ASB's economists have pushed out their expectation for when the Reserve Bank will start increasing the Official Cash Rate (OCR) to June next year from March citing the lack of resolution in the Eurozone sovereign debt crisis.
The move brings ASB into line with the expectations of economists at ANZ, BNZ and Westpac.
In ASB's Economic Weekly report chief economist Nick Tuffley says the expectation of the first hike coming in March 2012 was based largely on, what is now looking an increasingly optimistic assumption, that the Eurozone situation would have stabilised somewhat by the end of the year.
In particular, ASB's economists assumed markets would become more settled by the announcement of a comprehensive solution, preventing contagion from a ‘managed’ Greek default.
"(But) that scenario is looking increasingly optimistic. To start, the market remains unsatisfied on the latest rescue plan due to the lack of details, particularly on the expansion of the EFSF (European Financial Stability Fund)."
"Furthermore, the G20 meeting in Cannes over the weekend proved extremely disappointing," Tuffley adds. "Hopes were raised that G20 leaders would deliver an announcement on expanding the resources available to the International Monetary Fund (IMF) and in turn its capacity to support European bailout efforts."
"Instead, leaders delayed a decision on how to boost the IMF’s fire power until February, highlighting how long we can expect this crisis to drag on. At the same time, hopes are fading that Europe can avoid a messy default scenario."
Greece could leave the EU; Too big to bail out Italy on shaky ground
Tuffley says last week's topsy-turvy developments in Greece, where Prime Minister George Papandreou called for a national referendum on the bail out package, were incomprehensible.
"As a result, European officials now also need to consider the scenario where Greece is in full default and cast out of the European Union, a very costly scenario for all parties involved," says Tuffley.
"Meanwhile, Italy, the country that is considered too big to bail out, appears to be on increasingly shaky ground. The ongoing uncertainty has led to a rapid rise in Italian bond yields, close to the point where borrowing costs become unmanageable and put further pressure on debt levels. Brinkmanship behaviour from politicians and a slow decision‐making process have created unnecessary volatility in markets."
This uncertainty stemming from the Eurozone crisis is damaging the health of the global economic recovery as investment and employment decisions are delayed.
"Given all these developments, we have pushed the first OCR increase out to June 2012. In addition to pushing out the timing of the first OCR increase, we also expect the tightening cycle will be more gradual. After the first three rate hikes, the Reserve Bank is likely to be wary about the pace of further tightening, taking more time to assess the domestic response to higher rates and the global outlook," Tuffley says.
He says ASB's economists have spaced out their expected final three OCR hikes over nine months, with the OCR reaching 4% by June 2013. However, this outlook depends on the Eurozone having a "working mechanism for serving the crisis" in place in the early months of 2012, and keeping it contained in the meantime.
"The global economy is sitting at a crossroad, and almost anything could happen. But the longer politicians fiddle, the more damage will be done to the global economy along the way."
The Reserve Bank left the OCR unchanged at 2.5% at its last review on October 27, where it has been since March 10. At the time Governor Alan Bollard said: “Given the ongoing global economic and financial risks, it remains prudent to continue to keep the OCR on hold at 2.5% for now. However, if global developments have only a mild impact on the New Zealand economy, it is likely that gradually increasing pressure on domestic resources will require future OCR increases.”
The next OCR review is on December 8, followed by January 26 next year, then March 8, April 26 and June 14.
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