Reserve Bank takes secateurs to economic growth track & carving knife to interest rate path

By Mike Jones

The New Zealand Dollar took a turn in the spotlight yesterday, weakening against the USD and on cross rates after the RBNZ said further rate increases will be more moderate.

Yesterday’s Statement looked a shadow of the bright one the Reserve Bank published three months ago. With its forecasts finalised the day before the Canterbury earthquake struck, the Bank has taken secateurs to its economic growth track, and a carving knife to its interest rate path.

The only thing it didn’t change was the OCR, which stayed at 3.00%, as all and sundry did expect. This latest statement does look more reasonable than the last one, which at the time seemed overly upbeat. Still, we are nervous that today’s MPS now appears just too relaxed about the many inflation threats ahead. Trouble is, only time will tell.

That the Reserve Bank has changed its tune, in the change of a season, is a something of an understatement.

Instead of GDP growth pushing 4% this year and next, for example, it now struggles to reach 3% in each. It’s tempting to think this has been driven by the wobbling international news over recent months. In fact it’s been because of a suddenly sombre view around NZ consumer spending and the housing market. Granted, the data around these have been lacklustre over recent months, even days.

But this should not have come as any great surprise. That’s where the leverage has been, and still is to a large extent. All things considered, however, we now think the RBNZ will delay its next OCR hike until March next year (previously December), which is pretty much what the Bank’s latest 90-day bank bill yield forecasts imply, and what the markets are now pricing following their modest further rally yesterday.

We opened this morning with the NZD near 0.7240, still vulnerable to a test of support in the 0.7155/0.7175 window which we have traded above since earlier this month. Our short-term NZD/AUD “fair-value” model (which is based on NZ-AU interest rate spreads, relative business confidence and relative commodity prices) has done a good job of front running the slide in NZD/AUD since May. Not surprisingly, plugging yesterday’s drop in NZ-AU interest rate spreads into the model causes “fair-value” to fall even further.

The fact NZ business confidence has fallen against steady or even rising Australian confidence adds more downside pressure. The model currently suggests a short-term NZD/AUD “fair-value” range of 0.7500-0.7700. Given this, we wouldn’t be surprised to see NZD/AUD continue to slide in coming sessions.

Majors

The EUR rallied overnight, encouraged by appetite against both the USD and on cross rates like the EURCHF. The Federal Reserve Bank of Philadelphia’s Business Outlook printed at -0.7, and while better than August’s -7.7 it disappointed analysts who had forecast a recovery into positive territory. A reading below zero indicates contraction in the diffusion index. The SNB left the three month Libor target rate at 0.25%, in line with forecasts.

However, there was some surprise that they cut their 2010 inflation forecast to 0.7% from the previous 0.9%. After the intervention of Wednesday the Yen has tended to stabilise, as analyst debate the actions and various Japanese officials become the target of the financial paparazzi. Prime Minister, Naoto Kan, and others were playing things with a straight bat with repeated reference to not tolerating rapid movements in the currency and ready to take “decisive” measures.

It’s a case of so far, so good for the BOJ as the size and timing of the intervention has surprised most in the market. US Treasury Secretary Geithner is on the American soapbox testifying for China to increase the speed of their Yuan revaluation.

Analysts expect that it would be too contentious for the US to actually brand China a currency manipulator, especially in the wake of the BOJ intervention and with the up-coming mid-term elections in the US. Interestingly, the Yuan has actually risen to it’s strongest level since 1993 ahead of Premier Wen Jiabao meeting with President Obama in New York during next week’s UN General Assembly, another reason to avoid earning the ire of the Chinese administration, just yet.

Equity markets in Europe and subsequently in the US have traded with a marginal negative bias, on the day noting the weaker Philly Fed outcome as well as a poor UK retail sales update. The August update was -0.5%, economists had forecast a +0.3% outcome following on from the previous months +0.8%.

* Mike Jones is part of the BNZ research team. 

All its research is available here.