The Reserve Bank should avoid further damaging the economic recovery by making "another premature" Official Cash Rate (OCR) hike next Thursday, the New Zealand Manufacturers and Exporters Association (NZMEA) says.
The central bank lifted the OCR by 25 basis points to 2.75% on June 10, its first hike since July 2007. ASB economist Jane Turner expects the Reserve Bank to hike the OCR by another 25 basis points on July 29 lifting it to 3%, with the accompanying statement retaining a similar tone to June's.
"Weighing up the export-led economic recovery and growing inflation concerns against the risks remaining around the global outlook, the Reserve Bank is likely to keep an element of caution, sticking with the line that future hikes remain dependent on economic and financial market developments.”
Turner suggests the Reserve Bank may have made slight downward revisions to growth, given weaker than expected GDP, recent fall in dairy prices and rapid slowing in net migration. That said, she says the outlook for an export-led recovery remains in place.
"However, the slightly softer growth outlook does not allow for comfort on the inflation front. Headline inflation is still set to peak well over 5% due to a raft of Government related price spikes, and in our assessment the Reserve Bank was slightly underestimating medium-term inflation pressures in its last forecasts."
Hike 'not warranted'
In contrast NZMEA chief executive John Walley argues below forecast cost price inflation (CPI) and lower than expected economic growth simply don't warrant another interest rate rise yet.
"The Reserve Bank based last month’s decision on a reading of economic conditions that has been shown to be optimistic," Walley says.
"Demand, commodity prices and employment point to, at best, a weak and unbalanced recovery."
"Currency and commodity price volatility, lower growth than expected, weak house sales and supermarket spending slipping for the first time ever in May; all these factors point to an unstable recovery."
None of these indicators highlight an inflation problem, Walley maintains.
"A dip back into recession in Europe or stagnation in China could see commodity prices fall further and very quickly. The risks posed today by these potential shocks far outweigh any potential inflationary pressures a year or so down the track.”
Furthermore he says the latest CPI statistics show non-tradeable inflation is driving the CPI numbers while tradeable inflation was negative. Increasing the OCR has little impact on non-tradeable inflation so is unlikely to fix the problem.
“Further efforts by the Reserve Bank on prudential supervision to restrict banks access to offshore funds, rather than another damaging cycle of rate hikes and currency appreciation, would better target domestic inflation pressures.”
Additionally upwards pressure on the New Zealand dollar since June's OCR hike damages economic recovery and any economic rebalancing.
“We have said for some time that September should have been the earliest point to consider any moves on the OCR. At this point even September seems too early," adds Walley.
'No comfort on inflation'
Turner, however, says the slightly softer growth outlook doesn't allow for comfort on the inflation front. The Reserve Bank is tasked with keeping inflation between 1% and 3% on average over the medium term.
The "raft of Government related price spikes" Turner refers to include GST being increased to 15% from 12.5% on October 1, higher energy costs since July 1 following the introduction of the Emissions Trading Scheme, higher than usual increase in ACC levies and increased tobacco excise taxes.
"There remains a clear risk that inflation expectations will become unanchored further down the track," says Turner.
"We expect the Reserve Bank will continue to withdraw monetary stimulus by steadily increasing the OCR in 25 basis point steps at each meeting until the OCR reaches 5%," says Turner.
She notes, however, that market pricing is more gradual than this, reflecting ongoing "event risk" posed by Europe’s sovereign debt difficulties.
She does acknowledge that the overall flow of recent economic data has been on the softer side of the June Monetary Policy Statement forecasts. The Reserve Bank may therefore be facing some downward revisions to its growth outlook.
"(But) In contrast to the Reserve Bank, the recent flow of data has been less of a surprise to us. The Reserve Banks forecasts have been above the consensus average for some time, and any downward revisions would largely reflect the Reserve Bank moving closer to the consensus view."
2 Comments
FYI, Westpac economists (see below) are also picking a 25 basis point hike.
We expect another 25bp hike at next Thursday's OCR review, with a slightly more subdued statement compared to June.
* Recent economic data has been on the soft side of expectations, but not enough to divert the RBNZ from its stated intention to normalise interest rates over the next couple of years.
Since the June Monetary Policy Statement, the economic news has generally been on the weaker side of expectations - not hugely so, but the disappointments have been widespread. That will probably bring a more subdued tone to the language of next week's OCR statement, but the intent to return rates to more normal levels over the next two years will remain intact.
Economic conditions
In terms of the major data releases (which we can compare directly to the June MPS forecasts), two have undershot slightly and one was stronger. First, March quarter GDP grew by 0.6% against the RBNZ's forecast of 0.8%, with the difference likely coming from a subdued consumer. Top-down indicators to date suggest that the June quarter will also fall short of the RBNZ's previous forecast of 1.1%.
June quarter CPI was also lower than expected, taking the annual inflation rate down to 1.8%, although the RBNZ will take some mixed messages from the details. Food prices have fallen, and the strength of the NZ dollar over the last year is still being passed through to the prices of many tradable goods. However, non-tradables prices (in particular housing-related costs) rose by more than they expected.
On the plus side, the export sector continues to benefit from high commodity prices and solid demand growth. That saw the current account deficit narrow to 2.4% of GDP, much lower than the RBNZ forecast of 3.3% (with about half of the surprise coming from the trade surplus). So all together, the data points to a continued rebalancing of the economy, with the contrast between weak consumption and strong production even greater than thought.
More frequent data has pointed to subdued retail spending, a weak housing market, and slowing net migration inflows (the latter perhaps contributing to the first two). Business confidence has dipped recently, but it remains at levels that are consistent with recovery.
Financial developments since June have been mixed. The NZD trade-weighted index has averaged about 3% higher than the RBNZ assumed, but global credit market conditions have been steadily improving. The June OCR hike was not fully reflected in short-term mortgage rates, and fixed-term rates for two years or more have actually fallen outright.
Statement
Next week's statement is likely to be peppered with references to flat or weaker economic conditions compared to June. However, we think that the 'bias' paragraph - the crucial message from the market's point of view - will be left largely intact. In June that paragraph read:
"Given this outlook and as previously signalled, we have decided to begin removing some of the monetary policy stimulus that is currently in place. The further removal of stimulus will be reviewed in light of economic and financial market developments."
Keeping the first sentence would hark back to the June MPS projections, which pointed to the OCR rising from a low of 2.5% to a more 'neutral' level of 5.5-6.0% over the next two years. The RBNZ has spent many months making the case that interest rates will need to be normalised as the economy improves. There is nothing in the recent data that would warrant a change to the end-point of that plan, though it perhaps argues for less front-loading of hikes.
The phrase "removal of stimulus" will definitely be retained - the RBNZ has tried to deflect criticism by portraying rate hikes as taking the foot off the accelerator rather than hitting the brakes.
Finally, the last sentence of the paragraph was fairly non-committal for a central bank projecting 300 basis points or more of hikes over the next two years. We think it was meant to imply "don't automatically assume another hike in seven weeks", and that seems like a reasonable message to convey this time as well - even if a follow-up hike is more likely than not.
Market implications
Interest rate markets have fully factored in a 25bp hike next week, and pricing for the next year is broadly in line with the RBNZ's June projections - a touch lower if anything. We expect that a 25bp hike with an unchanged 'bias' would see a modest rise in wholesale interest rates (no more than 5bps). The NZD remains beholden to sentiment in global equity markets, so the OCR decision is unlikely to have a sustained impact.
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