By Bernard Hickey
The Reserve Bank of New Zealand has raised the Official Cash Rate by 0.25% to 3%, as widely expected.
But it said it expected the OCR to rise by less than it has previously forecast because of a softening of the economic growth outlook.
Reserve Bank Governor Alan Bollard said the economic outlook had softened and the "pace and extent" of future rises in the OCR would be less than the Reserve Bank forecast in its June Monetary Policy statement.
He also said the recent rise in the New Zealand dollar was inconsistent with recent softening in commodity prices, which was a rare warning about the currency rising too fast.
(Updated with more detail from RBNZ statement, NZ dollar's fall to 72.1 USc from 72.8 USc, 1 year wholesale interest rate rate falling to 3.72% from 3.78%, ASB economist Nick Tuffley seeing the OCR rising to 5%, with a possible pause with the December quarter Monetary Policy Statement on December 9, JP Morgan economist Helen Kevan warning of possible spike in inflation expectations, My views on the move and what it means for borrowers and savers)
The New Zealand dollar fell to 72.10 USc by 9.20 am from 72.8 USc just before the 9am announcement.
“While the outlook for economic growth has softened somewhat, it is still appropriate to continue to reduce the extraordinary level of support implemented during the 2008/09 recession," Bollard said. “The world economy continues its fragile recovery. Trading partner growth has turned out stronger than we predicted, however, future prospects for growth have deteriorated. While still at high levels, our commodity prices have moderated," he said.
“In New Zealand, domestic demand is subdued. Households are cautious, with retail spending growing only modestly, housing turnover in decline and household credit growth weak. While this caution has been evident for some time, the recent slowing in net immigration will act to further dampen consumer spending. Business investment remains very low, with corporate lending continuing to be subdued."
Bollard said the appreciation of the New Zealand dollar in recent weeks was "inconsistent with the softening in New Zealand’s economic outlook and moderation in our export commodity prices."
“Overall, we continue to predict respectable near-term GDP growth, with manufacturing confidence remaining elevated and forestry exports continuing to expand. An eventual recovery in business investment will assist growth over the medium term," he said.
"Annual CPI inflation has been near 2 percent for the past five quarters. As the economy grows, inflationary pressures are expected to pick up," he said.
“Given this, some further removal of monetary policy stimulus is appropriate at this stage. Even after today’s move, the level of the OCR is still very supportive of economic activity. The pace and extent of further OCR increases is likely to be more moderate than was projected in the June Statement. Our policy assessment will be continually reviewed in light of economic and financial market developments."
Bollard said the coming increase in the rate of GST and other government-related price changes were likely to temporarily push annual CPI inflation above 3 percent.
"The Bank does not expect this price spike to have a lasting impact on inflation. However, the price and wage setting behaviour of firms and households will be monitored for evidence of any increase in inflation expectations.”
Bollard argued in a May 6 speech that he was like a truck driver taking his foot off the accelerator before going into a corner. His speech was seen as signalling the first rate hike that was delivered on June 10.
Economist reaction - Time to pause?
ASB chief economist Nick Tuffley said he expected the Official Cash Rate to continue rising to 5%, although the probability of a 'pause' had grown after the Reserve Bank's comments on a 'more moderate' increase than previously forecast.
"Our judgment is that the 3.5% mark would be the more probable point for a pause, which would imply at the release of the December Monetary Policy Statement," Tuffley said.
"At 3.5% the OCR would still be delivering effective interest rates that are still unequivocally stimulatory. Moreover, December gives the RBNZ another few months to assess the strength of the local recovery and the risks hanging around the otherwise sunny global economic outlook, as well as some time to assess the impacts of the GST increase," he said.
"We have been of the view that the OCR would not get as high as the 5.75% mark implied by the RBNZ’s June MPS interest rate forecast. Our view is the OCR peak will be 5%, with the risks skewed to a lower peak than that if funding premiums remain elevated."
Tuffley said he expected a firm New Zealand dollar to do some of the work of containing inflation.
"It was evident from the jawboning in today’s statement that the RBNZ was a little uncomfortable with the recent lift in the NZD. Incorporation of a stronger NZD would in itself imply a lower track for the RBNZ’s 90-day bank bill outlook," he said.
"We expect the RBNZ will continue to lift the OCR, and that it will move again by 25bp in September. In spite of discussion of a pause we have, however, kept to our view that the RBNZ will steadily increase the OCR to 5%. Although the RBNZ has again had to question the optimism of its growth outlook, we are still of the view that the RBNZ’s inflation outlook is on the light side. Whether or not economic data soften further prior to the RBNZ reassessing the stubbornness of future inflation will be one key factor in determining if there is a pause. "
Tuffley said markets placed a 65% chance of a September OCR increase.
Wholesale market interest rates fell 2-8 basis points across the curve in the half hour following the statement release. The 1-year swap rate fell from 3.77% just prior to the release to 3.72% after the release.
