By Bernard Hickey
The Reserve Bank of New Zealand (RBNZ) has left the Official Cash Rate (OCR) on hold at 2.5% and signaled it may remove its March 10 rate cut if global financial risks recede and the economy continues to recover.
Economists and markets interpreted the comments to mean the OCR would be hiked as much as 50 basis points on September 15 to remove the earthquake 'insurance' cut. The bank may then pause at 3% if the high New Zealand dollar helps the Reserve Bank keep inflation under control, they said.
The central bank fired an obligatory shot across the bows of currency traders, saying the high value of the New Zealand dollar was acting as a drag on the New Zealand economy. But it then appeared to give the high currency it's tacit blessing by saying the NZ dollar's strength may help the bank avoid further rate hikes later in the year after the emergency stimulus was removed.
“If this persists, it is likely to reduce the need for further OCR increases in the short term,” RBNZ Governor Alan Bollard said in a four paragraph statement issued with the OCR announcement.
The statement made no mention about currency intervention and gave no timeframe for when it would increase the OCR.
Bollard said the economy had grown more strongly than expected and the recovery appeared to be getting back on track, supported by strong export prices and cheaper import prices.
“At the same time, however, current fragility in global financial markets, including the uncertainty around the US Government’s debt ceiling, continues to highlight the downside risk to trading partner activity noted in the June statement,” Bollard said.
“Annual headline CPI inflation continues to be above the bank’s 1-3% target bank. However, much of the current spike in inflation has been driven by the October 2010 increase in the rate of GST, and will therefore be temporary,” he said.
“Wage and price setters should focus on underlying inflation, which is currently estimated to be below 2.5%,” he said.
“Provided current global financial risks recede and the economy continues to recover, the Bank sees little need for the March 2011 ‘insurance’ cut to remain in place much longer.”
Markets interpreted this a slight toughening of the bank's rhetoric. Short term wholesale interest rates rose a few basis points and the New Zealand dollar rose to a record high 87.3 USc from 86.8 USc shortly before the announcement.
Economists had not expected the bank to increase the OCR from the record low 2.5%, but relatively strong growth and inflation figures in recent weeks has seen some economists bring forward their forecasts for the first hike in the OCR to September from December. Some economists said there had been a small chance of a hike today.
BNZ says Bollard too cuddly
BNZ Economist Stephen Toplis said in a note titled "RBNZ too cuddly by half" that the bank appeared to be making the same mistakes it made during 2006 and 2007.
"In the last major tightening cycle the Reserve Bank got it horribly wrong because each and every time it raised interest rates to contain inflation it suggested that the hike, at the time, might be enough. In that fashion it failed to change the behaviours of the populace as there was no “fear” that interest rate increases might prove painful. Consequently, both interest rates and the exchange rate ended up higher than needed to be the case," Toplis said.
"Lightening appears to be striking twice. In today’s OCR review the Reserve Bank has given the green light for the removal of the emergency rate cut introduced immediately following the February 22 Christchurch earthquake but has then failed to push through with a stern warning that inflationary pressures are building. In fact the Bank goes so far as to downplay inflationary risks," he said.
The bank had sold its message poorly and signalled it would raise rates 50 basis points in September, although Toplis wondered why the bank was waiting until then.
"More worrying, though, is that the RBNZ goes on to say that the strength of the currency “is likely to reduce the need for further OCR increases in the short term”. We interpret this as meaning the Bank, currently, sees rates on hold at 3.0% until March next year. However, we also note the reference to “short term”. Accordingly, we still think the Bank believes rates will move up to its previously proposed 4.75% in due course."
ASB brings forward rate hike, but sees pause in October and December
ASB Economist Nick Tuffley moved his rate hike forecast forward to September from December after the announcement. He now sees a 50 bps hike on September 15 to 3% before a pause until January.
"The RBNZ was very specific that further increases in the OCR (i.e. beyond the removal of the 50bp insurance cut) were dependent on the level of the exchange rate (the Trade Weighted Index is likely to be the most appropriate measure to consider)," Tuffley said.
"What is apparent is the RBNZ wants to take back the March 50bp ‘insurance’ cut very soon. That suggests a September hike is very likely, and in our view a 50bp is more probable than a 25bp. The RBNZ sees “little need for the March 2011 ‘insurance’ cut to remain in place much longer”, and our interpretation is that means an imminent move and also reversing the March cut in one hit," Tuffley said.
