Westpac economists see 'a better than even chance' that the RBNZ Governor will in her upcoming speech give a preliminary assessment of how the Middle East shock is impacting the RBNZ's assessment of the monetary policy outlook

Economists are seeing a good chance that Reserve Bank (RBNZ) Governor Anna Breman will push back against sharp wholesale interest rate rises that currently price-in about three hikes to the Official Cash Rate this year.

Breman's speech on Tuesday laying out the RBNZ's thinking on the Middle East crisis is hotly anticipated by economists and the financial markets.

And those are financial markets that have been thoroughly upturned by the Middle East developments.

In her weekly This week in NZ Economics podcast, ANZ chief economist Sharon Zollner said that as of Monday morning "I think the market was pricing 77 basis points of hikes from the Reserve Bank this year, whereas after the February Monetary Policy Statement it was a third of that".

"I would  not interpret that as a literal reflection of what the collective wisdom of the market is," she said.

"The market is extremely illiquid, barely functional really, as global money just scarpers really, and so essentially the market pricing is more a reflection of flows going through it than of anything else and rates are gapping quite extensively," Zollner said.

What the Reserve Bank is going to do is highly uncertain, she said.

On the one hand we've had a confidence shock and economy is comin from a bad place and with spare capacity in the economy the RBNZ could "look through" the initial inflationary impacts of the crisis, confident these would not become persistent. On the other hand, we are starting from having annual inflation as of the December quarter already at 3.1% and outside the RBNZ's 1% to 3% target range. 

Zollner said there were already some signs in the ANZ Business Outlook survey of increasing pricing intentions and also to some extent higher wage setting. So, the situation is uncertain.

Therefore on the Breman speech, Zollner said the market "will be watching that very closely to see whether she pushes back against the interest rate increases that we’ve seen in the wholesale rates and tells everyone to chill out or whether she focuses rather on the potential inflation expectations and stresses that the Reserve Bank is ready to offset those by raising rates.

"So, it’s hard to sound reassuring and threatening at the same time, and, it’s going to be quite a balancing act.  Essentially,  wait and see makes perfect sense at the moment. But markets are extremely unsettled and so are going to keep reacting to every headline, whether that’s to what the Reserve Bank of New Zealand says or what Trump posts or anything else."

'Rate hikes completely unwarranted'   

Kiwibank's chief economist Jarrod Kerr and economist Sabrina Delgado in their weekly First View publication said regarding the Breman speech that "a lot hinges on the messaging around inflation and demand risks, and in light of the push higher in wholesale rates".

"Fears of inflation have markets traders pricing in three rate hikes this year.

"Rate hikes are completely unwarranted in our view. And we completely disagree with market sentiment. We see hikes as infeasible for the RBNZ, given the immense demand shock that the oil disruption brings to the Kiwi economy."

The Kiwibank economists said that taking a leaf from the number of central Banks taking the stage last week Breman was expected to acknowledge near-term inflation, but emphasise the significant downside risks to growth.

"...And in doing so, push back on wholesale rates… much like she did at the end of last year, and then again at their February MPS."

In Westpac's Weekly Commentary, senior economist Darren Gibbs said Breman "will have the opportunity to guide the market" with her speech.

"While the RBNZ’s [pre-speech] advisory states that this speech will not pre-empt the [RBNZ Monetary Policy Committee's] April Monetary Policy Review decision, at the very minimum, we expect that the Governor will lay out the framework the Bank will use to analyse the impact of the war on the New Zealand economy i.e., the main channels of influence and the short-term inflation and activity trade-offs that the MPC may need to consider when setting monetary policy," he said.

'Every chance that Breman will go further'

"We think that there is a better than even chance that the Breman will go further and give a preliminary assessment of how the shock is impacting the MPC’s assessment of the policy outlook. If she does, we think that her comments will lean against the market’s current pricing of close to three 25bps OCR hikes this year (which compares starkly with the RBNZ’s February MPS indication of just a chance of a single 25bp hike).

"We expect Breman to acknowledge that headline inflation will be higher this year than forecast in February."

Gibbs said that "as any good central banker should" he expects that the Governor will indicate that the RBNZ will be vigilant in looking for signs of any second-round impacts that might cause higher-than-target inflation to persist well into next year.

"However, crucially, we also expect Breman will argue that the New Zealand economy is operating with a large degree of spare capacity – including in the labour market – and that this 'negative output gap' makes it less likely that a temporary oil price shock will lead to persistent inflation.

"And she may indicate an expectation that this negative output gap will remain for longer than the Bank estimated in February, given that higher oil prices and the current tightening of financial conditions will weigh on both trading partner and domestic economic growth."