Coming inflation spike
JP Morgan economist Helen Kevans said the pace of tightening would depend on three factors, including the outlook for trading partner growth, the rate at which households consolidate their balance sheets, and the behaviour of inflation expectations.
Kevans said a rise in already-elevated inflation expectations had the potential to have a lasting impact on reported inflation.
"In the June quarter, the RBNZ’s measure of inflation expectations was higher over both the one- and two-year horizons, spiking to 2.9% and 2.8%, respectively. The impact on published expectations of the forthcoming spike in inflation will ultimately determine the pace of future changes to monetary policy," she said, point to the next survey of inflation expectations due on August 24.
What I think - Hitting the brick wall of too much debt
You almost have to feel for Alan Bollard.
Right at the time when he would like to leave his foot on the accelerator to rumble over a few bumps in the road, the government is forcing him to slow down because of the extra chicane it built on the road ahead.
The government's decisions to impose the extra Emissions Trading Scheme costs, the ACC levy increases and the Goods and Services tax hike all within the space of 7 months in the middle of 2010 will push the headline inflation rate to 5%, well over the 1-3% band the Reserve Bank targets.
Bollard rightly points out the Policy Targets Agreement allows him to 'look through' such one-off increases in inflation, but only to the extent that consumers and businesses don't lift their long term inflation expectations.
This is the key. Will New Zealanders believe in their price setting and wage expecting bones that the inflationary surge of 2010 is a short term thing?
The initial signs are not good, even by the Reserve Bank's own measures. Here's what it said in its own June quarter survey of expectations of business managers.
"Average one-year-ahead CPI inflation expectations have surged to 2.9 percent from just 2.1 percent last quarter. Two-year-ahead expectations have also increased, but less dramatically, from 2.65 percent last quarter to be 2.80 percent now, an increase of 0.15 percentage points," the RBNZ said.
This chart here shows how those expectations have blipped up. They have been well above 2% and headed for 3% for most of the current governor's reign. That may not be a coincidence.
The National Bank's Business Outlook survey out yesterday also showed 37.2% of respondents expected to increase prices in the next 12 months, while only 5.8% expected to cut prices and 57% expected them to remain the same.
This, unfortunately, is an ugly combination. The same National Bank survey showed business confidence down for the third month running as the impact of the June 10 rate hike shuddered through the domestic economy.
We simply have too much debt and can't take any more. This was disguised when interest rates were falling. Now the true nature of the indebtedness of the New Zealand domestic economy is laid bare.
New Zealand's household sector is up to its gills in debt to the tune of 155% of disposable income. We hit a ceiling of 159% in the third quarter of 2008 when the Global Financial Crisis struck.
That is no coincidence either.
Over the previous 15 years New Zealand's household sector doubled its house hold debt as a percentage of disposable income. Now we can't take it any more and we don't want any more.
Unfortunately for the New Zealand economy, Alan Bollard can't use the interest rate lever any more to ease the pain and cover up load of debt.
We just have to live with it and dig ourselves out.
It will mean very slow growth in the retailing, construction and other domestically driven parts of the economy.
Luckily for us, and for Bollard, the export sector is steaming up behind. Today's figures show the first surplus in a June for eight years.
Bollard is right to point out to exchange rate markets that the New Zealand dollar's recent rise isn't compatible with a softening in commodity prices.
He, and the export sector, will hope that his warnings about a slowing and lowering of the OCR track will keep a lid on the currency.
So what does this mean for borrowers and savers?
The governor's comments about the more moderate and slower increase in the Official Cash Rate track will be some relief for those up their gills in debt. But not too much. On June 10 the Reserve Bank forecast the 90 day bill rate would rise to 6% by the end of 2012, which economists said meant the Reserve Bank expected to increase the Official Cash Rate to 5.75% by then.
Now economists are saying the OCR is likely to rise to around 5% by the end of next year. That would mean floating mortgage rates would rise to around 8% from around 6% now.
This makes the decision about choosing to fix or float that little bit tougher. With the two year fixed mortgage rate around 7% at the moment, it's still nominally cheaper initially to go floating at 6.2%, given that floating mortgage rates are likely to go up to 6.2% from 5.9% later this week or early next week.
However, if you expect the OCR to keep rising to 5% by later next year then a two year fixed mortgage rate looks slightly more attractive over the full two year period.
It all depends on your interest rate outlook and your appetite for certainty.
Those who subscribe to the theory that the global and local economy is set for a slow, grinding recovery beset by deleveraging may opt for floating. Those who see inflationary pressures spiking as central banks print money around the world may opt to fix.
Savers, meanwhile, will be grumpy about the forecasts of a slower and lower rise in the OCR.
Term deposit rates of around 5% are set to rise over 6% in the next year, rather than the 7% plus they might have expected. Although they may well see their rates rise relative to the OCR because the banks are demanding more local and long term savings to meet the Reserve Bank's Core Funding Ratio.
Your view? I welcome your thoughts below.