"Beyond that we see the RBNZ pausing until January, then resuming steady 25bp OCR increases. Further hikes, beyond removing the ‘insurance’ cut’ are conditional on the level of the NZD, ongoing NZ economic recovery, and the fluid global situation. We expect the NZ dollar will remain elevated, and “likely to reduce the need for further OCR increases in the short term”," he said.
"This means NZ interest rates are going to be trading as if the MCI was still in use. Furthermore, NZ commodity prices (and the Terms of Trade) are likely to moderate, reducing the income boost to NZ. These are reasons, we believe, for the RBNZ to pause (after removing the insurance cut) for the rest of the year."
Tuffley said markets had now fully priced in a 25 basis point hike in September.
"Meanwhile, longer-term domestic interest rates declined slightly, given the uncertainty around further OCR increases beyond the 50bp increase by the end of the year," he said.
'Two small hikes and then a pause'
Westpac Chief Economist Dominick Stephens said he now expected two 25 bps hikes in September and October before a pause in December.
"The Reserve Bank today kept the OCR on hold at 2.5%, and issued a rather nuanced interest rate outlook. The upshot is that the RBNZ is planning 50 basis points worth of hikes in the near term, followed by a pause. But the early hike(s) are conditional on the domestic economy continuing to recover (which seems likely), and global financial risks receding (which is less certain)," Stephens said.
"We believe the most likely scenario is two 25bp OCR hikes, one in September and one in October, before a pause in December. A 50bp hike in September is distinctly possible, should global financial concerns about US and European sovereign debt abate. But that’s far from certain at this juncture. Indeed, a significant deterioration in financial market sentiment could yet delay the early hikes altogether," he said.
'Hawkish for September'
JP Morgan economist Ben Jarman described the bank's statement as concise and hawkish.
"We expect the RBNZ to remove the insurance cut in one fell swoop in September, hiking the OCR by 50bps. There is an argument for the RBNZ treading more lightly, perhaps moving with a 25bp hike initially, given that the recovery has been punctuated with disappointments over the last couple of years. But today’s statement sends a fairly clear message that “the March 2011 ‘insurance’ cut” – singular, i.e. the entire 50bps – should be removed," Jarman said.
"NZD has risen 15% since February (i.e. before the “insurance” cut), which is imposing a meaningful tightening of monetary conditions, particularly given that the economy is rebalancing with a greater weighting toward the traded sector. This reduces the required pace of tightening beyond the first 50bps," he said.
"Indeed, the statement today was also quite clear on this point, with elevated NZD “likely to reduce the need for further (i.e. beyond the insurance component, emphasis added) OCR increases in the short term”. We expect the RBNZ to hike the cash rate by 25bps a quarter from 1Q12 to 3Q12, with the OCR ending 2012 at 3.75%."
ANZ Chief Economist Cameron Bagrie said he now saw the RBNZ removing their March 10 'insurance' cut of 50 bps at the September 15 meeting.
"We see no point in unwinding the insurance cut in multiple steps. But we think the RBNZ will pause thereafter to assess the landscape," Bagrie said.
"The Governor made it clear that the high NZD is a concern, which will lessen the need for further increases thereafter. The bottom line is that the OCR is set to move off emergency settings but still remain stimulatory."
Here is a summary of the various economists (and my) view on interest rates, house prices and fixing vs floating.
|Forecaster||First OCR move||Peak OCR||Fix or float?||House prices|
|RBNZ*||December quarter||4.75% by Dec 2013||Prefer you float||<2% pa|
|ANZ National||September 15 by 50 bps||4% by end 2012||Float for now||Listless|
|ASB||September 15 by 50 bps||4.5% by Nov 2012||Float for short term||3.5% pa|
|BNZ||September 15 by 50 bps||4.75% by Dec 2012||Fix for 2-3 years||n/a|
|Westpac||September 15 by 25 bps||6.0% by Dec 2013||Fix||0% in 2012|
|HSBC||September 15 by 25 bps||4.25% by Dec 2012||n/a||n/a|
|Bernard Hickey||December 8 by 25 bps||4.0% by Dec 2012||Float||-5%|
* Forecasts implied from 90 day bill forecast track in June 9 Monetary Policy statement
(Updated with NZ$ rise and swap rate chart below, ASB economist Nick Tuffley's comments, JP Morgan economist Ben Jarman's comments, Westpac economist Dominick Stephens comments, BNZ economist Stephen Toplis' comments, ANZ's Cameron Bagrie's comments)