forecast round, and an updated pick would be published nearer the end of the month. He noted a risk their pick could be pushed further out.
ASB pushes back its expected timing of a cut
ASB economists were the only ones to change their first OCR hike pick following the inflation figures, shifting from June 2013 to September.
"Our view shift is largely based on other factors than the muted Q3 inflation outcome. The slow pace of Eurozone crisis resolution, coupled with dim Eurozone growth prospects, and likelihood of further RBNZ caution over persistent NZD strength all argue for a much later start than June," ASB economists said.
"But we remain wary about the housing market in an environment where mortgage rates are likely to remain very low well into 2013 and risk further boosting demand in a supply‐constrained market (notably in Auckland)," they said.
"We expect that ongoing strength in the housing market, coupled with gradually rising domestic inflation pressures (some of which were evident in today’s release), will push the RBNZ to start gradually tightening in the closing stages of next year."
'Watch the labour market'
ANZ economists said while the hurdle for a rate cut remained high, the case would get stronger if their concerns about the labour market outlook eventuated, and if there was evidence of a sustained weakness in medium-term inflationary pressures.
"The Q3 outturn was the fifth successive downward inflation surprise to the RBNZ. Much of the downside surprise was from tradable prices, but the RBNZ would also have noted the undershoot of nontradable prices," ANZ economists said.
"Our short-term inflation outlook remains for a gradual lift in annual inflation towards the inflation target midpoint by late 2013. Risks around this are on the downside given the possibility of a more influential impact of the high NZD, and benign readings for core inflation," they said.
"While a benign headline inflation starting point is helpful, it is future inflation that matters to the RBNZ. While an OCR cut is possible given our concerns over the labour market outlook, the global outlook, and the pace of domestic activity, the hurdle to this is high. It would take evidence of a sustained weakening in medium-term inflationary pressure.
"This would need to be corroborated in activity, labour market, and inflation expectations angles. We will continue to focus on the labour market and will closely monitor readings from our Monthly Inflation Gauge. Given that the risk profile is tilted downwards it remains prudent to keep the OCR low, with a long wait on the sidelines for the RBNZ," they said.
ANZ economists said they were comfortable with their 'lower for longer' interest rate theme, with their core view centred around the OCR not lifting until 2014.
'They're all joining me'
Of the forecasting agencies, NZIER principal economist Shamubeel Eaqub said he was sticking with the early 2014 hike pick made earlier this year while others were still eyeing early 2013 rate hikes.
Meanwhile Infometrics economist Benjamin Patterson said the forecasting agency was sticking with its pick for the next move in the OCR to be a hike at the end of 2013.
"Instead [of cutting,] the Bank will sit tight, knowing that inflationary pressure is contained and they have room to move should financial conditions abroad deteriorate markedly. We expect inflation to rise back towards 2%pa during 2013, although we are cautious about how quickly cost pressures associated with the Christchurch rebuild will show up in the CPI," Patterson said.